A Value Added Tax in Dubai is often confused with a national sales tax. With a sales tax, the tax is only collected once – at the final point of purchase by a consumer – and so only the retail customer ever pays it. The VAT system is invoice-based and collected at several points throughout an item’s production, each time value is added and a sale is made. Every seller in the production chain charges a VAT tax to the buyer, which it then remits to the government. The amount of tax levied at each sale along the chain is based on the value added by the latest seller.
A value-added tax (VAT) is a consumption tax levied on products at every point of sale where value has been added, starting from raw materials and going all the way to final retail purchase. Ultimately, the consumer pays the VAT; buyers at earlier stages of production receive reimbursements for the previous VAT they’ve paid.
Example of Value-Added Taxation
To calculate the amount of VAT a consumer or business must pay, take the cost of the goods or service, and subtract any material costs previously taxed. An example of a 10% VAT in sequence through a chain of production can occur as follows:
A manufacturer of electronic components purchases raw materials made out of various metals from a dealer. The metals dealer – the seller at this point in the production chain – charges the manufacturer $1 plus a 10-cent VAT, and then pays the 10% VAT to the government.
The manufacturer adds value through its manufacturing process of creating the electronic components, which it then sells to a cell phone manufacturing company for $2 plus a 20-cent VAT. The manufacturer remits 10 cents of the 20-cent VAT it collected to the government, the other 10 cents reimbursing it for the VAT it previously paid to the metals dealer.
The cell phone manufacturer adds value by making its mobiles, which it then sells to a cellphone retailer for $3 plus a 30-cent VAT. It pays 10 cents of this VAT is paid to the government; the other 20 cents reimburse the cell phone manufacturer for the previous VAT it has paid to the electronic component company.
Finally, the retailer sells a phone to a consumer for $5 plus a 50-cent VAT, 20 cents of which is paid to the government.
The VAT paid at each sale point along the way represents 10% of the value added by the seller.
Value Added Tax Arguments
In Favor of VAT
Those who favor value-added taxation make the argument that a VAT system encourages payment of taxes and discourages attempts to avoid them. The fact that VAT is charged at each stage of production rewards tax compliance and acts as a disincentive from operating in the black market: For manufacturers and suppliers to be credited for paying VAT on their inputs, they are responsible for collecting VAT on their outgo – the goods they create or sell. Retail businesses have incentives to collect the tax from consumers since that is the only way for them to obtain credit for the VAT they have paid in buying their goods wholesale. A VAT is also supported as a better alternative to so-called hidden taxes.
Because it is typically levied at the same percentage on different products and services, a VAT tends to have less of an impact on economic decisions than an income tax. Still, it can register on a country’s economy. Along with improving the efficiency of tax collection, a VAT is considered an effective way to improve the growth of a nation’s gross domestic product (GDP), raise tax revenues and eliminate government budget deficits.