Value-added tax (VAT) does not exist in the United States, but American companies are increasingly having to deal with VAT mandates in Latin America, Europe and Asia. Seeking to make up a massive gap in revenues, tax administrations are mandating strict policies to digitize VAT collection. American companies that fail to comply could see their businesses effectively shut down in countries with mandatory VAT controls.
But what is VAT, anyway? If you’re not sure, don’t worry. This brief excerpt from the 11th annual Trends in Continuous Global VAT Compliance report provides a primer.
What is VAT?
The basic principle of VAT is that the government gets a percentage of the value added at each step of an economic chain, which ends with the consumption of the goods or services by an individual.
While VAT is paid by all parties in the chain, including the end customer, only businesses can deduct their input tax. Therefore, VAT requirements concerning invoices ordinarily only apply between businesses. Many governments use invoices as primary evidence in determining “indirect” taxes owed to them by corporations. VAT is by far the most significant indirect tax for nearly all of the world’s trading nations. Roughly speaking, VAT contributes more than 30 percent of all public revenue. VAT as a tax method essentially turns private companies into tax collectors. The role of the taxpayer in assessing the tax is critical, which is why these taxes are sometimes referred to as “self-assessment taxes.”
The form, content and method of creating or exchanging invoices is often regulated because invoices are the prime source of audit for VAT purposes. VAT was first introduced in the 1950s and quickly spread throughout Europe and other countries.
Despite the OECD’s attempts to create high-level standards for streamlined taxation of cross-border trade, there are no global rules for VAT. The EU’s VAT system is the closest any region has come to harmonization, but even its rules are notoriously complex and diverse.
The VAT gap
VAT depends on companies meeting public law obligations as an integral part of their sales, purchasing and general business operations. The dependency on companies to process and report VAT makes it necessary for tax authorities to audit or otherwise control business transactions — but despite such audits, fraud and malpractice often cause governments to collect significantly less VAT than they should. The difference is often referred to as the VAT gap.
In Europe, the VAT gap amounts to approximately 137 billion EUR every year, according to the latest report from the European Commission. This amount represents a loss of 11.2 percent of the expected VAT revenue in the block. Globally, we estimate VAT due but not collected by governments because of errors and fraud could be as high as half a trillion EUR. This is comparable to the GDP of countries like Norway, Austria or Nigeria. The VAT gap represents some 15 to 30 percent of VAT that should be collected worldwide. These numbers only consider bona fide, registered business activity and would certainly be much higher if one added lost tax revenue due to unregistered business activity.
Do you know everything you need to know about VAT and VAT enforcement? Download the most comprehensive guide on VAT controls in the industry and find out.