United States: Value-Added Tax 101 – A Far Cry From A Border Tax

Last Updated: May 5 2017
Article by Alev Fanny Karaman and Stanley C. Ruchelman


Although the U.S. is the world's largest economy, it is the only world economy that does not have a value-added tax ("V.A.T."). While most U.S. states impose state sales and use taxes to fund state and local governments, those taxes are imposed at much lower rates than the V.A.T. found in Europe. On the other hand, all world economies, including the U.S., have a corporate income tax. As a result, the U.S. is viewed to have attractive tax features because it competes with economies that raise revenue from both corporate income tax and V.A.T. – with V.A.T. often being the major source of revenue for national governments. Ongoing discussions about a potential repeal of the U.S. corporate income tax on exports and implementation of a U.S. border adjustment tax on imports have suggested that similarities exist with a V.A.T.

While both provide exemption for exports and taxation of imports, the border adjustment tax, as currently proposed, is a far cry from a V.A.T. Whether the two systems ultimately align will depend on the final version of the border adjustment tax, whenever enacted. For those who ponder on possible similarities, this article provides a baseline of comparison – it summarizes the V.A.T. mechanism drafted at the E.U. level.


Nature of a V.A.T.

Countries worldwide generally have the choice among four revenue-raising categories of taxation: income, wealth, wages, and consumption. A V.A.T. is a tax on consumption.

It is a tax on the value that every economic agent ("Taxable Person") in a given production and distribution chain adds to the produced good or the provided service. Upon the sale of that good or service, whether to the next Taxable Person in the production and distribution chain or to the final customer, a Taxable Person must collect V.A.T. from the purchaser at the applicable rate imposed on the value of the transaction. Because the person subject to the V.A.T. is the Taxable Person and because that Taxable Person collects the tax from the purchaser (as opposed to incurring it itself), a V.A.T. is referred to as an "indirect tax." As explained in further detail below, the Taxable Person is responsible for collecting V.A.T. and paying it to the relevant tax authorities. Such payment is referred to as a "remittance." The tax base is generally the value added by a given Taxable Person to the good or service – hence the name "value-added tax." In all V.A.T. systems, a mechanism must exist to prevent multiple levels of taxation as a product proceeds through a production and distribution chain.

Input V.A.T. v. Output V.A.T.

In a given production and distribution chain, a taxable person generally pays V.A.T. on goods and services purchased for its trade or business, and collects V.A.T. on goods or services sold in its trade or business. The V.A.T. that is collected is referred to as an "Output V.A.T." in the hands of the seller and an "Input V.A.T." in the hands of the buyer.

The following diagram best describes Input and Output V.A.T. in the hands of Producer 2:

A key characteristic of a V.A.T. is that the tax burden crystalizes at the level of consumption but is collected at each level of production. Filing and reporting obligations exist at every stage of the production and distribution chain, reflecting the view that the V.A.T. system should be self-policing, which it is to a certain degree.

Remittance of a V.A.T.

The computation of the V.A.T. amount owed to the tax authorities is based on a Taxable Person's Input and Output V.A.T. Thus far, countries have adopted three different methods to calculate the amount of V.A.T. to be remitted: the "Credit Method," the "Subtraction Method," and the "Addition Method."

Credit Method

Under the Credit Method, a Taxable Person deducts its Input V.A.T. from its Output V.A.T. and remits the difference to the tax authorities. This system generally implies compliance with specific invoicing requirements, such as the requirement to separately list V.A.T. on all sales invoices. Since V.A.T. in the E.U. can be imposed at different rates, this method allows a true-up to the proper rate when a product is sold to a Taxable Person in a different country.

Subtraction Method

Under the Subtraction Method, a Taxable Person must calculate the value it adds to the good or service it sells. It does so by subtracting the taxed input costs from the sales price of a good or service and then multiplying this difference by the applicable V.A.T. rate. The result must be remitted to the tax authorities. This method differs from the Credit Method in that only local costs are taxed at the Output V.A.T. rate, without affecting the actual rates of Input V.A.T. imposed on the Taxable Person. It accomplishes this by subtracting taxed input costs from sales price generating Output V.A.T.

Addition Method

Under the Addition Method, the taxpayer first calculates its added value by totalling all the untaxed costs of supplying the goods or services (such as wages) and then multiplies this added value by the applicable V.A.T. rate. This amount must be remitted to the tax authorities. This method simply ignores transactions and Input V.A.T. at lower levels in the production chain.

Most countries that are U.S. trade competitors have adopted the Credit Method. As a result, the remainder of this article will focus on this method, which can best be explained by the following diagram:

In this example, every Taxable Person in the production and distribution chain can deduct its Input V.A.T. from its Output V.A.T. and remit the difference to the tax authorities. Thus,

  • the product producer remits the difference between V.A.T. 2 and V.A.T. 1,
  • the derived product producer remits the difference between V.A.T. 3 and V.A.T. 2, and
  • the retailer remits the difference between V.A.T. 4 and V.A.T. 3.

Only the ultimate consumer, who is not a taxable person, will bear the burden of the entire amount of V.A.T. incurred throughout the production and distribution chain.



The E.U. was formed to implement a common European market. For this purpose, Member States transferred part of their sovereignty to the E.U. and its institutions. As a result, European institutions can draft legislation that applies to every Member State in certain areas only. Indirect taxes, such as V.A.T., are one such area.

The European V.A.T. system mostly originates from European directives. Once the European Commission issues a directive, every Member State must "transpose" the directive into its own legislation using the means it considers most appropriate to achieve the directive's goal. The V.A.T. directives give every Member State a certain degree of autonomy with regard to specific aspects of internal V.A.T. legislation. As a result, harmonization is not perfect among E.U. Member States – which explains, inter alia, the difference in V.A.T. rates among E.U. countries.

In broad terms, the following flow-chart best summarizes a European V.A.T. analysis:

International Aspects

Sale of Goods

For European V.A.T. purposes, three separate categories of cross-border transactions exist in relation to the sale of goods:

  • Imports
  • Exports
  • Intra-community acquisitions

Imports are supplies of goods that are made from outside the European community, from so-called third countries in relation to the E.U. Generally, the acquirer or recipient of the goods must reverse charge ("self-declare") the V.A.T. due on this transaction. In common U.S. sales tax terms, this is a compensating use tax that applies when an item of personal property is acquired from outside the state and brought into the state. An example would be a valuable painting purchased in Paris and imported to the U.S. to hang on the wall of a New York City apartment owned by the purchaser. New York State imposes compensating use tax on the purchaser, as the purchase of the painting was not subject to New York State sales tax.

Exports are supplies of goods from a Member State to a consumer in a third country. With respect to U.S. sales tax, this is equivalent of purchasing a painting from a Beverly Hills gallery that ships the item to the purchaser so that it may be hung on the wall of a New York City apartment. California sales tax will not apply to the transaction.

Intra-community acquisitions are acquisitions of goods from a supplier established in another Member State. Intra-community acquisitions of goods and services are exempt in the Member State of the vendor and usually subject to V.A.T. in the Member State in which the supply ends. As a result, the acquirer must self-declare the V.A.T. due on this transaction. Again, to analogize to a U.S. sales tax fact pattern, this transaction is akin to the purchase of a painting from a gallery in Beverly Hills for delivery to a customer in New York City when the art dealer making the sales operates galleries in New York State and California. For sales tax purposes, the gallery must collect New York State sales tax but not California sales tax.

Sale of Services

The cross-border taxation of services is subject to slightly different rules. In broad terms, when the transaction relates to services and the recipient of the services has a V.A.T. number in another E.U. Member State, the recipient generally must self-declare the V.A.T. due on the services provided. On the other hand, when the services are provided to a person without a V.A.T. number in another E.U. Member State, the supply of services is generally taxable at the supplier's place of business.

To enable the various Member States to track supplies that are exempt from V.A.T. in one Member State but subject to V.A.T. in another, and to ensure that proper V.A.T. is collected, certain obligations are placed on Taxable Persons. These include

  • the maintenance of a valid V.A.T. number in all E.U. Member States in which activities for V.A.T. purposes are conducted,
  • the designation of a fiscal representative in certain cases to ensure that V.A.T. is collected properly and paid, and
  • the filing of a European Declaration of Services or a European Declaration of Goods in which all provisions of intra-community supplies of goods or services are reported.

The Potential for "Carousel Fraud"

Carousel fraud in a V.A.T. context generally combines two elements of V.A.T. rules. The first is an intra-community acquisition of goods by a Taxable Person who is registered to collect to V.A.T. The second is the right to deduct Input V.A.T. related to the intra-community transaction.

Generally, this type of fraud occurs in transactions subject to V.A.T. between at least three parties, as in the following example:

  • A Taxable Person, A, in Member State A makes a taxable, but exempt, supply to a Taxable Person, B, in Member State B.
  • In principle, B must self-declare Input V.A.T. to the tax authorities of Member State B. Nonetheless, B fails to declare and pay input V.A.T. on the intra-community acquisition.
  • B resells the good to a related Taxable Person, C, without declaring the sale while charging and collecting V.A.T. on this supply. The collected Output V.A.T. is not declared by B.
  • Shortly after the transfer, B is wound up, therefore embezzling V.A.T. proceeds from Member State B (and occasionally harming competition).
  • C sells the final goods either in Member State B or in Member State A, collecting V.A.T. and claiming a deduction for the V.A.T. paid to B.

This type of fraud can best be illustrated as follows:

In reaction to this type of fraud, certain E.U. Member States have adopted legislation that makes every participant that knew or could have known about the fraud in this chain of fraudulent transactions responsible for the payment of the embezzled V.A.T.


While V.A.T. certainly raises valuable tax revenues, it also is a tax borne by the final consumer. As such, it has been referred to as an unfair tax on consumers with lower incomes, since lower income taxpayers will incur the same tax burden as higher income taxpayers, thus making the tax proportionately more burdensome for the former. In the U.S., some states have addressed this issue by allowing a refundable credit against state income tax for a fixed amount of purchases based on income levels. Only people with limited incomes are allowed the credit.

Having mastered this basic course in V.A.T. rules imposed by E.U. Member States, the reader is urged to compare these rules with the border adjustment tax when, as, and if finally adopted. The border adjustment tax proposed to date, dramatically differs from a V.A.T. because there is only one point of collection – at the point of entry to the U.S. As with a V.A.T., retailers and others in the distribution chain may attempt to pass the cost to the next person in the chain and on to the ultimate consumer. However, in comparison to a V.A.T., the next person in the chain may refuse to absorb the price increase.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.