VAT: Value Added Tax in Nigeria | How to Calculate Vatable Goods & Services

Value Added Tax (VAT) in Nigeria

The idea of introducing   VAT in Nigeria came from the study group set up by the Federal Government in 1991 to review the entire tax system. VAT was proposed and a committee was set up to carry out feasibility studies on its implementation. In January, 1993, the then government agreed to introduce VAT by the middle of the year. It was later shifted to 1st September, 1993 by which time the relevant legislation would have been made and proper ground work done.

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What is a Tax?

a tax on the amount by which the value of an article has been increased at each stage of its production or distribution.

Value Added Tax - Definition from Wikipedia

A value-added tax (VAT), known in some countries as a goods and services tax (GST), is a type of general consumption tax that is collected incrementally, based on the surplus value, added to the price on the work at each stage of production, which is usually implemented as a destination-based tax, where the tax rate is based on the location of the customer. VATs raise about a fifth of total tax revenues both worldwide and among the members of the Organisation for Economic Co-operation and Development (OECD)

Value added tax act 1993 no. 102, 1993 according to Federal Inland Revenue Service Website is as follows; The standard rate of tax is currently 5% of invoice value of goods and services except items specifically stated as exempt or zero-rated. The VAT system in Nigeria is administered by the Federal Inland Revenue Service (FIRS). ... These include goods and services supplied in Nigeria or imported.

The actual implementation however, did not commence until January 1994 after the promulgation of the Value Added Tax Decree No. 102 of 1993. According to the decree, a ‘VATable’ organization is an existing manufacturer, distributor, importer or supplier of goods and services.

VAT as Replacement for Sales Tax. The rationale behind replacing Sales Tax with VAT was informed by a number of factors and considerations, notable among these are: The base of the Sales Tax in Nigeria as operated under Decree No. 7 of 1986 is narrow.

It covers only nine categories of goods plus sales and services in registered hotels, motels and similar establishments. The narrow base of the tax negates the fundamental principle of consumption tax which by nature is expected to cut across all consumable goods and services.

VAT base is broader and includes most professional services and banking transactions which are high profit-generating sectors. Only locally manufactured goods were targeted by the Sales Tax Decree of 1986, although this might not have been the intention of the law.

VAT is neutral in this regard. Under VAT; a consideration part of the tax to be realized is from imported goods. This means that under the new VAT; locally manufactured goods will not be placed at a disadvantage relative to imports.

Since VAT is based on the general consumption behaviour of the people, the expected high yield from it will boost the revenue collectible by governments with the minimum resistance from taxpayers.

Definition VAT is a consumption tax payable on the goods and service consumed by any person, whether government agencies, business organizations or individuals. The target of VAT is consumption of goods and services and unless an item is specifically exempted by law, the consumer is liable to the tax. It can also be defined as a tax on spending/consumption levied at every stage of a transaction but eventually borne by the final consumer of such goods and services. It is levied at the rate of 5%.

The Nigerian VAT System has the Following Features:

It is a Multi-Stage Tax System Under this principle, VAT is imposed at every stage of the production chain from the manufacturer to the consumer (see below example).
Credit Mechanism: In order to eliminate the cascading effect of taxation at every stage of production, a credit mechanism system is installed to allow VAT paid on imports or purchases of raw materials (input taxes) to be deducted from the VAT charged on sales (output taxes) and therefore, the tax to be paid by a taxable firm is the difference between output tax and input tax.
 Tax in Nigeria - Click Here to read more

This credit mechanism acts as a safeguard against the negative impact of the tax so that VAT is made neutral to price determination (VAT is not an element in the price). The credit mechanism also helps VAT to promote export drive in view of its neutral characteristic to international trade.

In export trade, the total input taxes incurred on production is refundable. Tax Invoice System The VAT system is invoice based and not cash based. Understanding the Nigerian VAT System There are some key facts which will help us understand the implementation of VAT in Nigeria.

Among these are: 

  1. VAT is a tax on consumption. The tax is borne by the final consumer of goods and services because it is included in the price paid.
  2. The tax is at a flat rate of 5%.
  3. The tax is collected on behalf of the government by businesses and organizations which have registered with the Federal Inland Revenue Service (FIRS) for VAT purposes.
  4. A business or organization which has registered for VAT is classified as a “registered person”. Such persons will pay 5% VAT on goods and services purchases but can claim credit for this tax (called input tax) when sold.
  5. 5% VAT (called output tax) is included in the price of all goods and services supplied/sold by registered persons.
  6. The “registered person” has to make regular VAT returns and either pays to, or receives from the FIRS, the difference of the input tax and the output tax.
  7. VAT returns (and payments) are normally made monthly to the FIRS tax offices on or before 30th day of the month following that in which the supply was made.
  8. To claim a credit for input tax, a registered person must hold a “Tax Invoice”. Records and accounts have to be kept.

Although VAT is a multiple stage tax, it has a single effect and does not add more than the specified rate to the consumer price no matter the number of stages at which the tax is paid.

Illustration 1: If a product moves from Raw Materials Producer
(A) to Manufacturer
(B) at N1,000.00 then to wholesale
(C) at N1,500.00, then to Retailer
(D) at N2,000.00; and finally to the consumer who pays N2,500 to the Retailer.

VAT payable to government at 5% rate of VAT on the product is as follows:

VATable           Sales       VAT        VAT on Inputs  VAT paid Person Price Collected  (Input Tax) to government (Output VAT) N A                                                       
1,000              50                    –                            50 B                     1,500                 75                    50 25 C               2,000                 100                  75                          25 D                2,500            125    100                        25                          350                  225        125

Thus, the VAT paid to government in the four transactions if N125 which is 5% of the final consumer price of N2,500.

See also: Border-adjustment tax (United States); Excise; Flat tax; Gross receipts tax; Income tax; Indirect tax; Land value tax; Missing Trader Fraud (Carousel VAT Fraud); Progressive tax; Single tax; Turnover tax; X tax.
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