Indirect taxes
Company formation and accounting in Latvia
Last updated: 2017-01-07

Indirect taxes. Meaning.

Indirect taxes are included in price (or added to price) and these taxes relates with circulation of goods and services. Name “indirect taxes” means that a payer pays these taxes indirectly, through another person.

The government may levy indirect taxes on consumption, expenditures, privileges (rights), but not on the income or property.

Indirect taxes may also be called as consumption taxes. Indirect taxes are introduced (invented) later in comparison to direct taxes. Many of indirect taxes are related with recording (bookkeeping / accounting), registration of transactions and reflection in documents and calculations. Indirect taxes are: value added tax, sales tax, excise, tax on electricity, transport taxes and customs.

According to publicly available information, revenues of Latvian government from indirect taxes is about 42% of all tax revenues.

Who must pay indirect taxes and must transfer to government?

Actual payers of indirect taxes are end customers (end buyers of goods and recipients of services). Sellers and service providers only collect the taxes and transfer them to the state budget. Indirect taxes as if pass on from one taxpayer to another taxpayer (the buyer of goods and services).

For example, a company – manufacturer produced clothes and sold to a shop (retail seller). The retail seller paid to the manufacturer for the clothes (goods). Price of the goods includes, for example, materials, work, profit, and indirect taxes such as value added tax. The manufacturer must transfer the received VAT to the state budget.

The retailer adds mark-up to the purchase price and imposes VAT on full amount. A natural person for personal needs purchases clothes and pays to the retailer. The retailer transfers to the state budget part of received VAT. As a result, the natural person - the final purchaser has paid the VAT to the state budget by (through) the retailer and manufacturer of clothing.

Therefore, the actual payer of indirect taxes is not the one who transfers the indirect taxes to the state budget (contrary to direct taxes, where the actual payer pays taxes to the state budget). The buyer even may not be aware that paying indirect taxes.

The impact of indirect taxes on persons with different income.

The rate and amount of indirect taxes does not depend on income of a payer (for comparison, for example, the amount the direct tax - personal income tax depends on the income of particular individual). It means that the indirect tax burden is higher for low-income individuals than for those with high incomes. It is because all persons, regardless of income, for the same volume of consumption pay the same amount of indirect taxes. For example, for the poor and the rich price of computer in a shop is the same (and the poor and the rich for the computer must pay the same amount of indirect taxes).

From the above it follows that indirect taxes are regressive taxes (the amount of the taxes does not depend of a particular person's solvency or ability to pay these taxes).

Taxable object.

Indirect taxes are levied on goods (products) during sale / purchase or on rendered services (indirect taxes not directly levied on income). Indirect taxes increase the price of goods and services for the end user.

Classification of indirect taxes.

Indirect taxes may be divided to:
  • Individual indirect taxes (excise tax). Indirect taxes increases price of goods only one time. For example, if several intermediaries sell goods, then each intermediary adds his margin to the price of goods, but does not add the excise tax.
  • Universal indirect taxes (the value added tax). If several intermediaries (VAT payers) resell goods / services, then each intermediary increases the price for his margin and also increases the price for VAT, calculated from the margin. So, unlike the excise tax, VAT is added multiple times to the price of goods.

Customs duty (tax) can be divided to:
  • the tax on import,
  • the tax on export,
  • the tax on transit.

Types of indirect taxes.

  • Special taxes, applicable to each item of goods / services. Fixed amount of tax is applicable to each item of gods / services.
  • Ad valorem taxes. A tax is calculated proportionally to price of goods or services.
Income from ad valorem taxes usually increases, if increases economics of a state. So it is not necessary frequently to change tax rates.

Division to direct and indirect taxes is related with:

  • Features of withholding of taxes. Indirect taxes from actual payer withholds intermediaries. Government determines persons that withhold and transfer taxes, but government does not determine the tax burden (distribution) between actual payers and intermediaries for withholding and payment of taxes.
    For example, if government changes rate (amount) of indirect tax, then changes in price of goods and services does not always corresponds to the change of tax rate (amount).
    Responsibility (obligation) before government for payment of indirect taxes has a mediator, but does not have actual payer.
  • Activities of actual payer. The more the actual payer consumes (buys goods and receives services) the higher amount of indirect taxes must pay. Actual payer has no obligation to report to government about paid indirect taxes.
  • Taxable object. Consumption (purchases of goods and receiving of services) is taxable object. The same corporeal (physical) thing may be subject to both, - direct taxes (because of ownership) and indirect taxes (because of alienation of physical thing).

The aim of indirect taxes.

  • To generate tax income for government.
  • To prevent consumption of "unhealthy foods" or foreign goods.
  • To encourage the consumption of "good" products and products, made by domestic manufacturers.

The most common reports, related to indirect taxes.

  • The value added tax declaration. Depending on type and amount of transactions, a taxpayer must submit declaration once per month, 3 or 6 months. In general, a taxpayer specifies amount of calculated (received or receivable) VAT and specifies amount of deductible VAT (paid or payable to other persons). The difference between calculated and deductible VAT a taxpayer must pay to the budget of government.
  • Different reports, related with excise tax. Must submit during 5-15 after the end of taxation period.




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