U.S. VAT or National Sales Tax - Understanding the Issues.

The news continues to speculate on the future of a U.S. based VAT (value added tax) or "national sales tax." While the future of such a tax is uncertain, an understanding of what may come to pass here in the U.S. is available by looking to our neighbors in Europe (and Asia, Canada, South America, etc.).

Provided below is a description of the European-Based VAT system from TTR's International Tax Library:

OVERVIEW & DIAGRAM The United Kingdom and its member European Union countries employ a system of tax known as a value added tax system or (VAT). This system differs from the United States tax system in many ways. Most notably, the VAT system taxes the transfer of taxable goods and services at every stage of getting a product to a retail customer. VAT applies to transactions from manufacturers to wholesalers and wholesalers to retailers and retailers to end user customers. The VAT system permits every buyer of taxable goods, except the end user customer, to take a credit against the tax already paid on purchases. This is known as an input tax credit. The following example illustrates the VAT system:

DESCRIPTION: Miner sells $1000 to Refinery. Refinery pays $1000, plus $100 tax. Miner remits $100 to UK. Refinery sells $2000 to Steel Factory. Steel Factory pays $2000, plus $200 tax. Refinery keeps $100 for the tax it paid to the Miner and remits $100 to UK. This process continues down the line.

1. Value Added Tax (VAT) - DETAILED DESCRIPTION VAT is what is known as a “multi-stage tax”. This means that taxes are levied at each point of sale all along the chain, finally ending with the consumer. At each point, the goods are taxed at their value at that point. As the goods increase in value through the chain, so does the taxable value, thus “value added” tax. During this process, each participant in the chain (except the final purchaser/consumer) is permitted to take a credit against the tax they already paid or an Input Tax Credit (ITC). This allows dealers/manufacturers along the chain to claim a credit for taxes paid on purchased goods used to manufacture or sell the product.

Here’s an example (assuming a 10% tax rate): A smelter buys ore from a mine. The ore costs the smelter $1000. The smelter pays $1200; $1000 plus $200 in taxes. The smelter receives a tax invoice from the mine itemizing the tax paid of $200. The smelter spends $100 on equipment and tools used to smelt. The smelter sells the modified goods to a factory (end user or consumer) for $2000 plus $400 in taxes. The smelter provides the factory with a tax invoice itemizing the $400 paid by the factory to the smelter in taxes. Smelter’s Tax

Consequence: The smelter received $400 from the end user/consumer (the factory). Before the smelter sends this money to the United Kingdom, the smelter is permitted to “keep” some of this money by using its Input Tax Credits to offset the amount due to the United Kingdom on this sale. The smelter is permitted to submit an Input Tax Credit for the $200 it paid in taxes initially. Therefore, the smelter deducts $200 from the total it must remit to the United Kingdom. Additionally, the smelter purchased $100 worth of equipment and tools and is permitted a credit for these purchases. Therefore, the smelter deducts another $100 from the total it must remit to the United Kingdom.

At the end of the day, the smelter has $300 in available credits and received $400 from the factory. Therefore, the smelter may keep $300 from the factory and must remit $100 to the United Kingdom on this transaction. Transactions are subject to United Kingdom VAT only if the place of supply is within the VAT territory of the United Kingdom.

Generally speaking, the place of supply for goods is the place where the goods are physically located at the time of supply. When goods are transported the place of supply will normally be the place where the transportation commences. Services are treated as being supplied at the place where the supplier is established. When the supplier has no establishment, the place of supply is where the supplier has his usual place of residence. In the United Kingdom this is known as the place where the supplier “belongs.”