How traders calculate ex-VAT prices of goods

 By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

19 January 2014

Keegan Kerugo, a medicine student at the University of Nairobi, is confused about the way traders calculate VAT. He writes: “From my high school mathematics, I understand that the government charges a 16% VAT on supermarket goods. How comes the tax charged and the total cost of goods in the supermarket doesn't tally?

"From my calculation of the supermarket receipts, if the total cost of goods is KSh1,000 [then] 86.2% of this value is taxed. That is, KSh862 (the VAT-ABLE amount). Hence 16% of this value gives us the VAT. So 16% of 862 = KSh138. So where does the figure 86.2% come about?

“On another point of view, this method of coming up with the VAT is less costly compared with using the initial value of KSh1,000 which could have come to KSh160.”

If I understand you correctly Keegan, you are wondering why a product valued at Sh1,000 should attract VAT of Sh138 instead of Sh160. Well the answer lies in whether the Sh1,000 is inclusive of VAT or exclusive. Notice that in normal usage, these terms do not refer to whether the item is VAT-able or not: they only indicate whether the listed price includes or excludes the tax.

If, on the one hand, the Sh1,000 is exclusive of VAT, then it means that the buyer will have to pay an additional 16% on the listed price at the time of purchase; that is, add Sh160 to make a total of Sh1,160.

If, on the other hand, the Sh1,000 is inclusive of VAT, then the trader is saying he has already calculated the 16% tax and, after adding it to the value, the total amount payable comes to Sh1,000.

In this second scenario, the simple mathematical problem is this: the value of the item is X shillings; when you add 16% VAT to this, you get Sh1,000. That is, X plus 16% of X = 1,000.

We can write this as a formula thus: X + 0.16X = 1,000.

This simplifies to 1.16X = 1,000.

Therefore X = 1,000/1.16 = 862.07.

Thus the trader is saying that the value of the product is Sh862.07 and when you add 16% VAT, the total payable is Sh1,000.

Now, it may well be that the trader had calculated that the fair value (including his costs and profit margin) should be Sh850. When he added 16% VAT to this, he got Sh986. Then he wondered where he would be getting the Sh14 change each time a customer paid with a KSh1,000-note. So, he rounded off the selling price to Sh1,000 and then worked backwards to find the new ex-VAT value.

If my memory serves me right, the VAT Act prohibits traders from listing prices exclusive of VAT. So the common practice where many shops quote seemingly low prices only for buyers to be hit with the 16% VAT at the time of purchase is actually illegal! I wish the authorities could put and end to this kind of trickery.