How VAT Works

Value Added Tax (VAT) is a consumption tax applied to most goods and services. Unlike a simple sales tax charged once at the final point of sale, VAT is collected in stages — at every step where value is added, from raw materials through manufacturing, distribution, and retail.

VAT is used by more than 170 countries, including the UK and all EU member states. Rates and rules vary by country: the UK's standard rate is 20%, Germany's is 19%, and France's is 20%. Our VAT Calculator supports multiple countries and rates.

Each business in a supply chain charges VAT on what it sells and pays VAT on what it buys. It then pays the tax authority the difference between the two — the VAT it collected minus the VAT it already paid. This means the tax is never really "owned" by any one business; it passes down the chain, stage by stage, until it lands on the final consumer.

Prices can be shown VAT-inclusive (tax already built into the price, standard for consumer receipts) or VAT-exclusive (tax added separately, standard on B2B invoices). See our dedicated VAT inclusive vs exclusive guide for a full breakdown with formulas and examples.

The end consumer ultimately bears the cost of VAT, since it's built into the final price of whatever they buy — and consumers cannot reclaim it. Registered businesses, by contrast, act mainly as tax collectors: they charge VAT on sales and remit it to the government, but they aren't usually out of pocket themselves because they can reclaim the VAT they paid on their own business purchases.

This is why VAT is described as an "indirect tax" — it's collected by businesses but economically paid by consumers. Country-specific rules on registration thresholds and rates vary; see our UK VAT and Europe VAT calculators for country-specific figures.

A VAT-registered business adds VAT to its invoices and receipts at the applicable rate, itemizing it clearly so the amount collected is transparent to both the customer and the tax authority. On a periodic basis — usually quarterly — the business files a VAT return summarizing all the VAT it has charged and all the VAT it has paid, then settles the net amount with the tax authority.

Clear, correctly itemized invoices make this process far easier to manage. Tools like our Invoice Generator can help small businesses produce compliant, VAT-itemized invoices without manual formatting.

Output VAT is the VAT a business charges on its sales — the VAT it collects from customers on behalf of the government.

Input VAT is the VAT a business pays on its own purchases — stock, equipment, supplies, and other business expenses. A registered business can usually reclaim this input VAT, offsetting it against the output VAT it owes.

The amount actually paid to the tax authority is: VAT Due = Output VAT − Input VAT. If input VAT exceeds output VAT in a given period — for example, during a period of heavy equipment purchases — the business may be entitled to a VAT refund instead.