Taxes are one of the earliest as well as predominant sources of revenue generation for governments all over the world. Without taxes, it is almost impossible for governments to meet their day to day administrative expenditures.

Accordingly, governments all over the world collect two types of taxes- direct tax and indirect tax.

VAT, short form for Value Added Tax is a form of indirect tax or consumption tax that is levied on services and goods for the value attached to them at each stage of production or distribution chain, beginning from the procurement of raw materials to the point of the final sale to the consumers.

The amount of VAT that a consumer needs to pay is only for the cost of the final product and not for the raw materials used in it. It is because the manufacturers have already paid the VAT for the cost of the raw materials.

## How does VAT work?

A VAT is charged on the gross margin (net sales minus cost of goods sold) at each stage of the production and distribution chain of a product. It has two components:

1. Output VAT: It is charged on the customer by a dealer who can be a retailer or a wholesaler or a manufacturer enrolled under the VAT. Registration under VAT is a must for a dealer who is making sales more than the prescribed limit. Once a dealer is enrolled, VAT is to be levied on all taxable sales that the dealer makes.
2. Input VAT: It is charged on the dealer for purchasing raw or wholesale materials and bienes de equipo like equipment and machinery. However, a credit can be claimed for this tax charged on most business-related purchases if the concerned dealer is enrolled under VAT.

### Calculation of VAT

The amount of VAT to be paid to the government by a dealer is equal to the tax collected by him from the customers on the sales he made (output tax) minus the tax paid by him for business-related purchases (input tax).

In short, VAT= Output Tax – Input Tax.

### Ejemplo

A retailer spends \$10 at the rate of 10% VAT on a purchase of goods costeo \$100. He sells those goods for \$150 and procures \$15 as tax (at the rate of 10% VAT).

The amount of VAT he will pay to the government will amount to \$5 (\$15 – \$10) as he has already paid \$10 to the wholesaler while purchasing the sold products.

Over 160 countries of the world employ the value-added taxation system. Besides that, regional blocs like the European Union are one of its significant subscribers. These facts explain how popular VAT is as a taxation system, and that is undoubtedly not without any reason.

Difference Between Yield to Maturity and Yield to Call (With Table)

The following are some of the significant advantages of VAT.

1. Prevents double taxation: Unlike impuesto de venta which is levied on each sale, VAT is charged on value added to a product at each production-distribution chain. Consequently, it prevents a tax on tax.
2. More comfortable to track: As VAT is charged on each phase of production and distribution, the precise amount of tax can be calculated and collected quickly.
3. Makes tax evasion difficult: Since VAT takes into account each phase of the supply chain, any attempt made to evade tax is bound to be unsuccessful.
4. Acts as an incentive to be more productive: Under the VAT system, consumers do not need to pay more tax for earning more. Therefore, they have the option to save their hard-earned money. Consequently, they become motivated to work more and earn a higher salary.