Value-Added Tax, also referred to as VAT, can be understood as a general tax on consumption used for the upkeep of society. This article explains, how VAT-systems function and why they exist, using the example of the Danish VAT-system.
VAT is a historical form of taxation, introduced both after World War 1 and World War 2 as general taxes on consumption used for rebuilding. Today, the VAT-system primarily functions as a means of financing the state’s public spending and thereby a driving force for society’s overall welfare.
Denmark was one of the first countries that introduced a VAT-system, meaning a tax on the added value that is charged on every part of professional income. This happened on the 29th of March in 1967, when the parliament adopted the Law on regular sales tax, which has since then been revised and is now called the VAT-law.
VAT is a tax on added value and is charged as a surcharge on the sales price of wares and services delivered in the respective country. Danish VAT-law defines a legal or physical person operating a commercial enterprise as subject to VAT. § 33 of the law sets the percentage at 25 % of the taxable amount. However, there are some exceptions to this, according to § 34. Keep in mind that this rate can vary, depending on the EU member state.
Simply put, this means that companies are charged a VAT of 25 % of the value added, which is added to the goods or services in a given revenue stream. It has to be said, that companies do not defray this tax but rather add it onto the sales price that is the basis for the VAT. Thus, the entity subject to paying VAT lets the consumer bear the cost.
Thus, VAT is practically a fiscal percental toll charged on wares and services by the state with respects to tax authorities’ later VAT-claims. From legislators’ side it is important to uphold the VAT’s neutrality. That is to say, that it should not cause changes in consumer behavior or the tendencies of economic actors.
For domestic and foreign economic actors, the demand for VAT to be neutral means, that they are charged the percentage of VAT when importing goods produced abroad or services, that answers to similar goods and services domestically. The same is valid for Danish companies exporting goods. When exporting, their products are not charged with any kind of tax, since taxation occurs in the importer’s country. Thus, the goal is for it to be irrelevant to a consumer, whether a product has been produced domestically or abroad.
The tax burden, that VAT represents for goods and services, has to be expressed as 25 % of the sales price, accordingly. It is of no regard, whether the product is traded often or rarely. Likewise, there can not be a difference between goods produced industrially or manually. This principle of neutrality is predominantly important to legislators and for the purpose of creating a trade environment, where the tax burden does not discriminate specific product categories.
Companies are, in principle, obligated to provide a VAT-statement every half year. The report is partially based on if the company is older than one and a half years and partially, whether the company’s revenue subject to VAT exceed DKK 50,000 or not. If an economic actor’s amount is lower than DKK 50,000 over a period of 12 months, they are free to choose, if they want to register their company for VAT. In contrast, every company with more than DKK 50,000 worth of revenue subject to VAT over a period of 12 months is obligated to register for VAT.
Before a company can report VAT for the first time, they have to register at their countries respective tax authority. Companies that buy goods from countries outside the EU have to register as an importer. Thereafter, they can hand in their reports to the authorities. For more comprehensive information as well as with any open questions, one should consult their local tax authorities (the Danish SKAT offers several guides).
This only applies to private individuals who pay VAT otherwise. If a carpenter completes an assignment for DKK 10,000, they have to charge DKK 2,500 on top for VAT. In case the assignment has been completed for a company, they can subtract the DKK 2,500 on their next VAT-report to SKAT (in Denmark). If, on the other hand, the carpenter has completed said assignment for a private customer, the DKK 12,500 have to be paid by the customer. As the vendor of a product or service, the question arises, whether the 25 % VAT are simply added to the sales price or if the price itself is lowered in order to keep up with competition. As owner of a newly founded company, it is recommended to consult your tax authorities for further information like, whether you can deduct VAT or not, for instance.