What is VAT?

VAT, short for value added tax, is a consumption tax charged on goods and services at each step of the supply chain. Businesses collect it from customers, subtract the VAT they paid on their own purchases, and send the difference to the tax authority. The end consumer ultimately bears it.

How it works

VAT is used in the European Union, the United Kingdom and many other countries. Each country sets its own rates and rules, and most have a standard rate plus reduced rates for certain items. The UK standard rate, for example, is 20 percent, while Germany’s is 19 percent.

The mechanism has two sides. Output VAT is the VAT you charge on your sales. Input VAT is the VAT you pay on business purchases. Each period you file a return and pay the difference. If input VAT is larger, you may get a refund or credit.

For this to work, the invoice matters. A VAT invoice usually shows the seller’s VAT number, the net amount, the rate, the VAT amount and the gross total. The buyer needs that document to reclaim input VAT. For the exact fields, read the guide on VAT invoice requirements.

Cross-border sales add wrinkles. Between businesses in different countries, a rule called the reverse charge can shift the responsibility to the buyer. Rules for digital services sold to consumers differ again. This is general information, not tax advice, so confirm details with your tax authority or accountant.

Example

Follow a wooden table through three businesses at a 20 percent VAT rate.

An invoice from the carpenter would show net $300.00, VAT $60.00 and total $360.00. Use the free invoice generator to add a tax line with your own rate today. PayToMe is in public beta, and you can sign in to PayToMe to create and send invoices today.

Related terms

• VAT number: the registration number that appears on VAT invoices.
• Reverse charge: shifts VAT accounting to the buyer.
• Sales tax: the single-stage US alternative.
• E-invoicing: structured digital invoices increasingly required for VAT.