VAT Explained

By: Kalu Aju

I saw this graphic online; it’s great for explaining VAT.

VAT Stands for Value Added Tax, a tax on Value added. The seller collects the tax, and the buyer pays that tax.

The orange part is the VAT charged and paid to the government. In this example, VAT is 10%

1. The Raw Material Producer has produced, say, Maize. The cost is $1.00. When the Raw Material producer sells the bag of maize for $1.00, he charges the Manufacturer 10% or $0.10, so the total cost paid by the Manufacturer is $1.10. The $0.10 is the VAT remitted to the government.
2. The manufacturer adds value to the maize by milling it into flour, then marks the product for $1.20. A retailer comes to him to buy his flour, and he sells it, adding 10% VAT to his selling price of $1.20; thus, $1.20 x 10% = $1.32. To pay VAT, the manufacturer will deduct the VAT he already paid to the raw material producer ($0.10) from the VAT he collects from the retailer ($0.12). Thus, $0.12- $0.10 = $0.02. The VAT that is remitted to the Government is $0.02
3. The retailer now adds value to the maize flour by displaying it online so individuals can buy it with ATM cards; he then marks up the product for $1.50. If a consumer buys his flour online, the Retailer adds  10% to his selling price of $1.50; thus, $1.50 x 10% = $1.65. To pay VAT, the Retailer will deduct the VAT he paid the Manufacturer ($0.12) from the VAT he collects from the Consumer ($0.15). Thus $0.15- $0.12 = $0.03. The VAT that is remitted to the Government is $0.03
4. The consumer bakes a cake with the Maize flour. The consumer paid $1.50 for the bag and was charged 10% VAT; the total charge was $1.65. He pays $0.15 as VAT to the Government
5. Nigeria, in the past, has used the address of the manufacturer filing the VAT as a basis to capture where the VAT is coming from. Nigeria then allocates the bulk of the VAT to the State that the Manufacturer filed that VAT from. Take livestock sold from Bauchi; they are not VATed, and no processing is done in Bauchi to convert the livestock to, say, Beef, chemicals and buttons all from livestock. This is VAT income lost to Bauchi. That same beef is sold in a mall in Lagos, and Lagos State charges VAT.

6 . Under the new proposal, VAT is distributed based primarily on derivation. Thus, if these were Gold, Kebbi could organise its informal gold mining, and the miners would charge the gold refinery in Osun that buys the gold VAT; 60% of the VAT would remain in Kebbi. Similarly, the gold refinery in Osun will charge VAT when the retailer from Abuja mall comes to buy the gold, and finally, if a consumer goes to Abuja and buys that gold wedding ring, he pays VAT

7. Clearly, this new proposal will spur entrepreneurship as States and Local Governments seek to develop the value chain of economic activities in their states. Governors will discourage the “export” of raw maize and encourage post-harvest processing so that more VAT can be captured along the value chain in each State.

This change in the definition of IGR to the actual strategic development of SMEs is a game changer in Nigeria