Value Added Tax (VAT) and how to determine it

Value Added Tax (VAT) is a consumption tax, which is charged by the government based on value added on a product starting from production stage up to the sale of the final product.

Value Added Tax (VAT) applies where there is activities adding monetary value on the product chain.

It is required in buying and selling of goods and services.

It is necessary for it aids the government to collect taxes on goods produced and sold which become a source of revenue to the government.

VAT is charged in every stage of production and the trader/producer only pays the net to avoid double counting

How VAT works-Additional notes

The Input / Output Tax system is the one that governs the working of VAT.

Input tax is the tax which is charged on taxable purchases and expenses paid for business purposes.

On the other hand, input tax is the VAT charged on the sales of taxable products (ie goods or services).

Tax payable is the net of Output tax over the Input tax.   The formula is as follows;      

Output Tax – Input Tax = Tax Payable

Illustration

Isosceles Co. ltd bought VAT taxable goods at a total cost of $10,000. In the course of the same period, the company sold the same goods at sales margin of 20%. The government charges VAT rate of 16%

Required

Determine VAT tax payable

Solution

Input VAT calculation

PURCHASES                                   Amt.$                  

Purchase net price                         10,000

16% VAT                                        1,600 (Input tax)

Gross purchase price                     11,600

NB1: When Isosceles Co. ltd purchased the goods, it paid VAT of $1,600

SALES

Gross purchase price                   11,600

Less VAT paid                                1,600

Net Purchase price                       10,000

Add 20% profit margin                  2,000

Net Sales Price                             12,000

Add 16% VAT                                1,920 (Out Put Tax)

Selling Price                                  13,920

NB2: When Isosceles Co. ltd sold the goods, it received VAT of $1,600

Therefore, the total VAT tax the business is liable of paying to the government is the difference between the Output tax and Input tax as follows

VAT tax payable 1,920 -1,600 = $ 320                           

This approach is as good as considering the additional value on goods or services provided and charge the VAT tax rate as follows

16%*2,000=$320