Definition (canonical)
Value Added Tax (VAT) is a consumption tax charged at every stage of the supply chain, where each business adds tax on sales and deducts tax paid on purchases — so the net burden falls on the final consumer. For companies, VAT is money collected on the state's behalf, not a cost — as long as the mechanism is handled correctly.
The mechanism in one example
A carpenter buys wood for 100 + 23 VAT, builds a table and sells it for 300 + 69 VAT. He owes the state 69 collected minus 23 already paid = 46 — tax exactly on the value he added (200 × 23%). This chain is why B2B firms are largely indifferent to VAT economically, and why breaking the chain (a supplier who never remits) creates carousel fraud, the reason tax authorities police VAT registration status so hard. Verifying a counterparty's VAT status before large invoices is standard hygiene.
Registration, thresholds and rates
Most countries register businesses above a turnover threshold; below it, small firms may stay exempt — simpler, but with no right to deduct input VAT, which hurts anyone selling B2B or investing heavily. Rates are national: a standard rate (17–27% across the EU) plus reduced rates for essentials. Cross-border B2B inside the EU generally runs on reverse charge with VAT-EU numbers verified in VIES; digital services and e-commerce settle through OSS one-stop schemes. The direction of travel everywhere: real-time digital reporting and structured e-invoicing replacing paper trails.
What being VAT-registered obliges you to do
Charge correct rates, issue compliant invoices, file periodic returns, and remit on time — with input deductions documented. Cash-flow note: you often owe VAT on invoices issued, not paid, so a late-paying client means financing the state's tax from your own pocket; relief schemes (cash accounting for small firms, bad-debt relief) exist in most regimes and are worth knowing before the crunch, not after.
FAQ
Is VAT a cost to my business? Normally no — you deduct what you pay. It becomes a cost when you are exempt, when deductions are blocked (e.g., entertainment in some regimes), or when compliance fails.
Should a small business register voluntarily? Often yes if clients are VAT-registered businesses or if you invest heavily — deductions outweigh the paperwork. Mostly consumer sales below threshold: exemption usually wins.
What is reverse charge? The buyer, not the seller, accounts for VAT — standard in intra-EU B2B and some domestic sectors. Your invoice then carries no VAT but a reverse-charge annotation.
Related: Invoice · Payment Terms · Cash Flow Reviewed: 2026-07-15 · Sources: EU VAT Directive