Value Added Tax (VAT) is a consumption tax added to products and services at each stage of production and distribution, ultimately paid by the end consumer.

Unlike sales tax (added only at final sale), VAT is collected incrementally throughout the supply chain.

Calculation methods: (1) Add VAT to price—if selling £100 item with 20% VAT, charge £120 total (£100 + £20 VAT), formula: Final Price = Net Price × (1 + VAT Rate); (2) Remove VAT from price—if gross price is £120 including 20% VAT, net price is £100 (£120 ÷ 1.20), formula: Net Price = Gross Price ÷ (1 + VAT Rate).

Business example: manufacturer sells to wholesaler for £50 + £10 VAT (20%) = £60 total, wholesaler sells to retailer for £75 + £15 VAT = £90, retailer sells to consumer for £100 + £20 VAT = £120.

Each business pays VAT only on the value they added: manufacturer pays £10, wholesaler pays £5 (£15 collected minus £10 paid), retailer pays £5 (£20 collected minus £15 paid), total government revenue £20.

Common rates globally: Standard rate (most goods/services): UK 20%, Germany 19%, France 20%, Spain 21%, Italy 22%, Sweden 25%.

Reduced rate (food, books, medical): UK 5%, EU 5-13%.

Zero rate (exports, some essentials): 0%.

Exempt (financial services, education): no VAT charged or recoverable.

VAT rates vary dramatically across 170+ countries that use VAT systems (or GST/Goods and Services Tax equivalent).

Europe (highest rates): Hungary 27% (highest globally), Denmark/Sweden/Norway 25%, Finland/Greece/Ireland 23%, Poland/Portugal 23%, Italy 22%, Belgium/Netherlands/Spain 21%, Germany/UK 19-20%, France 20%, Luxembourg 17% (lowest EU), Switzerland 8.1% (not EU).

Americas: Canada 5% GST (federal) + 0-10% provincial, Mexico 16%, Brazil 17-25% (varies by state and product), Argentina 21%, Chile 19%, Colombia 19%.

Asia-Pacific: Japan 10%, Australia 10% GST, New Zealand 15%, China 13%, India 5-28% (tiered system), Singapore 9%, South Korea 10%, Indonesia 11%, Thailand 7%, Vietnam 10%.

Middle East/Africa: UAE 5%, Saudi Arabia 15%, Egypt 14%, South Africa 15%, Kenya 16%, Nigeria 7.5%.

No VAT countries: United States (uses state sales tax instead 0-10%), Hong Kong (no VAT/sales tax), most Middle Eastern oil states.

Rate complexity: many countries have multiple tiers—UK has 20% standard, 5% reduced (children's car seats, energy), 0% zero-rated (food, books), exempt (financial services).

Ireland: 23% standard, 13.5% reduced (hotels, restaurants), 9% reduced (newspapers), 4.8% livestock, 0% exports.

Business consideration: selling digital services into EU requires charging customer's local VAT rate (French customer pays 20% French VAT even if seller is UK-based), mini one-stop shop (MOSS) simplifies multi-country VAT compliance.

VAT and sales tax both tax consumption but differ fundamentally in collection method, burden distribution, and business impact.

Collection Method—Sales tax (USA): single-stage tax collected only at final point of sale to consumer, retailer adds 5-10% tax to purchase price and remits entire amount to government, businesses pay no tax on inputs used to create products.

VAT (global): multi-stage tax collected at each level of production and distribution, each business in supply chain charges VAT on sales and deducts VAT paid on purchases, only net amount remitted to government.

Business Impact—Sales tax: businesses exempt from tax on wholesale purchases (using exemption certificates), only final consumers pay tax, simple for businesses (collect and remit), but encourages tax evasion at retail level.

VAT: businesses pay VAT on all purchases but recover it through credits against VAT collected on sales (input VAT vs output VAT), more administrative burden requiring detailed VAT accounting, harder to evade because government collects tax multiple times through supply chain.

Example comparison: $100 product journey—Sales Tax System: Manufacturer sells to wholesaler $50 (no tax), wholesaler to retailer $75 (no tax), retailer to consumer $100 + $8 sales tax = $108, government receives $8 from single transaction.

VAT System (20% rate): Manufacturer sells $50 + $10 VAT = $60, pays $10 to government.

Wholesaler buys for $60 (reclaims $10 input VAT), sells for $75 + $15 VAT = $90, pays $5 net to government ($15 collected - $10 paid).

Retailer buys for $90 (reclaims $15), sells for $100 + $20 VAT = $120, pays $5 net ($20 - $15).

Government receives $20 total from three transactions.

Revenue efficiency: VAT typically generates 6-8% of GDP in revenue vs sales tax 1-2% because harder to evade.

Administrative cost: VAT requires more business compliance (quarterly filings, detailed records) vs sales tax simpler monthly returns.

Geographic scope: 170+ countries use VAT, USA is only major economy using sales tax (though 5 states have no sales tax at all: Alaska, Delaware, Montana, New Hampshire, Oregon).

VAT-registered businesses operate as tax collectors for government, charging output VAT on sales and reclaiming input VAT on purchases, remitting the difference quarterly.

Input VAT (VAT paid on business expenses)—deductible on: inventory purchases for resale, raw materials and supplies, business equipment and machinery, professional services (accounting, legal), office rent and utilities, business vehicles and fuel, computers and software, advertising and marketing.

Non-deductible: client entertainment (meals, events), personal use items, purchases for VAT-exempt activities.

Example: £10,000 equipment purchase includes £2,000 VAT (20% rate), business claims £2,000 refund or credit against output VAT.

Output VAT (VAT charged to customers)—must charge VAT on all taxable sales: goods sold, services provided, rental income, online sales to domestic customers, imports from outside EU (UK context).

Calculate: £5,000 service fee × 1.20 = £6,000 invoice (£5,000 + £1,000 VAT).

VAT Return Calculation (quarterly)—Output VAT collected: £50,000 sales × 20% = £10,000.

Input VAT paid: £30,000 expenses × 20% = £6,000.

Net VAT owed: £10,000 - £6,000 = £4,000 payment to HMRC.

If input > output (more expenses than sales), government issues refund.

Cash vs Accrual Accounting: Standard (accrual) scheme—account for VAT when invoice issued/received regardless of payment, required for businesses over £1.35M revenue (UK).

Cash accounting scheme—account for VAT only when cash actually changes hands, cash flow advantage for small businesses, available up to £1.35M revenue.

Flat Rate Scheme—simplified VAT for small businesses (<£150K revenue), charge customers standard 20% VAT but remit flat percentage (typically 12-14.5% of gross turnover), keep difference as compensation for irrecoverable input VAT, reduces admin burden.

Record keeping requirements: retain invoices 6 years (UK), separate VAT on sales invoices, maintain VAT account tracking input/output VAT, submit quarterly returns (1-month + 7-day deadline), annual reconciliation with accounts.

VAT registration becomes mandatory when business turnover exceeds country-specific thresholds, with significant compliance obligations following registration.

Major country thresholds (2025)—UK: £90,000 annual turnover (increased from £85,000), must register within 30 days of exceeding threshold, voluntary registration allowed below threshold.

EU countries: Germany €22,000, France €36,800 (goods) / €23,700 (services), Spain €0 (mandatory for all businesses), Italy €85,000, Netherlands €20,000, Poland PLN 200,000 (~€43,000), Ireland €37,500 (goods) / €75,000 (services).

Other regions: Australia AUD $75,000, Canada CAD $30,000 (federal GST), New Zealand NZD $60,000, Singapore SGD $1 million, UAE AED 375,000 (~$102,000).

Voluntary registration benefits—can reclaim VAT on business expenses (important for startups with high initial costs), appears more established to B2B customers, required to sell to other VAT-registered businesses in some industries, EU businesses need VAT number for intra-EU trade.

Voluntary registration drawbacks—administrative burden (quarterly returns, record keeping), must charge VAT to all customers including consumers (prices increase 20% if can't absorb VAT), penalties for late filing (£100+ per missed return), de-registration difficult if turnover drops.

Registration process—UK: online application through HMRC, receive VAT number within 2-4 weeks, effective date usually from registration request, backdated if turnover already exceeded threshold.

EU: register in each country where established or use one-stop shop (OSS) for digital services.

Required information: business details, turnover estimates, bank account, business activities.

Post-registration obligations: Issue VAT invoices (must include VAT number, breakdown of VAT amount, customer details), Submit quarterly VAT returns (MTD compatible software required UK), Pay VAT owed within 1 month + 7 days of period end, Keep digital records 6+ years, Annual accounting reconciliation.

Penalties for non-compliance: Late registration: backdated VAT liability plus interest and penalties (up to 100% of VAT owed for deliberate concealment), Late returns: £100 initial penalty, increasing to £400+ for persistent default plus daily penalties, Late payment: interest + surcharge starting at 2% of VAT owed, Errors: penalties 0-100% of VAT underpaid depending on behavior (careless, deliberate, concealed).

De-registration: allowed if turnover drops below £88,000 (UK), must repay VAT claimed on assets still held, simplified process compared to initial registration.

Tourists from outside the EU (or non-UK visitors to UK post-Brexit) can reclaim VAT on purchases taken home, recovering 10-20% of purchase price through tax-free shopping schemes.

Eligibility requirements—Permanent residence outside the country visited (proof: passport), Goods exported within 3 months of purchase, Minimum purchase amount: UK £30-£100 per store (varies by retailer), EU €25-€175 per country, Purchase from participating retailers (display "Tax Free Shopping" signs), Original receipts and tax refund forms completed.

Process steps: (1) Shopping—request VAT refund form at time of purchase, provide passport details, keep goods unused and in original packaging with tags attached, minimum spend thresholds apply per transaction. (2) Customs Validation—before departing: present goods, receipts, and tax refund form to customs officer at airport/port, must be before checking luggage (customs needs to see goods), get customs stamp on refund form (required for refund approval), allow extra 30-60 minutes at airport for validation queues. (3) Refund Collection—Cash refund at airport (available for some schemes, higher fees 20-30% of VAT), Credit card refund (submit stamped form, receive refund 4-12 weeks later, typical 10-15% processing fee), Mail refund form (if cash not taken at airport, slowest option 8-16 weeks).

Refund amounts by country—UK purchases: 20% VAT less 10-15% processing fee = ~15% refund, €1,000 purchase recovers £130-150.

EU purchases: 19-25% VAT less fees = 14-20% refund.

Example: £500 designer handbag in London includes £83.33 VAT (£416.67 + 20%), tourist receives £70-75 actual refund after fees.

Luxury purchases (watches, jewelry): worthwhile refunds on £1,000+ items.

Digital/app-based services—newer schemes (like Global Blue, Planet) offer: Upload receipts via app before departure, Faster refunds to PayPal/bank account (3-5 days vs 12 weeks), Lower processing fees (8-12% vs 20%), Track refund status online.

Restrictions and exceptions—Cannot reclaim on: Services (hotels, meals, tours), Goods consumed in country (food eaten, opened cosmetics), Goods posted home (must hand-carry), Business purchases (tourists only).

Special rules: Switzerland not EU—separate 7.7% VAT refund process, Norway 25% VAT but strict rules and lower refunds after fees, UK post-Brexit—no longer part of EU VAT refund area, separate process required.

Practical tips: Make large purchases in one store to meet minimums, Keep all receipts organized in envelope at airport, Arrive early at airport (customs validation takes time), Credit card refund more reliable than cash (less fraud), Compare processing fees between refund companies (varies 10-25% of VAT), For major purchases (>£1,000), fees worth it for £150-200 refunds, For small purchases (<£100), fees may exceed refund value.