Direct vs indirect tax schemes

What is VAT?

For a native of a relatively tax-free haven like Dubai, an introduction to government schemes for collecting revenues can be a cold, cruel revelation. For expatriates from tax weary European countries and the US it is old news. The two things you can't avoid, the old saying goes, are death and taxes.

Tax schemes fall into two broad categories: direct and indirect. Direct taxes usually take the form of an income tax on personal or business earnings. A European earning 50,000 euros (Dh231,695) per year, for example, might pay the government 15,000 euros or more of that amount in direct income taxes. The same basic idea applies to taxable businesses.

As opposed to a direct tax on income, indirect taxes are usually based on value and are associated with consumption. They are indirect because they are usually collected from an intermediary - the manufacturer, shipper or retailer - and thus indirectly become part of the purchase price to the end consumer.

The value added tax (also known as a goods and service tax or GST) and sales taxes are both examples. A sales tax is added when the final good is sold to the end consumer. For example, the New York City sales tax is 8.38 per cent of the sales price.

The major difference between a VAT and a sales tax is that a VAT is generally charged at every stage in the supply chain and is ultimately borne by the final consumer. However a sales tax is only charged on certain goods at a given point. As a result, a sales tax may be charged not only to a final consumer but to businesses as well, and therefore can result in a cash cost to business.