Indirect tax problem

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• Greetings,

I have some difficulties in realzing the method behind the calculation of ‘indirect tax’. In the BPP study text for F3 paper, page 118, there is an example supposed to illuminate the nature and mechanism of indirect sales tax, but it seems to me that it’s actually more confusing.

Here’s the example:

Quote:
1.1 How is sales tax levied?
Sales tax is a cumulative tax, collected at various stages of a product’s life. In the illustrative example
below, a manufacturer of a television buys materials and components and then sells the television to a
wholesaler, who in turn sells it to a retailer, who then sells it to a customer. It is assumed that the rate for
sales tax is 15% on all items. All the other figures are for illustration only.
1.2 Example
Price net Sales tax Total
of sales tax 15% price
\$ \$ \$
(a) (i) Manufacturer purchases raw materials
and components 40 6 46
(ii) Manufacturer sells the completed television
to a wholesaler 200 30 230
The manufacturer hands over to tax authorities 24
(b) (i) Wholesaler purchases television for 200 30 230
(ii) Wholesaler sells television to a retailer 320 48 368
Wholesaler hands over to tax authorities 18
(c) (i) Retailer purchases television for 320 48 368
(ii) Retailer sells television 480 72 552
Retailer hands over to tax authorities 24
(d) Customer purchases television for 480 72 552
The total tax of \$72 is borne by the ultimate consumer. However, the tax is handed over to the authorities
in stages. If we assume that the sales tax of \$6 on the initial supplies to the manufacturer is paid by the
supplier, the tax authorities would collect the sales tax as follows.
\$
Supplier of materials and components 6
Manufacturer 24
Wholesaler 18
Retailer 24
Total sales tax paid 72

The problem is that how a manufacturer pays, according to BPP text, just \$24, while in the example it has been shown that he pays \$30?! He buys the raw materials for \$46, right? out of this \$46, 15% which equals to \$6 was added because of sales tax, so the supplier has paid \$6 on sales tax.

Now, the manufacturer has bought the materials for \$46 and intends to sell them @ \$200. But since ther’s a 15% sales tax, he sells them @ \$230 and pays @30 to the tax authorities. Right?! Then why in the text it has been mentioned that he hands over just \$24?! Isn’t it correct to assume that in ‘each sales transaction’ a 15% of the sales price should be deducted as tax and be handed over to authorities?

Any input is greatly appreciated.

Regards

Ok, it seems that the example above was based on the ‘Value Added Tax’ (VAT) system.

http://ec.europa.eu/taxation_customs/taxation/vat/how_vat_works/index_en.htm

But still an explanation is appreciated.

Regards

mahdiniaacc
Member

Dear Ali

Have you solved your problem with this topic or no ?

Greetings mahdi jan,

I just managed to know that how indirect tax is calculated using the VAT formula. But any input from you is appreciated, as always!

Regards

mahdiniaacc
Member

Now, the manufacturer has bought the materials for \$46 and intends to sell them @ \$200. But since ther’s a 15% sales tax, he sells them @ \$230 and pays @30 to the tax authorities. Right?! Then why in the text it has been mentioned that he hands over just \$24?!

Hi again dear compatriot

the key point in VAT’s issues is that each registered seller or producer is a representative of the tax authority and should collect the sales tax on behalf of the tax authority in each sales. now the first question is that what about the seller’s taxes paid on his purchases?
the answer of this question is depend on the concept and goal of the VAT system. as you know, VAT is an indirect tax and levied on each final consuming of goods or services ( except some goods or services ).
it’s an indirect tax because it’s not a tax for seller or producer of goods or services, actually it’s the final consumer’s tax that indirectly given to the tax authority, the seller gets the tax from the customer and transfer it to the tax authority.
therefor, if the producer or seller is not the final consumer so he can reclaim his tax which is paid in respect of his business activities, it means that the paid tax by the seller or producer on his purchases could be his tax credit.
according to your example, the manufacturer paid the tax of \$6 on his purchases and collected the tax of \$30 in his sales. the paid tax is his tax credit and the collected tax is his tax payable. so based on the value added tax law the business has the permission to deduct his tax credit from his tax payable therefor the remaining amount is his final tax payable or tax credit.

good luck

Thank you Mahdi jan,

I now have a clearer understanding of the VAT system.

Regards

mahdiniaacc
Member

Now, I’m so happy because I was useful for you.

hope you good luck with your December exam

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