What Is Value Added Tax (VAT)?
A consumption tax charged at each stage with credits for business inputs.
Detailed Explanation
Rates and rules differ by country. Tax invoices must usually show VAT breakdown.
Example
A German B2B sale lists 19% VAT on a compliant tax invoice.
Why It Matters
Wrong VAT blocks deductions and invites audits.
Key facts
- VAT (Value-Added Tax) is a consumption tax applied at each stage of production/distribution where value is added — collected by sellers but ultimately paid by the final consumer.
- VAT is used in 175+ countries including the entire EU, UK, Australia (as GST), Canada (as GST/HST), China, India (as GST), South Africa, and most of South America.
- EU VAT rates range from 17% (Luxembourg) to 27% (Hungary). Standard UK VAT rate is 20%. Most countries also have reduced rates (5-10%) for essentials like food, books, and medicine.
- Businesses can typically reclaim VAT they've paid on business inputs (input tax credit) by offsetting it against VAT they've collected on sales (output tax) — net amount goes to the tax authority.
- VAT registration thresholds vary widely: UK £90,000, Germany €22,000, France €37,500, Australia AU$75,000. Below threshold = optional registration; above = mandatory.
How it shows up in practice
A UK consultancy is VAT-registered (over the £90,000 threshold). They invoice a London client £6,000 + 20% VAT = £7,200 total. In the same quarter, they paid £400 VAT on business expenses (software, travel, equipment). At quarter-end, they owe HMRC £1,200 VAT collected − £400 VAT paid = £800 net. The client, being VAT-registered, reclaims the £1,200 VAT they paid — net cost to them is just the £6,000.
Common mistakes
- Not registering when crossing the threshold — back-VAT liability plus penalties can be severe.
- Charging VAT before being registered — illegal in most jurisdictions; must wait for registration confirmation.
- Forgetting to add VAT to invoices for taxable supplies — you owe the VAT regardless of whether you collected it from the customer.
- Confusing zero-rated supplies (0% VAT, can reclaim input VAT) with exempt supplies (no VAT charged, cannot reclaim input VAT) — meaningful financial difference.
- Mishandling cross-border B2B transactions — usually subject to reverse charge where the buyer accounts for VAT, not the seller.
Frequently asked questions
What's the difference between VAT and sales tax?
Sales tax (U.S. style) is collected only at the final retail sale. VAT is collected at every stage of production/distribution, with each business reclaiming what they paid. Net effect on the consumer is similar; administration is very different.
Do I need to register for VAT?
Mandatory if your taxable turnover exceeds the registration threshold in your country (varies: UK £90K, Germany €22K, France €37.5K, etc.). Optional voluntary registration is available below threshold and may be beneficial if you have significant input VAT to reclaim.
What's reverse charge VAT?
A B2B mechanism where the buyer (not the seller) accounts for VAT on certain transactions — common in cross-border services within the EU and for specified domestic services (construction, scrap metal, telecom). Simplifies cross-border trade but requires buyer's tax compliance.
Can I reclaim VAT on all business purchases?
No — most business inputs are reclaimable but exceptions exist: client entertainment (often non-reclaimable), private use of business assets, certain capital purchases requiring specific treatment. Always consult VAT-specific guidance for your jurisdiction.
What about VAT on digital services to international customers?
Complex — EU's MOSS/OSS scheme requires sellers of digital services to EU consumers to charge VAT at the customer's local rate. UK has its own post-Brexit rules. Many small sellers use specialized tax-automation tools (Quaderno, TaxJar Digital) to handle this.
Related Resources
Last verified: May 2026
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