Value Added Tax (VAT)

What It Is:

A value added tax (VAT) is a consumption tax added to a product's sales price. It represents a tax on the "value added" to the product throughout its production process. 

How It Works/Example:

The VAT system is invoice-based. Each seller in the product chain includes a VAT charge on the buyer's invoice. Under a VAT taxation system, all sellers collect the tax and then pay it to the government. The VAT gives sellers along the supply chain a direct economic motivation to collect the tax, thereby reducing the incidence of tax evasion. 

Don't confuse the VAT with sales tax. Under a sales tax, the tax is collected only once at the consumer's point of purchase. The VAT tax, however, is collected every time a business purchases products from other businesses within the product's supply chain.

Why It Matters:

The VAT is a highly efficient flat consumption tax that reduces the incidence of non-compliance. More than 100 countries have adopted it -- with rates ranging from 10% - 25%.

Investors who are looking for safer overseas investments should consider whether the prospective country uses a VAT, which indicates a more stable fiscal environment.