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What is VAT?

January 5, 2023

Before a business can sell its product to a customer, it needs to be completely sure that it’s ready to begin selling. That’s where the production stage comes in: products and goods need to go through production to gain value during each step of the way.

Products gain a little bit of value at each stage of their manufacturing process, all the way from their initial point of production to their final point of sale. It’s no wonder, then, that some countries choose to collect a tax from a product at each manufacturing stage. In many countries, that tax system is called a Value Added Tax (VAT). It taxes the consumption of products sold domestically and applies to all product transactions that take place in a certain country.

More than 160 countries have implemented a VAT system, though it isn’t always called VAT. The VAT rates differ by country – for example VAT is 8% in Singapore and 16% in Kenya (as at 2022).

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What About VAT in Australia?

Standard VAT tax in Australia is known as Goods and Services Tax (GST) and this figure is a set rate of 10%. It applies to most goods and services but does not include things such as basic foods, some medical and healthcare services, and some educational classes.

To work out the total VAT or GST, multiply the original price by 1.1 or, you can figure out the total price without the standard rate of 10% by dividing the original price by 1.1.

It’s important to note that only businesses that earn over $75,000 per annum need to register for GST in Australia.

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How Does GST Work

To understand the way GST works, let’s take a look at an example of how GST applies to goods and services.

Let’s say that a company that manufactures car parts buys raw materials for $11, which includes a 10% GST ($1 out of $11). Then the raw materials are processed into parts which an assembly company later buys at $20 plus 10% GST for a total cost of $22. Since the cost for the raw materials included GST ($1) then the assembly company will only pay the government $1 (their GST is $2, but since they have already paid the manufacturing company a $1 GST, this value gets deducted from the amount they would need to pay).

Where exactly is GST applied and paid?

Let’s say that a company that manufactures toy car parts buys raw materials for $11, which includes a 10% GST. This would mean $1 has been paid to the Government as part of GST.

Then, the manufacturing company processes these raw materials into parts which an assembly company then buys at $22. Since the cost includes a 10% GST rate, the price for the parts is $20 and $2 are paid to the Government as GST.This process repeats until it is passed on to the final buyer of the goods, who will be paying the sum of the GST paid by the other buyers through the different production stages.

Goods & Services Tax Calculation Example

Production & Purchase Stage	Cost	GST Charged	Total Cost	GST Paid
Purchase of raw materials	$10.00	$1.00	$11.00	$1.00
Purchase after manufacturing stage	$20.00	$2.00	$22.00	$1.00
Purchase after assembling stage	$30.00	$3.00	$33.00	$1.00
Final sale stage	$40.00	$4.00	$44.00	$1.00
GST charged to the final buyer				$4.00

As this example demonstrates, GST applies to each stage of the supply chain including the manufacturing, distribution and final sale of a product. This means that GST is assessed and collected at each stage of production rather than at the end of a transaction, making it different from a traditional sales tax.

Although GST and sales taxes can raise similar amounts of revenue, a sales tax revenue is rendered at the end of a sale rather than during production. With VAT, goods are taxed each time they gain value during production rather than taxing the sale of a good itself. Remember to include all details in your VAT return at the end of the financial year.

Countries That Collect VAT

As of 2021, there are more than 160 countries worldwide that use some form of a VAT system. Although systems to apply VAT payment on goods are most common in the European Union, many other industrialised countries use VAT as well. The majority of industrialised countries that form the Organisation for Economic Cooperation and Development (OECD) use some form of VAT system.

Generally speaking, industrialised countries that levy standard VAT rates on goods and products sold have been using their VAT systems since the 1980s. Notable among industrialised countries that do not use a VAT system is the United States, which considers the VAT as regressive and less-effective than a progressive sales tax.

Some countries refer to VAT as GST and some of the differences between the two are around taxation rate, tax-free items and exemptions, and some registration requirements that would be specific for each country.

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