Value Added Tax

Definition

Value-added-tax—commonly known as VAT—is a consumption tax applied to the gross margin of goods and services at each stage of production (such as securing raw materials and producing the parts) and the final sale.

Roughly 160 countries, including countries in the European Union, levy a VAT and all have different VAT rates and tax deadlines. Sometimes, countries use a different term than VAT; in Japan, for example, the VAT is called the “consumption tax.”

Instead of the VAT, the United States levies sales tax on the final sale amount. Here are a couple of key differences between the VAT and sales tax:

  • Paying the tax: the final consumer pays the sales tax while all purchasers pay a VAT
  • Invoicing: In countries with a sales tax, an invoice will separate the sales tax from the product cost. In countries with VAT, the invoice price typically includes the VAT as well as a VAT registration number.
  • Collecting the tax: the retailer collects the sales tax at the final sale; the final consumer pays the sales tax, and the tax jurisdiction receives the tax after the final sale. When it comes to VAT, all sellers in the supply chain (i.e., suppliers, manufacturers, distribution) pay VAT on what they purchase; businesses document the VAT they have paid so they can receive a tax credit. Instead of waiting for the final sale, tax jurisdictions collect the tax during the supply chain.

In recent years, countries have expanded the value-added-tax to apply to digital services. The definition of “digital services” and application of VAT on digital services differs among countries; the European Union defines digital services subjected to VAT as any telecommunications service or products that are electronically supplied, such as radio and television broadcasting.

Best Practices

When issuing cross-border payments, accounts payable is responsible for ensuring that remittances comply with country-specific tax regulations, such as VAT.  Those challenges include not only checking thousands of complex VAT rules around the world but also verifying the accuracy of the tax liability. Here’s how to make VAT compliance as part of your remittance process instead of an afterthought:

  • Require that payees provide a VAT ID during the onboarding process
  • Place a hold on remittances for payees who still need to submit a VAT ID
  • Utilize automation tools that validate tax IDs and digitally extract data from electronically submitted documents

Data Points

Image source: Zoho

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