In light of the state’s need for financial resources, in order to provide public services for projects and consumers, it is entitled to collect taxes in the form of resources for the public treasury.
The tax base is different from one country to another according to the tax policy that reflects the legislative and executive policy in the country.
-A state-supported economy: This policy is adopted by countries wishing to reduce the burden of living on citizens and support the building process based on the development of the public sector. Such countries impose income tax on high-income earners such as merchants and foreign commercial companies in particular, and may exempt citizens from this tax.
According to this scenario, the state establishes and runs large and strategic government projects with the aim of achieving profits that finance the general budget and allow the continuation of the government support policy.
-Free economy: It is a strategy in which the state does not interfere in the market, as its role is limited to imposing law and order only, and in return it is based on the collection of wide segments of taxes on the basis of income and value added.
Government projects are almost non-existent in this type of economy, and accordingly, there is no financial support from the public budget, and therefore the market is free and the prices are not supported, but in return the level of development is high and the economy is active; So that job opportunities increase, wages rise, and the country is attracts foreign direct investment.
It can be said that the most sensitive period of economic transformation of the tax policy is the state’s shifting from a subsidized economy to a free economy. Where the state has to impose taxes on income and value added at a time when people are not used to nor ready for this kind of direct financial burden which may impact their living.
This is the case in Kuwait, which is moving from a rentier state supporting economy where there is no tax burden on the income of the Kuwaiti citizen or the Kuwaiti companies, to a free economy that attracts foreign investment in which tax burdens citizens.
What is the difference between profit margin, net income and value added?
When goods and services are produced and then traded, each party during the supply stages chain increases a margin of profit to that of the party to which it supplies the good or service.
Thus, the price of goods and services increases spontaneously, starting from the factory, passing through wholesalers and retailers, until it reach the consumer.
This increase in price arises from the need of each merchant to collect the profit from the previous merchant, and so on until the final value of the good or service is collected from the consumer.
Accordingly, the increase that the merchant adds on the selling price of the item is the profit margin, but this margin does not constitute the net income of the enterprise, which is not shown in an accurate numerical value until the completion of the annual accounting process and deduction of expenses.
For example, if the factory sells a specific commodity to the wholesaler at a price of 100 KWD, and then the wholesaler sells the same commodity to retailers at a price of 110 KWD, then the amount of 10KD is the profit margin, and after deducting expenses, the annual net income may become 7 KWD.
As for value added as a tax term, it is a cumulative value that is added to the price of the entire commodity, not to the profit margin.
For example, if the price of the commodity sold by the factory to the wholesaler is 100 KWD, then if the percentage of value added as a tax on this price is 5% then the value added is 5 KWD, regardless of the profit margin or the net income.
This indicates that this tax is not related to the profit margin or net income, but rather to the value measured on the basis of a certain percentage of the price.
Why is VAT (The Value Added Tax) charged?
In principle, the value added is imposed as a tax on the basis of the growth in the value of goods and services during the chain stages of their circulation from manufacturing until reaching the consumer. This growth, which constitutes an added value to the good and service, ends in the form of a cumulative increase in price.
Here we are not talking about the profit margin, as the profit may be realized or the trader may incur a loss and the net profit – if occurs – is the income tax base, while we are talking here about the value added to the price of the commodity, whether the trader generates profits or incurs loss.
Thus, the main reason for imposing the value-added tax is to collect a new tax resource from the person who is able to consume, and not from the merchant who is able to make a profit.
What is the purpose of imposing a value-added tax?
The main purpose of the value-added tax appears to be easing the burden on industrial and commercial establishments, and transferring part of it to consumers.
In this way, the state can offer higher investment incentives and more tax exemptions, and in return, the state can compensate for the lost tax revenue resulting from incentives and exemptions through value-added tax imposed on consumers.
The state sets a primary goal of the value-added tax, which is economic development that attracts investment, which needs to reduce the tax burden on establishments, and thus transfer it to consumers.
What is the nature of the value added tax?
This tax is mainly put for the consumption, as the full tax burden is on the final consumer and not on the manufacturer, the distributor or the trader.
How is VAT (The Value Added Tax) charged?
Here we have to focus on the following elements:
-Tax base: The value of the import or production process, after completing each stage of supply chain and distribution.
-Paying Tax: The tax is initially paid by a person who practices an industrial or commercial activity with the aim of generating profits.
-Tax refund: The taxpayer has the right to recover what he paid, until it reaches the final consumer who bears the entire burden of the tax without having any right to recover the tax amount.
What is the nature of establishments that pay the value added tax?
Despite the consumptive mechanism of this tax, it is collected cumulatively from establishments, starting from the factory that collects it from the wholesaler, then from the wholesaler who collects it from the retailer, and finally the retailer who collects it from the consumer.
In each of these stages, the merchant pays the amount of tax to the previous merchant, and collects the amount from the successive merchant, which means that each merchant has a balance represented by what he paid in cash.
Instead of recovering this balance in cash from the tax administration, the merchant deducts his balance from the amount he must collect from the next merchant, and so on until we reach the consumer who pays the full amount of the added tax without being entitled to recover it.
In this way, the merchant is temporarily charged of the tax, and then that merchant becomes a tax collector of the next merchant in the supply chain, until reaching the consumer.
Calculation Examples of Value Added Tax:
Supposedly that a food factory produces a specific commodity, then sells it to the wholesaler at a price of 50 KWD, then the wholesaler distributes it to retailers at a price of 60 KWD, and then the retailer sells this food commodity at a price of 70 KWD to the consumer.
If we assume that the percentage of value added on the basis of which the tax is imposed is 5%, then the tax will accumulate as follows:
-The factory sells the commodity at a price of 52.5 KWD to the wholesaler, where it collects the amount of tax 2.5 KWD from the wholesaler, and then transfers the additional amount (2.5 KWD) as a credit to the wholesaler with the tax administration (5% of the 50 KWD, the price of the item = 2.5 ).
-The wholesaler distributes the commodity at a price of 63 KWD to the retailer, where he collects an additional amount of 3 KD from the retailer, and the wholesaler has a balance with the tax administration represented in the amount that he had previously paid (2.5 KWD), then he transfers the difference between what he must collect (3 KWD for the retailer’s balance) and his balance (2.5 KWD), i.e. 500 fils (Kuwaiti penny) is transferred to the tax administration (3 KWD – 2.5 KWD = 500 fils).
-The retailer sells the commodity at a price of 73.5 KWD to the consumer, where he collects an additional amount of 3.5 KWD from the consumer, then the retailer transfers the difference between the amount he collected from the consumer (3.5 KD) and his balance with the tax administration (3) KWD), i.e. an additional 500 fils (3.5 KWD – 3 KWD = 500 fils)
-Thus, the wholesaler recovers the amount of tax he paid to the factory (2.5 KWD), and the retailer recovers the amount of tax he paid to the wholesaler (3 KWD), so they will not have any tax burden after completing the final sale to the consumer.
-In this way, the full amount of tax is collected from the consumer, which is 3.5 KWD as 5% of the final price of the commodity of 70 KWD, whereby the consumer pays 73.5 KWD in cash without being entitled to any refund.
International Department Team
Dr. Bader S. Al-Otaibi
Law Firm & Intl. Arbitration