Annual Accounting Scheme: Definition, Exceptions & Taxation

Instructor: Lee Davis

Lee has a BA in Political Science; and my MA is in Political Science with a concentration in International Relations.

This lesson discusses annual accounting schemes, most notably the VAT tax and how it affects companies and consumers alike. We will explore the pros and cons to this tax, an example, and how it is used.

Value-Added Tax and Clothing

Imagine that you have just fulfilled your dream of creating your own clothing brand. However, you now may have to pay a VAT tax. How will a VAT tax affect your pricing and sale of your brand?

In general, small businesses use the annual accounting scheme to file taxes. It helps them submit one tax form per year, rather than the standard four per year. They may pay installments based on the estimated tax liability, then pay the balance owed at the end of the year with the return. But, part of the accounting scheme is what do they pay taxes on? That is where the VAT tax comes in.

The Value-Added Tax

One of the most well know accounting schemes is the Value-Added Tax (VAT). A VAT tax is a consumption tax placed on a product. The tax is placed on each stage of production and on the final sale of the product. The cost of the product is the amount of VAT that the user pays, but it also takes out any of the cost of materials that have already been taxed in the production of the product.

With a VAT tax, the company pays a tax at each stage of production. Since there are many stages, and no company produces products solely in-house, a VAT tax puts a lot of tax on the product.

For example, let's look at your clothing brand. Under a VAT tax, the company that makes cloth pays a tax on the wool or cotton they purchase. The company that buys the cloth would then pay a tax on that. Then, the company that buys the clothing made from the cloth would pay another tax. Finally, the consumer who buys the clothing would pay a tax.

Pros and Cons of VAT

Pros

Proponents of the VAT tax note that it would collect revenue on all goods sold in the United States. Currently, the United States is one of the few nations that does not have a VAT tax. As such, the United States does not charge tax on goods sold over the internet. Thus, implementing a VAT tax on the U.S. would open up billions of dollars in revenue that would otherwise be lost.

Another point in favor of a federal VAT tax is that it would make it harder for people to evade income tax. The VAT tax would simplify the tax code and make tax services much more efficient. The VAT tax is a tax on goods bought and sold, which makes it hard to avoid.

Cons

Those opposed to a VAT tax believe there are many drawbacks. One of them is that it will increase costs for business owners. This would also create conflict between the state, local, and the federal governments. Each state and local government charges their own sales tax. This would be in direct conflict with a federal sales tax.

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