What is VAT?

VAT (actually V.A.T.) stands for Value Added Tax. It is a tax added when a product or service is sold. VAT is not applied to all sales, some products are exempt, as are companies that have a low turnover (usually quite small companies). Some products can also be sold with a reduced rate of VAT.

The rate of VAT varies between countries. In Ireland the standard rate of VAT is 21%, while in Germany it is 23%. VAT in europe was the first tax imposed by the European Union, in 1977 under the "Sixth Directive". VAT rates across europe vary from 8% in Liechtenstein to 27% in Hungary, but most are around 20%.

The standard rate of VAT in the UK (which was 17.5% since March 1991) was reduced to 15% in December 2008, changed back to 17.5% in January 2010, and then increased to 20% in January 2011.

VAT in business

If you are a VAT registered business, you must add VAT to your prices. You should make the VAT rate and the amount of VAT charged clear on your invoices or receipts. If you make a sale outside of the EU (e.g. if you are in the UK and your customer is in India), you do not have to charge VAT. Also, if you make a sale into a different EU country (e.g. you are in France and your customer is in Germany) then you can zero-rate the sale provided you have the correct paperwork (see your accountant for details).

A VAT registered business will make regular VAT Returns, usually quarterly (every 3 months), but other arrangements are possible e.g. monthly. Doing your VAT Return involves working out how much VAT you owe your VAT authority, filling out your VAT Return paperwork, and then paying the amount owed.

There is an advantage (well, a silver lining) to being VAT registered though: you can reclaim VAT on your purchases. Also you don't have to pay the VAT and then claim it back. You can deduct this 'purchase VAT' from the payment you make with your VAT Return.

Say you buy an item for £600 which includes £100 VAT, then you sell it for £660 including £110 VAT. You have paid out £100 and you have charged £110 VAT to your customer, so as a business the VAT on this sale has only cost you £10. When it comes to doing your VAT return, you deduct the £100, declare the £10 on your VAT return and pay only the £10 to your VAT authority.