Value Added Tax (VAT) is a multi-stage consumption tax levied on the value added at each stage of the production and distribution chain. Unlike single-stage retail sales taxes, VAT is collected by registered businesses on behalf of the government throughout the economic cycle.
 
The Mechanics of VAT
 
The tax operates on a fractional collection system. This system ensures that the burden falls entirely on the final consumer. It utilizes two primary concepts:
  • Output Tax: The VAT charged by a registered business on its taxable supplies of goods or services.
  • Input Tax: The VAT paid by a registered business on business purchases, raw materials, and expenses.

[Supplier] ---> (Input Tax Paid) ---> [Manufacturer] ---> (Output Tax Charged) ---> [Wholesaler]

The Credit Invoice Method
Most jurisdictions utilize the credit invoice method to calculate the net VAT liability. Under this method, businesses must possess a valid tax invoice to claim input tax deductions.

Net VAT Payable/Refundable = Total Output Tax − Total Allowed Input Tax

If Output Tax exceeds Input Tax, the difference is paid to the revenue authority. If Input Tax exceeds Output Tax, the business generates a VAT credit or a refund claim.
Constitutional and Statutory Basis
VAT is strictly governed by statutory legislation (such as the Value Added Tax Act). The law establishes:
  • The mandate of the revenue authority to collect the tax.
  • The legal definition of a taxable person and a taxable supply.
  • The territorial scope, ensuring tax is only levied on economic activity within the country’s borders.

 
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