The "who-what-where" of Value-Added Tax (VAT)

Investigating the inner workings of Value-Added Tax

In the previous article, we stared deep into the soul of the T-Monster and discovered why it came into existence: The citizens of a country must pay taxes in order to receive public goods and services, such as roads, hospitals, and police services. To continue the process of conquering the T-Monster, we will discuss the three main forms of tax in greater detail: Value-added tax (VAT), personal income tax, and corporate income tax.

How is VAT calculated?

Benji buys ice cream at Spar for R11.50. If he is paying R11.50 for the ice cream, it must be worth R11.50, right? Wrong. VAT is an indirect tax added to the cost of products and services. In Benjis case, the VAT of 15% (R1.50) is added to the price of the ice cream (R10), to arrive at the final price of R11.50. When it comes to VAT, what you pay is not what you get. [Refer to figure 1]

Who pays VAT?

It is compulsory for an entity to register for VAT if its revenue generated is in excess of R1 million in any consecutive twelve-month period. A million rand in revenue is small change for most companies, and thus almost all entities in the supply chain are registered as VAT vendors. 

Input vs Output VAT

VAT is levied at each stage of the supply chain where value is added, from initial production to the point of sale. In a nutshell: VAT registered businesses charge VAT on their sales (output VAT) and recover VAT on their purchases (input VAT) and settle the difference with SARS. VAT is thus not a cost to the business themselves they merely collect and pay it on behalf of the government. [Refer to figure 2]

Crunching the numbers

As youll discover in this article, these companies dont actually pay VAT The end consumer - you and I pay for it. How does that work?

Lets engage the numbers in a classic supply chain setup. 

• Farmer produces cotton. Sells it for R10 (plus R1.50 VAT @ 15%) to the manufacturer
• Manufacturer makes T-shirts from cotton, and it sells for R50 (plus R7.50 VAT @ 15%) to the distributer.
• The distributer supplies T-shirts to retailers across the country at R100 (plus R15 VAT @ 15%) per T-shirt.
• Finally, the retailer sells it to customers at R220 (plus R33 VAT at 15%), to bring the total price to R253 that customers pay for the product. 

Value gets added along the way in the chain of supply. Each participant provides specific value addition before selling it to the next participant in the chain. Each company sells at a higher price than what they purchased the goods for. 

Once again, VAT is not a cost to businesses themselves. They collect and pay it over various stages in the chain of supply on behalf of the government. VAT is really a tax that impacts the consumer, as they are the ones ultimately paying the R53 that is embedded in the retail price of R220. [Refer to figure 3]