Question

1. A farmer sells wool to a textile company for $20, collects $2 in tax ($20 times 10 percent), and sends the $2 to the government. (The farmer's value added equals sales less purchases; that is, 20 minus 0 equals 20, making the simpli­fying assumption that the totally self-sufficient farmer buys nothing from any business but grows or makes everything herself.) The textile company receives the wool, for which it has paid $20 plus $2 tax, or $22, and a state­ment showing that it paid $2 in VAT. The text worked the logic of a VAT through a production-distribution process from a farmer to the final customer (above). Work the same process through with a 10 percent turnover or gross receipts tax. Assume that value added at each stage is the same as before, but that no credit for prior tax paid is provided and that each sales price equals tax-inclusive cost of purchases, plus value added at that stage, plus the 10 percent tax. Compute the final price paid by the consumer and the effective tax rate as a percentage of total value added. Make the same computa­tion, assuming the sweater manufacturer and the retailer merge (i.e., there is no taxable sale in this exchange).

Answer 1

Additional point to remember : when credit of Taxes paid at earlier stages is not allowed to take, product cost will increase by tax rate at each stage. It is called cascading effect i.e. Tax on Tax

In normal cases where set off allowed, Tax effect stays only on Value added portion.

If you have any queries in answer, Kindly drop a comment in coment box, i will solve it earliest.