Input tax

By:

Arti

Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.

Reviewed by:

James Knight

James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.

Updated:  Jun 19, 2024

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4 min read

3 key takeaways

• Input tax is the VAT paid by businesses on their purchases of goods and services used for business activities.
• Businesses can reclaim input tax as a credit against their output tax, which is the VAT they charge on their sales, thus lowering their overall VAT liability.
• Proper documentation and compliance with tax regulations are essential for businesses to successfully reclaim input tax credits.

What is input tax?

Input tax is the VAT a business incurs on its purchases of goods and services used in the course of its business. When businesses buy products or services, they pay VAT to their suppliers. This VAT is considered input tax. In many VAT systems, businesses can reclaim this input tax by offsetting it against the VAT they collect from their customers on their sales (output tax). The difference between the output tax and the input tax is the amount of VAT the business must pay to the tax authorities.

How input tax works

VAT Registration: To reclaim input tax, a business must be registered for VAT. VAT-registered businesses are required to charge VAT on their sales (output tax) and can reclaim VAT on their purchases (input tax).

Reclaiming Input Tax: When preparing their VAT return, businesses calculate the total input tax paid and the total output tax collected. If the output tax exceeds the input tax, the business pays the difference to the tax authorities. If the input tax exceeds the output tax, the business can typically reclaim the difference or carry it forward to offset against future VAT liabilities.

Eligibility: Not all input tax can be reclaimed. To be eligible, the purchases must be directly related to the business activities, and proper VAT invoices must be provided. Certain types of purchases, such as those for personal use or certain exempt activities, may not qualify for input tax credits.

Example of input tax in action

Example: Retail Business

A retail business buys goods from a wholesaler for resale. The wholesaler charges VAT on the sale. The retail business also incurs VAT on various expenses such as rent, utilities, and office supplies.

• Purchases from Wholesaler: £10,000 + £2,000 VAT (input tax)
• Expenses (Rent, Utilities, Supplies): £5,000 + £1,000 VAT (input tax)
• Total Input Tax: £2,000 (wholesaler) + £1,000 (expenses) = £3,000

The retail business sells its goods to customers and charges VAT on these sales.

• Sales to Customers: £20,000 + £4,000 VAT (output tax)

When the retail business files its VAT return, it will offset the input tax against the output tax.

• Output Tax: £4,000
• Input Tax: £3,000
• VAT Payable to Tax Authorities: £4,000 – £3,000 = £1,000

In this example, the retail business would pay £1,000 to the tax authorities after reclaiming the input tax.

Importance of input tax

Cash Flow Management: Reclaiming input tax can significantly improve a business’s cash flow by reducing the net amount of VAT it needs to pay to the tax authorities.

Cost Control: Properly managing input tax helps businesses control costs and maintain competitive pricing by minimizing the VAT burden.

Compliance: Accurate tracking and reporting of input tax are essential for compliance with VAT regulations and avoiding penalties or audits.

Challenges and considerations

Record Keeping: Businesses must maintain accurate and detailed records of all purchases and related VAT invoices to reclaim input tax successfully.

Regulatory Compliance: Ensuring compliance with VAT regulations is crucial. Businesses must stay updated on changes in VAT laws and regulations to correctly claim input tax credits.

Partial Exemption: Businesses involved in both taxable and exempt activities may face challenges in reclaiming input tax. They may need to apportion input tax based on the percentage of taxable activities.

International Transactions: For businesses involved in cross-border transactions, reclaiming input tax can be complex due to different VAT systems and regulations in different countries.

Related topics

• Value-added tax (VAT)
• Output tax
• Tax compliance
• VAT registration

Explore these related topics to gain a deeper understanding of how VAT systems work, the importance of input and output tax management, and the best practices for ensuring compliance and optimizing tax liability for businesses.