What is an ad valorem tax?

The term ‘ad valorem’ is Latin for ‘according to value.’ As the name suggests, this type of tax will change as a percentage according to the value of a specific purchase. Here’s everything you need to know about ad valorem taxes and how they’re calculated.

What is the meaning of ad valorem tax?

Ad valorem taxes are taxes determined by the assessed value of an item. One prime example is the Value Added Tax (VAT), which varies in percentage depending on the assessed value of the goods sold. Real estate is perhaps the most common area where ad valorem tax is levied, but it also extends to import duties and personal property.

How ad valorem tax works

Whether applied to a new car, luxury handbag, or house purchase, ad valorem taxes are based on the item’s determined value. Municipal property taxes are one of the most common applications of this type of taxation. In this case, a public tax assessor values real estate to determine the current market value. Tax is then computed and applied regularly by a government entity, fluctuating according to the assessed value.

By contrast, a sales tax is a flat transactional tax. It is only levied once, at the time of the transaction. Ad valorem taxes may be levied annually, as is the case with property taxes. 

What ad valorem tax is levied on

Ad valorem taxes can be levied on a wide range of different entities. In most cases, they’re levied by municipalities but can also be levied at the district, county, or broader government level. In the case of property, they represent a percentage of assessed real estate value or fair market value.

Ad valorem tax examples

An ad valorem tax is expressed as a percentage. For example, VAT is charged at a rate of 20% in the UK. A 20% ad valorem tax increases production costs by 20% at each level of output, if you consider the supply curve to be the same as a cost curve in an ad valorem tax diagram.

There’s flexibility involved in the percentages, as we’ll see in the ad valorem tax examples below.

Stamp duty

Stamp duty is a property tax that changes in percentage according to a property’s assessed value. Those whose houses are worth more will pay higher stamp duty. As of 2020, house purchases below £250,000 don’t incur any stamp duty. However, homebuyers will pay 5% for assets valued between £250,001 and £325,000, or 10% on purchases between £325,001 and £400,000. This adds a stamp duty tax of £7,500 to a home valued at £350,000.

Consumption tax

We’ve already mentioned that the VAT rate is 20% within the UK, but most countries charge their own form of this value-added tax, referred to as a ‘consumption tax’ because it’s applied to the final purchase price. Although the consumer pays higher prices, it’s an indirect tax because the retailer absorbs the cost. This type of ad valorem tax is levied on every stage of production, with the manufacturer and retailer both paying VAT at their respective stages.

Business implications of ad valorem taxes

Ad valorem taxes are widely used in transactions at every level, so businesses need to understand how they work. They’re applied by governments worldwide to collect revenue.

The main takeaway should be that this type of tax is determined by assessed value. Therefore, to accurately calculate ad valorem tax, you must determine the fair market value of your assets. This helps businesses stay on top of any tax implications from their sale or purchase.

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