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Why is VAT not a Tax on Tax?

Value Added Tax (VAT) will replace Goods and Services Tax (GST) on July 1 2012. There is a common misconception that VAT is a tax on tax since it is charged both at the point of entry (at Customs) and at the point of sale. However VAT is not a tax on tax because unlike GST or other taxes on turnover, the VAT system has a credit deduction mechanism.

How does the credit deduction mechanism work?
The credit deduction mechanism allows a VAT registered business to offset its input tax credit (meaning the VAT paid on its purchases and expenses) against the output tax (the VAT collected from its customers) so that it has only to remit the difference (output tax – input tax) to Seychelles Revenue Commission (SRC).

How can it be that VAT is not a tax on tax if it is charged twice (on output and input)?
VAT, as suggested by its name, only hits the value added to a good or a service. In other words the tax applies on the difference between the purchase price and the sale price of a good thanks to the deduction mechanism.
Example:
  1. Myra’s Ice Cream Deli, a VAT registered business, purchases ice cream at a cost of SR 115 per box from Max & Orpheé Supplies, which is also a VAT registered business (VAT of SR 15 is included in the price – VAT inclusive).
  2. In order to calculate the VAT amount from a VAT inclusive price the following formula is used VAT inclusive amount x 15/115). For Myra’s Ice Cream Deli, this SR 15 is an input tax to its business and is allowed as a credit. The SR 15 should therefore not be included when determining the selling price of the ice cream box.
  3. As a result when Myra’s Ice Cream Deli adds a profit margin of 20% on the box of ice cream, it is calculated on the VAT exclusive amount which is SR 100 (115 - 15 = 100), therefore the profit margin is SR 20.
  4. The SR 20 is added to the VAT exclusive amount of SR 100 to determine the sale price of the ice cream box which is SR 120. Note however that at this point the VAT has not been added to the price.
  5. When selling the ice cream box Myra’s Ice Cream Deli will have to charge VAT at 15% on the determined sale price of the ice cream box (that is, SR 120). The output tax charged will therefore be SR 18.
  6. Myra’s Ice Cream Deli adds the sale price of SR 120 with the output tax of SR 18 to derive the selling price of the ice cream box and finally sells the ice cream box for SR 138 to Ms. Flossy, the final consumer.
  7. Myra’s Ice Cream Deli (the retailer), offsets the input tax (SR 15) paid to Max & Orpheé Supplies (the wholesaler) against the output tax (SR 18) charged to Ms. Flossy (the consumer) and remits only the difference of SR 3 to SRC.
  8. The VAT amount remitted to SRC (the SR 3) is equivalent to the 15% of the profit margin, which is the value added to the ice cream.
Transactions of the VAT Registered Retailer

Transaction Figures

1. Purchases a good from wholesaler

115

2. Pays VAT to the wholesaler

15 (115 x 15/115)

3. Decides on a profit margin of 20%

20 (100 x 20%)

4. Value of good (VAT exclusive amount + profit margin

120 (100 + 20)

5. Charge VAT at 15% on the value of the good

18 (120 x 15%)

6. Sells the good to a final consumer

138 (120 + 18)

7. Remits VAT to SRC

3 (18 – 15)

8. VAT equivalent to the value added

3 (20 x 15%)



Since VAT is charged on the VAT exclusive amount, VAT is therefore not a tax on tax. The business is able to claim the input tax incurred when making purchases.

Does it mean that there is a tax-on-tax when non-VAT registered businesses transact together?
This is not necessarily the case, as a non-VAT registered business cannot charge VAT to any of its sales to its customers. As a result, when a non-VAT registered business sells goods or services to other non-VAT registered businesses, no VAT is being charged. However, a non-VAT registered business may pass on the cost of any VAT paid when purchasing a taxable supply as a hidden cost in its selling price.
  1. Using the same example: the retailer purchases a good for SR 115 (VAT inclusive) from a VAT registered wholesaler. He paid SR 15 as VAT.
  2. The retailer decides to add a profit margin of 20% on the good to determine its sale price. Since its input tax is not allowed as a credit, he will calculate his margin on the VAT inclusive amount 115 x 20% = 138.
  3. The retailer sells the good for SR 138 to the final consumer.
  4. We may assume that the amount passed on the consumer (15) is equivalent to the value added paid to the wholesaler.
For more information
You can contact Seychelles Revenue Commission on 4293737 or email us at advisory.center@src.gov.sc.
The Value Added Tax Act, 2010 is available here.


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