What Is VAT?
Value Added Tax (VAT) is a consumption tax applied to the sale of goods and services. Unlike a simple sales tax (applied only at the final sale), VAT is collected at every stage of the supply chain – but each business can reclaim the VAT it paid on its own purchases.
The net result: only the final consumer pays the tax. Businesses in the middle act as unpaid tax collectors for the government.
VAT is used in over 170 countries. In the EU, rates vary by country and product category. The US uses sales tax instead, which works differently.
The VAT Chain in Practice
A simple example with a 20% VAT rate:
- Timber merchant sells wood to a furniture maker for €100 + €20 VAT. They collect €20 and remit it to the government.
- Furniture maker pays €120 total but reclaims the €20 input VAT. They sell a table to a retailer for €300 + €60 VAT.
- Retailer pays €360 but reclaims the €60 input VAT. They sell to a customer for €500 + €100 VAT.
- Customer pays €600 total. They cannot reclaim VAT (they are the final consumer).
Total VAT collected by the government: €100 – exactly the 20% VAT on the final retail price. Each business in the chain has zero VAT cost if they are properly registered.
Key VAT Concepts
Input VAT vs Output VAT
- Output VAT: VAT you charge your clients on sales
- Input VAT: VAT you paid on purchases for your business
- VAT payable to government: Output VAT − Input VAT
If input VAT exceeds output VAT (common for businesses with large supplier costs), you claim a refund.
VAT Registration Thresholds
In most countries, small businesses only need to register for VAT once their revenue exceeds a threshold. In the UK, this is £90,000/year. In France, €36,800/year for services (€91,900 for goods). Below the threshold, you are VAT-exempt – you do not charge VAT and cannot reclaim it.
Standard vs Reduced Rates
Most countries apply different VAT rates to different product categories:
- Standard rate: most goods and services (20% in UK and France, 19% in Germany, 21% in Spain)
- Reduced rate: essentials like food, medicine, children's items
- Zero rate: some food, exports, children's clothing (in UK)
- Exempt: financial services, healthcare, education – these do not charge VAT and cannot reclaim input VAT
Reverse Charge (B2B Across Borders)
When a VAT-registered business in one EU country sells to a VAT-registered business in another EU country, the buyer accounts for the VAT themselves (reverse charge mechanism). The seller issues an invoice with no VAT, noting "reverse charge applies." The buyer declares both output and input VAT, which net to zero.
This matters for freelancers selling services internationally.
Practical Steps for Freelancers
- Check if you need to register – if your annual revenue exceeds your country's threshold, registration is compulsory
- Get your VAT number – issued by your tax authority after registration
- Charge the correct VAT rate on invoices to domestic clients
- Issue compliant invoices – must include your VAT number, client's VAT number (B2B), net amount, VAT rate, VAT amount, and gross total
- File VAT returns – typically quarterly or monthly; pay the difference between output and input VAT
- Keep records – retain invoices (sales and purchases) for at least 7–10 years
Quick VAT Calculations
To add VAT: multiply the net price by (1 + VAT rate). Net €200, 20% VAT → €200 × 1.20 = €240 gross.
To remove VAT from a gross price: divide by (1 + VAT rate). Gross €240, 20% VAT → €240 / 1.20 = €200 net.
The VAT Calculator on this site handles both directions (add or remove VAT) for any rate, instantly.
Summary
VAT is a consumption tax collected at each stage of the supply chain, ultimately borne by the final consumer. Registered businesses charge output VAT, reclaim input VAT, and remit the difference. Understanding the registration threshold, correct rates, and invoice requirements keeps you compliant and pricing correctly.