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Value Added Tax (VAT)

This article is intended to explain what VAT is, where you can see it in everyday life and why it is important to know how to calculate VAT. In addition, it describes which countries use the VAT system and which VAT rates are applied to which goods and services. You will also learn how to calculate Value-Added Tax (VAT). While this guide provides the introduction to the VAT topic, it should not be considered as a substitute for professional advice tailored to your specific needs.

What is VAT (Value Added tax)?

The VAT is an abbreviation for the Value added tax that is a broad-based tax imposed on the sale price of goods or services. The VAT is a consumption tax, and it is actually paid by the final consumer who uses goods and services. As end customers pay the total price which includes VAT, they can usually see the VAT inclusive price on receipts or invoices. For example, if a VAT rate is 20% and an end customer pays €300, this comprises the net price of an item €250 and the VAT amount €50.
The amount of VAT is proportional to the net price of an item. If a VAT rate is 20% and we purchase an item worth €100, the VAT amount we pay on it would be €20 and the final price – €120. In case of purchasing an item that costs €500 EUR, the VAT amount the final consumer should pay would be €100 that leads to the final price of €600.
However, it is important to keep in mind that VAT is levied at each step of the value chain and not only on the sale to a final customer.

How does the VAT system work?

The VAT applies incrementally to all the transactions in the supply chain when the value is added to a product or service. Any seller of goods and services, if their annual taxable sales exceed the certain threshold which varies between countries, charges VAT on their sales. And a buyer pays VAT to the seller. Small businesses, whose taxable sales are less than the VAT registration threshold, don’t have to include VAT into the sale price.
Tax-registered businesses collect and remit VAT to the revenue authorities. If, for example, a net price is €20 and the VAT rate is 20%, to come to the total price, the seller must add 20% to the sale price. In this case the VAT amount would be €4, and a buyer will pay the total price $24, where the VAT amount €4 will be remitted to the government and $20 will be kept by the seller.
The VAT is charged as a percentage of a sale during all the commercial activities including production and distribution processes as well as a sale to a final consumer. For example, the VAT is added to the price of raw materials when their producer sells them to a product manufacturer, then the VAT is included into the price of the completed product purchased by a wholesaler, who adds the VAT when selling the product to retailers, and finally the VAT is applied when a merchant sells the product to the end customer.
If goods and services are used as inputs for the next transaction in a value chain, to prevent double taxation, the subsequent buyer in the chain has the right to credit VAT paid on their inputs. As a result, due to the crediting mechanism, every business along the value chain receives a tax credit for the VAT already paid. And the VAT amount is charged to the final customer who pays the VAT inclusive price.

Which countries use the VAT system?

According to International Monetary Fund, in 2020 the Value Added tax was used in more than 160 countries around the world. The VAT system is used in all the European union countries where several types of VAT rates are applied to goods and services - standard rate, reduced rate, and special rates. Most goods and services that are sold for use and consumption in the EU are subject to the standard VAT rate. The standard VAT rates in the European union differ from country to country and according to the EU law must not be less than 15% with no limitation to the maximum limit.
The lowest standard VAT rate in EU is in Luxembourg (17%) while the highest VAT rate (27 %) is in Hungary. On certain categories of goods and services, the reduced VAT rate or the special VAT rate (zero VAT or exempt from VAT) applied.
In some countries, for instance in Canada, Australia and India, this kind of tax is known as a Goods and services tax (GST). The VAT system is not used in the United States.

How to calculate the VAT (Value-Added Tax) – formulas and examples

VAT calculation is involved in many aspects of our lives. The Value added tax is imposed on all the transactions in the supply chain, including business to business and business to consumer transactions. Whether you are a business and need to understand how much your goods or services will cost for a buyer or a final consumer who wants to know the total price, it’s always important to know how VAT is calculated.
The guide below will help you understand the math behind adding VAT to a net price and removing VAT from a gross price and explain which formulas you should use to calculate the final price with VAT, price without VAT, or just the VAT amount.
If you don’t want to deal with VAT formulas and calculate VAT manually, the Percentage Expert calculator app can do all the math for you. You can choose to use the Percentage Expert calculator app or use its online version.

How to calculate the VAT amount

The VAT amount is a percentage that a seller adds on top of a net price of goods or services. In case a merchant sells to both final customers and business, they usually list both VAT inclusive and VAT exclusive price. However, in case you need to you need to pay or claim VAT, you need to understand the VAT amount.

If you are a tax-registered business, you need to know the VAT amount you must add to a sale price of your product or service to get a gross price, you should multiply the net amount by the VAT rate. The VAT amount calculation formula will be:
VAT amount = VAT exclusive price * VAT rate, where the VAT rate should be entered as decimal (21% as 0.21, 15% as 0.15, etc.)
Or VAT amount = VAT exclusive price * VAT rate / 100

Example 1: if you need to calculate the VAT amount for a 15 % VAT rate, the formula you should use is:
VAT amount = VAT exclusive price * 0.15.

Example 2: The VAT amount for a 21% VAT rate would be calculated as:
VAT amount = VAT exclusive price * 0.2.

If you are an end consumer buying goods or services which are subject to VAT, or you are a VAT registered business, to calculate the VAT amount included into a gross price, you should use the following formula:
VAT amount (included) = VAT inclusive price / (1 + VAT rate) * VAT rate, where the VAT rate should be entered as decimal.

Example 1: Calculate included VAT of 20%:
VAT amount included = Gross price / (1+0.20) * 0.20 = Gross price / 1.2 * 0.20

Example 2: Calculate included VAT of 15%:
VAT amount included = Gross price / 1.15 * 0.05

How to calculate the price including VAT

Final consumers are usually interested in the price with VAT also known as a gross price as this is the amount they pay for goods and services. The VAT inclusive price is the price that includes the net price and the VAT amount which is charged on top of it. So, you can calculate the VAT amount separately and add it to the net amount.
However, if you know a price without VAT (or net price), calculating the price including VAT (or gross price) is as easy as multiplying the price excluding VAT by (1 + VAT rate / 100). The formula to get the gross price is:
VAT inclusive price = VAT exclusive price * (1 + VAT rate / 100).

Example: How to work out a gross price including 20% VAT
Adding 20% VAT to a net price is easy: Gross amount = Net amount * (1 + 20/100) = Net amount * (1 + 0.2) = Net amount * 1.2.
If a computer costs €500 and a VAT rate is 20%, then to find the final price with VAT, we should multiply net price €500 by 1.2, which gives us gross price €600.

How to calculate the price excluding VAT

The price excluding VAT (or net price) is the value of goods or services without any taxes, including VAT. In other words, this is the price of goods or services before VAT is added. If you are a taxable person and you are provided with the VAT inclusive price only, you might want to know the price before VAT.
While the VAT inclusive price calculation, when to get the gross amount, you need to add the VAT percentage to the net amount, is straightforward, the reverse VAT calculation is not as simple as taking off the VAT percentage from the gross amount. To work out the net price (price before VAT) you need to divide the gross price (price including VAT) by 1 + VAT rate (as decimal value).
The reverse VAT Formula: VAT exclusive amount = VAT inclusive amount / (1 + VAT rate).

Example: How to remove 20% VAT from the gross price €90.
To work out a price excluding VAT, you should take the gross amount and divide it by (1 + VAT rate/100). In this example, as the VAT rate is 20%, the gross price must be divided by (1 + 0.2).
Net price = Gross price / 1.2 = €90 / 1.2 = €75 (price without VAT)