Understanding Value-Added Tax (VAT): A Comprehensive Guide



Faisal, a small business owner, was reviewing his monthly expenses when he noticed something odd. Two receipts for the same product had different totals. One showed a price of 100 SAR, while the other listed 115 SAR. Confused, he dug deeper and realized the difference was due to Value-Added Tax (VAT). That moment sparked his curiosity: How does VAT work, and how can I calculate it correctly? Like Faisal, many business owners and individuals face similar questions. VAT isn’t just a line item on a receipt—it’s a critical part of pricing, compliance, and financial planning. In this article, we’ll break down how to calculate VAT easily, so you can navigate this essential tax with confidence.

Value Added Tax Definition

The Value Added Tax, commonly known as VAT, is a consumption tax that is applied to most goods and services. It is a type of indirect tax that is collected by businesses on behalf of the government at each stage of production and distribution. VAT is calculated as a percentage of the sales price of goods and services. This tax is prevalent in many countries around the globe, with varying rates depending on the region.

Businesses and individuals need to understand the mechanisms of VAT, as it directly affects the pricing and overall cost of goods and services. It also carries legal implications for businesses that are required to collect, report, and remit it to the government.

The Significance of Value-Added Tax in Today's Economy

The Value Added Tax (VAT) plays a pivotal role in today's global economy. It serves as a major source of revenue for governments, enabling them to fund various public services and infrastructure projects. Moreover, VAT promotes economic equality by distributing the tax burden among consumers based on their consumption patterns. This makes it a progressive tax system where individuals who consume more pay more taxes. Additionally, VAT helps maintain fiscal stability by providing a steady flow of income for governments, especially during economic downturns when other sources of revenue may decline.

How the Value-Added Tax Works

The Value Added Tax (VAT) is a consumption tax placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale. It involves a series of transactions between producers, suppliers, retailers, and end consumers.

Initially, when the manufacturer produces a product, VAT is applied to the materials cost. The manufacturer then sells the product to a retailer, charging VAT on the full price, while claiming back the VAT paid on the materials. The retailer, in turn, charges VAT to the customer on the full price and claims back the VAT paid to the manufacturer.

Thus, the actual tax burden is passed down the supply chain from producers to consumers. The final consumer, who is not able to claim back VAT, bears the full tax charged. This ensures that VAT is paid to the government at each stage of the product's lifecycle, but it is the consumer who ultimately pays the tax.

Understanding and Calculating Value-Added Tax (VAT).

Calculating the Value Added Tax: Adding the Tax to the Price

Calculating the Value Added Tax (VAT) involves adding a percentage of the original cost to the cost itself. In Saudi Arabia, the current VAT rate is 15%. This means for any product or service that you purchase, an additional 15% of the original cost is added as VAT.

Calculating Value Added Tax: Removing the Tax from the Price

When you need to determine the amount of VAT that was included in the total price of a product or service, you must perform a reverse calculation. Still considering a VAT rate of 15% in Saudi Arabia, if you have a product that costs 1150 SAR including VAT, you would like to know how much of that price was the VAT.

To do this, you'll divide the total amount by 1.15 (since 1 is the original price and 0.15 is the VAT). This gives you the original price before VAT. In this case, 1150 SAR ÷ 1.15 = 1000 SAR. The difference between the total price and the original price gives you the VAT amount, which in this case is 1150 SAR - 1000 SAR = 150 SAR. So, the VAT amount is 150 SAR.

In the above video, you will learn how to create a VAT return in Wafeq following a few simple steps.

Common Names for Value-Added Tax Calculation Services

The act of calculating VAT is a crucial one, and many services have been developed to facilitate it. These services can take various forms and have different names based on their specific features or the market they serve. Here are some common names for these services:

• VAT Calculator: This is the most basic form of service. It allows users to enter the price of a good or service and the VAT rate to calculate the final price or the VAT amount.

• VAT Software: These are more advanced tools that integrate with other systems like accounting or ERP software to automatically calculate VAT on transactions.

• VAT Compliance Services: These services are provided by tax professionals who ensure that businesses are properly calculating and paying their VAT liabilities.

• Online VAT Services: With the rise of digitalization, many services have moved online, allowing businesses to calculate, file, and pay their VAT obligations over the internet.

Methods of Calculating Value-Added Tax

Understanding the calculation methods of Value Added Tax (VAT) is vital for any business or individual subject to this form of taxation. There are two main methods to calculate VAT:

Adding VAT to the price: This involves multiplying the net price (without tax) by the VAT rate and adding this to the original price. This is typically used when businesses are setting prices for goods or services.

Removing VAT from the price: This involves deducting the VAT from the gross price (with tax). It's a more complex process which requires dividing the gross price by (1 + VAT rate). This is usually used when businesses need to know how much tax they've collected from sales. Each method serves a specific purpose and businesses often need to use both in their operations.

VAT Settlement Account

The VAT settlement account is a specialized account used by companies registered under the Value-Added Tax (VAT) system in Saudi Arabia. It records the difference between the output tax collected from customers (VAT due) and the input tax paid to suppliers (VAT recoverable). How Does It Work?

• Output Tax (VAT Due): This is the VAT a company charges on its sales of goods or services. For example, if a company sells a product for 10,000 SAR, the output tax would be 1,500 SAR (15% of 10,000).
• Input Tax (VAT Recoverable): This is the VAT a company pays when purchasing goods or services from suppliers. For instance, if a company buys raw materials for 5,000 SAR, the input tax would be 750 SAR (15% of 5,000).
• Settlement Process: At the end of the tax period (monthly or quarterly), the company calculates the difference between the output tax and input tax. If the output tax is greater than the input tax, the company pays the difference to the General Authority of Zakat and Tax (GAZT). Conversely, if the input tax is greater, the company can reclaim the difference from the authority.

Where to put VAT in financial statements?

When reviewing your monthly budget or your company’s general budget, you’ll notice that Value-Added Tax (VAT) appears in several places:

1. Purchase Invoices When you buy goods or services, VAT is clearly added to the invoice. For example, if you purchase an electronic device for 1,000 SAR, the VAT will appear as 150 SAR (15% of 1,000). This amount is included in the total payment you make.
2. Operational Expenses for Businesses If you run a company, VAT appears in your operational expenses, such as electricity bills, rent, or raw material purchases. This tax is considered part of the costs the company incurs before selling its products or services.
3. Tax Declarations: For companies registered under VAT, the tax appears in monthly or quarterly tax declarations. Here, the output tax (on sales) and input tax (on purchases) are calculated. The difference between the two determines the amount to be paid to or reclaimed from the General Authority of Zakat and Tax (GAZT). For example, when you buy a product or service, VAT is clearly added to the invoice. If you purchase an electronic device for 1,000 SAR, the VAT will appear as 150 SAR (15% of 1,000). This amount is included in the total payment you make.

Features of Our VAT Calculation System

Our VAT Calculation System is designed to make the process of VAT computation as seamless and accurate as possible. It includes a wide range of features, such as:

• Versatility: Our system is capable of both adding VAT to the net price and subtracting VAT from the gross price.
• User-friendly interface: With intuitive and straightforward controls, anyone can easily use the system, even without prior experience.
• Speed and efficiency: The system swiftly computes VAT, saving users valuable time.
• Accuracy: The system is designed to minimize errors and ensure precise VAT calculations.
• Up-to-date tax rates: Our system stays updated with the latest tax rates to ensure accurate calculations.

How Wafeq books VAT

Wafeq uses a system account called VAT to keep track of your Input and Output VAT. VAT is a liability account, because you will typically owe your tax authority the balance.

Wafeq records Output and Input VAT per tax rate in order to report the VAT amounts in each box of the VAT return.



The actual VAT Return may look slightly different depending on your tax authority's format. Wafeq will automatically generate the VAT return for you in supported countries.

Read more about How VAT works in Wafeq.