Understanding Today's VAT

What is VAT?

Value-Added Tax (VAT) is an indirect consumption tax used in more than 150 countries including China, India, and the European Union. VAT registered merchants collect VAT from their customers and pay the government the difference between the total VAT collected and total VAT paid by the merchant to acquire resources to produce the goods sold. This difference is the "value-added" to the good by the merchant.

Learn how VAT works with Will Freil from Avalara

Breaking it Down

Step 1

Lumber Company sells Lumber to Furniture Maker

Furniture Maker pays the Lumber Company 55€.

Lumber Company pays the Government 5€.

50€ Price of Lumber
10% VAT Price
5€ VAT amount

5€ Initial VAT Paid

Total VAT is 5€.

The Government receives 5€ from the Lumber Company.

Step 2

Furniture Maker sells furniture to a Retail Store

Retail Store pays the Furniture Maker 132€.

Furniture Maker pays the Government 7€.

120€ Price of Furniture
10% VAT rate
12€ VAT amount

12€ - 5€ = 7€ VAT Paid

Total VAT is now 12€.

The government already received 5€ from the Lumber Company, so 7€ is owed by the Furniture Maker to the Government.

Step 3

Retail Store sells furniture to a Consumer

Consumer pays the Retail
Store 165€.

Retail Store pays the
Government 3€.

150€ Price of Furniture
10% VAT rate
15€ VAT amount

15€ - 12€ = 3€ VAT Paid

Total VAT is now 15€.

The Government already received 12€ from the Lumber Company and the Furniture Maker combined, so 3€ owed by the Retail Store to the Government.

VAT in the European Union (EU)

This VAT website focuses on the EU's system of VAT collection for digital/electronic services. A merchant may be required to register and collect VAT in a member state of the EU when they have a physical presence in that member state or their annual sales in the member state reach a certain volume. See full list of EU countries.

General EU VAT Rate Rules

This is a simplified summary of current EU VAT rate rules. Please visit the European Commission's website for full rule details.

1. Sale Within Same EU Country

The country rate of the merchant is applied, which equals the customer's country rate.

2. Sale Between Different EU Countries

The country rate of the merchant is applied. If the customer is in a country that is in the merchant’s nexus jurisdiction, the country rate of the customer is applied.

3. Sale Between a Non-EU Country and an EU Country

If the customer is in the EU and the merchant is outside of the EU, the customer's country rate is applied. If the customer is outside the EU and the merchant is in the EU, no VAT is applied.

4. Sale to a VAT Registered Business

If a customer is in an EU country that is different than the merchant’s country and identifies themselves as a VAT registered business by providing a valid VAT number, VAT is not applied to the sale. The customer is responsible to pay VAT to the government themselves, at the customer's country rate. This is often called a Reverse Charge.”

EU VAT Invoicing

The EU VAT rules around invoicing focus on providing information about what was purchased, by whom, from whom, and the VAT details. In addition to normal invoice best practices, here are some important EU VAT invoicing rules:

  • Display the merchant's VAT number.
  • Display the customer's VAT number if one is provided.
  • Invoice text must be presented in the customer's local language.
  • VAT amount must be displayed in the customer's local currency.
  • If no VAT is applied, exempt or reverse charge notes must be provided.

EU VAT Changes for 2015

The European Commission issued EU VAT rule changes that went into effect January 1, 2015. The main rule change is that the applied country rate for digital/electronic services will now be the place of consumption, where the customer is located. Read the EU VAT rules.