Value Added Tax (VAT)

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• VAT for Expenses — track VAT paid out and set default VAT percentages
• VAT for Invoicing —  how to collect VAT

VAT vs. Sales Tax

If you are from a country that uses a sales tax instead of VAT then you may find the entire concept confusing. How is VAT different from a sales tax? Why use it?

To start, VAT's function is very similar to a sales tax. The government collects a tax on goods or services. The difference from a sales tax is when the taxation occurs. With a sales tax it happens at point-of-sale. A person goes to the register and 5% is added to the purchase price. This is very straightforward and easy to keep track of. With VAT, the taxation occurs as the product or service is created. Let's use a very simple example. An orchard grows apples and sells them to an applesauce maker for $1. VAT is collected on this initial amount. The applesauce maker then sells to a store for $2. Again, VAT is collected. Finally, the store sells the applesauce to a consumer and VAT is collected yet again. At each stage of the production process VAT is collected. You may have noticed that the more stages, the more times VAT got collected. Wouldn't this cause the government to get way too much VAT? The answer is no, and the reason is because you track VAT you've paid and VAT you've collected. Then you send the government the DIFFERENCE.

The table below visualizes the process. There is a row for each transaction stage and columns for VAT paid, VAT collected, and VAT sent to the government.  

Here is how the process would work using standard Sales Tax. The first two transactions don't matter because they are wholesaler transactions. Only the final sale to the consumer matters.

In either taxation scenario the government still collects forty cents and everything is even. The difference was WHEN that tax was collected.

So Sales Tax seems a lot simpler. Why in the world would you make people track taxes three times when you can track it once at the end of the line? One reason is that VAT removes a loophole where a company can purchase goods for themselves under the auspice that they are reselling the product. They won't pay sales tax and get the goods tax free. As VAT is taxed along the way, there is no way to avoid it.

As you can see, there are two sides to VAT. On one side you need to track how much VAT you have paid out. On the other you need to look at how much you have collected. The amount you paid out is accrued on the Expense side of Projector and is covered in the VAT for Expenses page. The amount that you have collected is on the Invoicing side of Projector and is covered in the VAT for Invoicing page.