Value Added Tax (VAT) and Modified VAT (Modvat) are quite similar in many respects. Both are designed as incremental, indirect consumption taxes on products and services, both offer provisions for the avoidance of double taxation and harsh export restrictions, and they are similar in the way that they are calculated.
According to the European Union website, VAT imposed on suppliers is calculated on the basis of a percentage of the sales price at each link along a product or service's value chain,. The purchaser of materials at a specific link will compensate the supplier for VAT paid due to the inclusion of VAT charges in the sales price. When the purchaser hands the product off to another link along the value chain, it must also pay VAT based on a percentage of its sales price. At this point, however, the original purchaser, who is now acting as a supplier, may deduct the amount paid to the previous supplier in compensation for VAT paid, and thus must only pay the amount of VAT incurred due to the increase in price, which reflects the economic value that has been added at that particular stage. This process continues until the product is sold to the final consumer, who pays the total of all incremental increases in VAT.
VAT is imposed in many nations, including each member state of the European Union (EU). Modvat, or Modified VAT, is native to India, and has been imposed in India since 1986. Major differences between VAT and Modvat include the exclusion of certain product categories such as tobacco products from the ability to subtract the previous supplier's VAT paid from the VAT owed at each step, the requirements of extensive, sometimes redundant, filing procedures.
VAT / Modvat Example
As a simple example of how VAT or Modvat is calculated throughout a value chain, consider the case of a wooden furniture manufacturer in a country that imposes a 10% VAT. If the first link in the value chain, the lumber producer, offers a price of $500 for a shipment of processed wood, it will be assessed a $50 Value Added Tax. It will then charge the client, the furniture manufacturer, $550, and the amount of VAT will be clearly labeled on the sales receipt. If the furniture maker will ultimately charge $1000 for the furniture made from that particular shipment, it will be assessed a $100 VAT, less the $50 already paid by the lumber mill. The manufacturer will then sell the finished goods for a total of $1100, accounting for the final sales price and the VAT assessed at each step.
Advantages of VAT and Modvat include the ability to avoid double taxation by reimbursing each link along the value chain, and the ability to tax consumers without imposing direct obligations.
VAT systems view exporters as the final consumers for tax purposes, allowing the nation's businesses to remain competitive in international markets by avoiding the imposition of additional import costs to foreign purchasers.
VAT rates vary among nations, as do certain specific filing and reporting requirements. Follow the links at the end of this article to find comprehensive listings of the VAT rates for EU and non-EU countries.
David Ingram has written for multiple publications since 2009, including "The Houston Chronicle" and online at Business.com. As a small-business owner, Ingram regularly confronts modern issues in management, marketing, finance and business law. He has earned a Bachelor of Arts in management from Walsh University.