Understanding VAT: A Complete Guide for Businesses and Consumers

What is VAT?

Value Added Tax (VAT) is a consumption tax assessed on the value added to goods and services. It applies to more or less all goods and services that are bought and sold for use or consumption. Thus, goods which are sold for export or services which are sold to customers abroad are normally not subject to VAT.

Unlike a traditional sales tax, which is only collected at the final point of sale to the consumer, VAT is collected at every stage of the supply chain where value is added to the product.

How VAT Works in Practice

Imagine a simple supply chain for a wooden chair:

1. The Logger: Sells wood to a furniture maker for $100 + $20 VAT. The logger sends $20 to the government.
2. The Furniture Maker: Turns the wood into a chair and sells it to a retailer for $200 + $40 VAT. The maker collected $40 but paid $20 to the logger. They send the difference ($20) to the government.
3. The Retailer: Sells the chair to you (the consumer) for $300 + $60 VAT. The retailer collected $60 but paid $40 to the maker. They send the difference ($20) to the government.
4. You (The Consumer): You pay $360 total. You bear the full burden of the $60 tax.

In this example, the government receives $20 + $20 + $20 = $60 total, which is exactly 20% of the final sale price ($300).

VAT vs. Sales Tax: What's the Difference?

While both are consumption taxes, they work differently:

• VAT is collected at every stage of production. It minimizes tax evasion because businesses have an incentive to record transactions to claim back the VAT they paid.
• Sales Tax is only collected when the final product is sold to the consumer. If the retailer fails to collect it, the government loses the entire tax amount.

For Businesses: Input and Output Tax

If you run a VAT-registered business, you need to understand two key concepts:

• Output Tax: The VAT you charge your customers on the goods or services you sell.
• Input Tax: The VAT you pay to your suppliers on business purchases.

Generally, you pay the government the difference between your Output Tax and Input Tax. If your Input Tax is higher (e.g., you bought a lot of stock), you may be eligible for a refund.

Who Needs to Register for VAT?

Not every business needs to register for VAT. Most countries have a VAT threshold. If your taxable turnover exceeds this amount over a 12-month period, you must register.

• UK Threshold: £90,000 (as of 2024/25)
• France Threshold: €91,900 for goods, €36,800 for services
• Germany Threshold: €22,000

Voluntary registration is also possible and can be beneficial if you sell mostly to other VAT-registered businesses, as it allows you to reclaim VAT on your expenses.

Conclusion

VAT is a fundamental part of the modern economy. For consumers, it's a tax on spending. For businesses, it's a pass-through tax that requires careful accounting but doesn't directly impact profits if managed correctly.

Ready to do the math? Head over to our VAT Calculator to handle your calculations in seconds.