value added tax

No. If the state decided to tax only profit, and not price, then I should be getting to keep £6400 out of my £8000. If it decided to tax only price and not profit, then I should expect to keep £7600 because the £400 surcharge on the equipment cost would have to come out of my profit.

But if the state decided to tax *both* profit and price, then of course I would expect what' left over for me at the end to be less than both of the above.

Correct.

Not at all. I don't see on what basis you argue that I should expect a post-all-tax profit of £6400.

Given that with no possibility of reclaiming input tax, the *real* cost of the equipment to me is £2400, therefore my pre-profit-tax profit is £7600 to be taxed at 20%. So long as the playing field is level, and everyone knows ab initio what to expect, that's fine.

With gratitude for the small mercy of having no income tax to pay. :-)

The point is that you can't make these examples up. There is no "natural" set of figures onto which you can "overlay" a tax system, because the tax system clearly has an effect on the overall economics of what is possible.

Not really. If a business's profitability is reduced to below the threshold of any reasonable payback, it has to increase the prices it charges to its customers. If competition is fair, all the company's competitors have to do the same. If that means the customers stop buying altogether, too bad, then the state has got is tax policy wrong.

"Ronald Raygun" wrote

In the example suggested it was supposed that the state took a 20% "cut" from economic actions. The person providing the service was effectively getting 8,000 for their work (pre- all tax) - hence the idea that a 20% "cut" is just 1,600 - leaving 6,400 net 'profit'.

"Ronald Raygun" wrote

You appear to be approaching the situation *after* the taxes have been set. Given that taxes are *not* "set in stone" (the state could re-arrange any and all taxes they wished to, at any time - what's a little public uproar!!), you shouldn't be thinking that the equipment costs 2,400 - you should think "2000+tax".

"Ronald Raygun" wrote

Of course there *is* a natural position onto which you *can* overlay the tax system. It is the position without any taxes!!

"Ronald Raygun" wrote

Ah, but what I am saying is that it should be set up in such a way as to

If you set up a business which happens to "work", by turning a profit, within a certain tax system - then it would be nice if that business still produced a profit when the tax system changed. If overall taxation increased, then fair enough the profit should go down. But what I'm saying is that it would be *extremely attractive* if, when the tax system was amended, a workable business before was *still* generally workable afterwards (albeit with a lower level of profit).

Letting a tax system turn a profitable business into a *loss-making* business seems absurd - it should just take a *proportion* of the profit. [After all, the principle of taxation is to collect some money, not a percentage of nothing!!]

"Ronald Raygun" wrote

Triple whammy!! Not only does your client have to pay the "VAT"-type tax [1] on your final fee (the 10,000 in earlier example) - but you have to increase that fee by the amount of the "VAT"-type tax [2] on the equipment which you used (the 20% of 2,000 spent on equipment) - and then of course you need to charge the "VAT"-type tax [3] on this extra amount of your fee (another 20% of 400)??

So now you've just "pushed the buck" from the service provider to the client, and increased the tax into the bargain.

"Ronald Raygun" wrote

My point entirely!! I believe that what you are suggesting, *would* mean that "the state has got is tax policy wrong" !!!

"Ronald Raygun" wrote

Sshhh! They'll be after you!

Bottom-line, in my example the service provider was only adding value of

Just one last example (!) :-

In the cut-throat world of web-site hosting, there is a very small profit margin - hence little added value. If you host yourself, you buy a computer - under your system you cannot reclaim the input tax. OK fair enough, let's run with this for a minute. Cost is (say) 1,000+VAT 1,175. You hook it up to the telephone line and you're away.

Alternatively, you can employ a service provider to host it for you - they buy the computer for 1,000+VAT, cannot reclaim the input VAT, and charge just 25 more (say) for their service. Hence they need to charge you: (1000 x 1.175 + 25) x 1.175 = 1,410 (including VAT). [Of this, they pass 210 to VATman, 1,175 to the computer supplier, leaving them with their 25 - which is later taxed!]

Obviously, you don't want to pay 235 extra for their service (that's why the amount they add is so small - 25). So they reduce their price. Suppose they do their service for free. (Generous people!). You would still end up paying 1,380.63 - ie still over 205 more than if you "do it yourself".

How do they make the service cheap enough for you to want to use it, if they cannot reclaim the input VAT?

"Ronald Raygun" wrote

Well, really you are saving because if you "do it yourself" you'd really be paying the money for the computer *plus* the wages to your employee who sets it up - which will be over the 25 "service charge" (or else you really *do* do it *yourself*, but you value your time at more than 25).

"Ronald Raygun" wrote

"Ronald Raygun" wrote

Hold on, *who* can reclaim the input VAT? The service provider, who is

"Ronald Raygun" wrote

But you didn't want to have to bother setting up the d#mn thing yourself, that's why you wanted to pay someone else a (small) amount to do it!

I don't believe you have. The first fly I meant is that it doesn't make commercial sense to hire a machine for 3 years for £350 a year when you can buy it for £1000 and it lasts for 3 years before you have to replace it and get a new one, unless cashflow is an issue (all other things being equal, e.g. it comes with free maintenance etc). The setting up cost is something I would have to carry anyway.

Have I misunderstood your example? I *am* re-selling the service.

The SP buys the computer for £1000+VAT. That's a capital item not for resale, and he cannot reclaim the VAT on it. He hires out disk space and CPU cycles on it to me and half a dozen others for £100+VAT per year. Over the projected 3 year life of the computer that gives him a good profit, since he collects 3x7x£100=£2100 and pays out only £1175. But I, who am buying in the service, and enhancing it by making the disk space and CPU cycles sing and dance to a web hosting tune, and am then re-selling that enhanced service to *my* customers, can recover the VAT I pay on the £100 each year.

No I didn't. It was your idea that I'd have the choice between buying the computer and hiring time on it. The setting up cost seems an unnecessary complication not central to our argument, the work needs to be done either way, and if I didn't do it, my specialist would do it for me either on my premises on those of who I hire it from, it makes no difference in the latter case whether the specialist is my hirer or a third party. Other than cashflow, then, I've not understood why I should choose hiring over buying.

Not only is it not clear, it isn't the intention. VAT is a tax on the total value added by a company, i.e. the difference between sales and input costs. Doing it the way you suggest would mean that the tax wasn't independent of company structure. Consider a completely integrated company which does everything in house; it would have no input VAT because it would have no input. Now suppose it outsources some thing like catering and payroll; it has to pay VAT on those, and by your argument that VAT would not be reclaimable, hence the total tax paid would increase. If the catering company outsourced its payroll and the payroll company outsourced its catering it would get even worse.

Nonsense. VAT is not a tax on value added by anyone, it is a tax on the total value which the end user gets. That happens to equal the sum of the bits of value added at each stage in the chain of production, and it also happens to be how it's administered, but the point is that all of the actual tax is paid by the end user.

All I'm suggesting is that inputs to a middleman which don't have corresponding outputs should make the middleman count as end user of those inputs.

Correct. If you think that would be a bad thing, then why?

Correct. So that would be one of many factors to be taken into account when deciding whether outsourcing makes business sense. Nothing wrong with that.

"Ronald Raygun" wrote

And indeed, anything that the middleman buys for private use has VAT charged as you are suggesting - it cannot be reclaimed - which is fair enough.

There is certainly no *independence* between the inputs we are concerned with here, and the outputs of the middleman. Every single output may have been dependent on eg a computer having been bought by the middleman in order to perform a service (his output). Take away the computer, and it is not possible to perform the service - the computer is crucial to producing the output, just as much as when a physical object (bought as an input) is incorporated into the outputs made.

"Ronald Raygun" wrote

But yes there *is* something wrong with that. Each business would be encouraged by the tax system (under your proposal) to do everything in-house, and never to outsource anything. Otherwise, as Stephen suggests, there would be more and more and more extra VAT "stacking-up" as each company outsources parts of their business (be it catering or payroll or whatever) - making everything cost more and more than if all businesses were "integrated".

This would suggest businesses move to a "jack-of-all-trades" system, rather than a "master of one". Overall, it would be found that inefficiencies creep in, because each business is not concentrating on the one thing that they are most efficient at. The modern world has come a long way since that sort of thing existed in caveman days ...

You can call it nonsense if you like, but it is in fact how it works and your proposed method is not!

(One of the most fundamental physical constants is the fine structure constant, a dimensionless number with a current best value of 1/137.03599976 according to last year's data book. I suspect that you view it as a mistake by the Universe to have such a peculiar number, it should obviously have been

What does "corresponding" mean? Is a chemical used to produce something only deductible if there are detectable traces of it in the final product? Does transport of the product count? In reality there is no way to identify some things as being part of the final product and others not, a business is being fairly stupid if it spends money on things which don't contribute to its product, VAT or no VAT.

Because intermediaries and outsourcing companies make things much more efficient. The effect of your proposed changes would be to undo many of the changes of the last 10-15 years and go back to having huge integrated conglomerates. It also makes small companies much less competitive than large ones, which is the opposite of what the government generally seeks to achieve, in fact in many service areas you would probably make small companies completely non-viable.

Everything wrong with that. With VAT at anything like current levels it wouldn't be a factor, it would be absolutely decisive.

My proposed method is indeed not how it works, because what I'm proposing is a change. Without the change, i.e. with the system as it is, we are both right. The way it works is that the end users come up with all the tax cash, and this flows upstream in such a way that each middleman splits off an appropriate share of the tax money to pass straight to the taxman, and lets the rest flow upstream a bit further. The facts support both your way and my way of looking at it, and ways of looking at it is all they are.

If you have to consult a publication to see how much the "constant" has changed since last year, then yes, it does seem a bit peculiar.

Chemicals which pass straight through would "correspond", as would those which by reaction turn into something else which becomes an output. Catalysts would not.

Fortunately transport is VAT-free.

Perhaps it isn't always possible, but often it is. I have in mind tools and machines as the main targets for being ineligible for input VAT recovery. They are fairly obviously not bits of product, they are labour saving devices. Invest a few thousand pounds in spinning machines and you can throw 90% of your workforce out onto the bread-line. Why should the company not pay tax on the machine out of its profits when it would have paid taxes (albeit of a different kind - employer's NI) on the wages of their ex-workers?

Aha! Now we know why the economy is in such poor shape compared with

Small companies would possibly not be VAT registered anyway, and so would automatically already be operating on the basis of my proposal. Or maybe you didn't mean "small" to be quite that small.

If the outsourcing is basically pipelining the mainstream business activity, then yes, but you mentioned outsourcing catering and payroll, which are trivial fractions of the turnover of the companies which would be putting out such contracts, so incurring VAT on these services would have only second-order effects.

Fine. That's why the expenditure can be set against profit for purposes of corporation/income tax. VAT is different.

The same would be true if you took away the staff. But you can't reclaim the "input tax" associated with employing them either.

"Ronald Raygun" wrote

If both are right, then it is *not* "Nonsense" !!!

"Ronald Raygun" wrote

Interesting analogy - perhaps employer's NI should indeed be scrapped??! :-)

No they don't, because my "way of looking at it" results in the conclusion that the current method for attributing VAT is basically right, whereas yours results in the conclusion that there is a fairly large mistake. Occam's razor would suggest that the government has in fact done what it intended to do.

Ever heard of measurement errors? In fact the value comes with (50) at the end which means that the estimated one-standard deviation error is 50 in the last two digits. Given the three 9s that means the true value might be 1/137.036, but it's still not obviously a round number ...

I mean anything too small to make all its own inputs, e.g. making computer equipment starting from sand and iron ore, so anything smaller than about the size of IBM or BP.

It might be a small effect on the company doing the outsourcing, at least for each piece individually, but it would be the end of the companies to which things are outsourced. Bear in mind that for most companies a 1-2% change in costs is a big deal, with a profit margin of 10% that translates into 10-20% change in profit. You are suggesting adding 17.5% to the cost of anything which gets outsourced, which as I say will kill it stone dead in almost all cases.

(This is also why the increase in NI is a bigger deal than it appears, if a company has half its costs in wages and a profit margin of 10% then a 1% increase in NI is equivalent to 5% on the corporation tax rate.)

Both interpretations of "how it works" are the same, because they will add up to the same result. The difference lies in the perspective and which one is the One True Way of looking at what it's for and why it works the way it does. You mustn't take me too literally, as my tongue was not a million miles from my cheek.

NOW we're talking! And while we're at it, let's scrap employee's NI as well, and CT too (both kinds), not to mention CGT and IHT, and of course (since nobody seems to understand it properly) VAT too. We really only need one tax. Income tax.

"Ronald Raygun" wrote

I'm all for that! I would, of course, immediately begin aiming for capital gains rather than income, to minimise my tax burden... :-)

Or alternatively, an expenditure tax, since we don't get any benefit from income until we spend it.

Can you tell us what you are trying to do so we can better understand the point of your question?

They still claim it back.

What's your view of an accountant using a computer but selling his services? Should he have to pay VAT on the computer but not be allowed to reclaim it? I don't see why VAT can't be reclaimed if you are in business selling VATable goods and services. Your expenditure is with the intention of making VATable outputs.