The rationale for the application of new tariffs by the US Government has expanded to include value-added tax (VAT). This development arrives as the challenges of imposing reciprocal tariffs against Europe and the UK collide with the reality of historically low tariffs on American goods entering those countries. Consequently, the conversation—which some might characterize as hyperbole—has broadened to include non-tariff obstacles. (Spoiler alert: VAT is not one of them).
Key Takeaways for Importers
- VAT is a consumption tax: It applies nationally to both domestic and imported goods, meaning it is not a discriminatory non-tariff barrier.
- Duty is a sunk cost: Import duties protect domestic industries and are generally non-recoverable.
- VAT is often recoverable: Registered businesses can typically claim back the VAT paid on imports, making it a cash flow consideration rather than a final expense.
VAT and Non-Tariff Barriers to Trade Explained
Understanding the difference between VAT on imports and import duty is crucial for businesses engaged in international trade. A simplified way to view VAT is as a sales tax. However, while the USA sales tax applies at the state and local levels, VAT is applied consistently at the national level.
For context, while state and local sales taxes in the US average less than 10 percent, VAT in Europe and the UK averages around 20 percent.
Value Added Tax vs. USA Sales Tax
VAT is imposed at every stage of the supply chain process (taxing the "value added" at each step). While businesses pay VAT, they can claim back the VAT paid on all their business purchases. This mechanism ensures there is no escalating or cumulative tax burden on the final finished product. By contrast, most businesses in the US are unable to claim back the sales tax they pay on intermediate purchases.
- VAT is a national tax, whereas US sales taxes are based on the local rate where the goods are consumed.
- If a European resident orders from a US retailer, they do not pay US sales tax.
- A European business (or a business in any other country with a VAT regimen) does not charge US consumers VAT.
Nearly half of US sales tax revenue comes from business-to-business intermediate transactions. Unlike VAT, this cost accumulates with every purchase made by US producers. The reclaiming mechanism built into VAT successfully avoids this duplication of tax.
The Rise of Non-Tariff Barriers
With the general lowering of tariffs over the last several decades, there has been a corresponding rise in what are known as non-tariff barriers. Learn more about non-tariff barriers.
Non-tariff barriers include requirements such as specific product certifications. While many can be viewed as reasonable restrictions necessary for public well-being and safety, others are criticized as unfair trade limitations. Common examples include:
- Licensing Requirements
- Technical Barriers to Trade (TBT)
- Sanitary and Phytosanitary (SPS) Measures (mostly related to agricultural products)
- Quotas and Restrictions
- Documentation and Customs Procedures
- Standards and Labeling Requirements
- Government Procurement Policies
- Local Content Requirements
- Investment Restrictions
- Environmental and Safety Standards
- Intellectual Property Issues
- Foreign exchange restrictions and exchange rate deviations
READ MORE: IMPORT DUTY EXPLAINED
Why VAT is Not a Non-Tariff Barrier
Historically, value-added tax was never considered a non-tariff barrier because VAT applies universally to all goods—whether they are imported or produced domestically.
Rather than being discriminatory against imports, international e-commerce companies actually benefited from VAT loopholes several years ago by shipping low-value orders tax-free. This heavily disadvantaged local domestic businesses. Authorities rectified this discrepancy, and now VAT applies to all goods regardless of their value or duty status.
Value Added Tax Versus Import Duty
Value Added Tax (VAT) and import duty are two distinct financial assessments that apply to imported goods. They serve entirely different economic purposes and are calculated using different methodologies. Let us break down these key differences to help importers manage their tax obligations effectively.
- Duty is not recoverable and only applies to imported goods.
- VAT is charged on both domestic goods and imported goods.
- VAT paid on imported goods can frequently be claimed back by the importing business.
- Import Duty rates are levied based on specific categories and classifications of goods.
Import duty is a direct tax usually levied as a percentage of the value of the imported goods. Its primary design is to protect domestic industries from foreign competition and generate revenue for the national government.
Calculation Methods: Duty vs. VAT
Import duties are usually calculated based on three primary factors:
- The customs value of the goods (read more about value for duty)
- The specific commodity code (read more about HS codes)
- The originating country (read more about country of origin rules)
VAT calculation is generally a straightforward fixed percentage applied to the total value of the goods plus any applicable import duties. While VAT rates vary by country, they are universally applied as a flat percentage, though reduced VAT rates exist for specific essential items.
The Crucial Difference: Recoverability
The most important distinction between these two costs lies in how businesses can recover them. Import duties represent a final cost. They act as a sunk cost that importers must permanently factor into their pricing models and cost of goods sold.
VAT, on the other hand, is typically recoverable for registered businesses. When a company imports goods for commercial use, they can usually reclaim the VAT paid at the border through their regular periodic VAT returns. This mechanism transforms VAT from a final expense into a temporary cash flow consideration.
Understanding these fundamental differences between VAT and import duty is essential for businesses trying to stay informed on ongoing free trade discussions between international trading partners.
