VAT: as law-abiding customers, we pay them every day, by means of our numerous purchases. But what exactly is VAT? What different rates exist? Which rules do you need to follow for charging and paying? And when are you exempt from VAT? Here are the answers to those many questions.
Let us start with the basics: VAT stands for 'valued-added tax'. It is an indirect tax that the government levies on the sale of products or services. The tax is calculated on the sales price of a product or service in each step of the production or distribution process. In fact, the value that someone has added to the product or service is always charged.
The tax is applied in no less than 166 countries, including all countries of the Organisation for Economic Co-operation and Development, except the US. For the EU, the basic rules are laid down in the VAT directive. Their application may vary from member state to member state, as long as it does not conflict with European legislation. The current European VAT directive has been effective since 1 January 2007.
How exactly does VAT work?
In almost all countries that charge a VAT nationally, a producer or supplier increases the sales price by a VAT percentage each time he sells a product or service. The buyer receives an invoice which states the amount of the VAT.
When that buyer, for example your SME, resells the product or service, do you need to charge VAT? In general, the following rule applies. You may deduct the VAT you pay on expenses for your taxable products or services from the VAT you receive on the sale. You must periodically declare and pay the difference to the state (or reclaim it, if you received less VAT than you paid).
Finally, the VAT is passed on to the end user (he only pays and cannot reclaim). If you, as an EU company, sell a product or service to another EU company located in another member state, you normally do not have to charge VAT. The company you sold the product or service to will then pay the VAT rate due in its country. You may, however, reclaim the VAT on goods and services that you had to purchase specifically for that sale.
If you sell products to consumers in another EU member state, you must normally register there and charge VAT at the rate of that country, unless your total sales that year are less than the VAT threshold of the country concerned. Then the customer pays the VAT rate that applies in your country as a seller.
If you sell these consumer services, you normally charge the VAT rate of your country. Except for electronic, telecom and broadcasting services: these are always in the country of the consumer. Unless you sold less than 10,000 euros worth of these services in all EU member states during the current and previous year: in this case, you may still use the rate of your own country. This new European measure, which has been in effect since 1 January 2019, is meant to simplify e-commerce.
Another important financial note: either you have to calculate the difference between what you have received and paid in VAT in a given period - what was added and deducted from the bank account - or between the VAT that you, in that time period, charged or have been charged on invoices. In the latter case, you may already be required to transfer VAT for invoices that have not yet been collected.
What different rates exist?
Governments all over the world use different VAT rates. Within the EU, member states apply a general tariff, which they levy on most goods and services. They may choose this themselves, as long as it is no less than 15%.
In addition, member states may apply a maximum of two different reduced rates to a limited number of goods and services. These may normally not be less than 5%. What falls under what rate is ultimately a political decision.
For example, Belgium uses 21% as standard rate, as well as 12% (goods and services that are important from an economic or social point of view, such as coal and margarine) and 6% (basic products and services with a social character, such as essential products). The standard rate applies to all goods and services that do not fall under another category, such as marketing services.
In addition, some countries have a super reduced rate of less than 5%. For example, Spain charges only 4% VAT on the maintenance and adaptation of vehicles for persons with a disability. There is also something like the parking rate. Some EU countries apply this rate to certain goods and services that do not qualify for the normal reduced rate. And then there is also the zero rate, but more about that right away.
When are you exempt from VAT?
When you need to charge and transfer VAT, most countries require you to register with the VAT administration, as a natural person or legal entity.
But in many EU countries you do not have to pay VAT if your annual turnover stays below a certain threshold, for example as a freelancer (25,000 euros per year in Belgium). You may therefore not claim any reimbursement. In just a few countries, you will receive a VAT reduction for part of your turnover below that limit (less and less as the turnover increases, until the threshold is reached). The threshold differs from country to country, and sometimes additional conditions apply to allow this measure to be enjoyed.
We must also distinguish between goods and services that are exempt from VAT and that are subject to the zero rate. In some cases national member states simply cannot charge VAT. This is the case with education, health care and financial services. Anyone who sells exempted goods and services may therefore not reclaim VAT.
In some countries, 0% VAT is also applied to certain goods and services. This rate applies, for example, to most food products, books, medicines and certain means of transport in the United Kingdom. Anyone who has to apply this rate to his offer may, however, reclaim VAT from expenses incurred.
Goods with a low value that you import from outside the EU can also be exempt from VAT in certain member states, with a purchase price between 10 and 22 euros. A country may decide to accelerate parcel delivery by post or if collection of the VAT is practically not feasible. Non-European e-commerce companies usually have to charge VAT in the member states where they are active.
Would you like to know more about the European VAT scheme? Consult this overview of the EU.