More than 170 countries have a value-added tax (VAT), and it isn’t always a blanket rate. Almost all countries, including the UK, have preferential rates such as zero-rated VAT as well as VAT-exempt goods and services. The distinctions between these categories influence how businesses price products, recover costs, manage cash flow, and stay compliant across markets.

Below, we’ll explain how VAT-exempt and zero-rated VAT sales work in practice, the accounting requirements that govern them, and how to maintain accurate VAT treatment across your portfolios.

What’s in this article?

• What’s the difference between VAT-exempt vs. zero-rated VAT?
  
• How do VAT classifications influence pricing, cash flow, and compliance processes?
  
• What rules determine whether a product or service qualifies as VAT-exempt or zero-rated?
  
• What accounting requirements apply to exempt vs. zero-rated transactions?
  
• What are some common challenges businesses face around exempt and zero-rated VAT rules?
  
• How can businesses maintain accurate VAT treatment across their portfolios?
  
• How Stripe Tax can help
  

What’s the difference between VAT-exempt vs. zero-rated VAT?

Neither VAT-exempt nor zero-rated purchases require a VAT payment, but these purchases have different places in the tax system.

Zero-rated goods and services are still technically considered taxable. Although the rate is 0%, the law treats them as VAT items. And a business can generally reclaim the VAT it paid on the inputs, which is the money spent producing and delivering those goods or services. A company that exports products, for example, charges overseas customers 0% VAT but still recovers VAT on its inventory, packaging, and shipping.

Meanwhile, exempt goods and services operate outside the VAT system. You don’t add VAT to the sale, and you lose the ability to recover VAT on the inputs tied to those activities. Education, financial services, and fundraising events by charities fall in this category in the UK.

When it comes to VAT registration thresholds—the sales levels at which a business becomes legally required to register for VAT—zero-rated sales typically count while exempt sales don’t. A business that sells only zero-rated goods might not have to register, although this varies by country. In the UK, a business that sells only exempt services cannot register for VAT at all.

How do VAT classifications influence pricing, cash flow, and compliance processes?

How a product or service is classified affects pricing decisions, cash flow patterns, and the compliance workload involved. Here’s how to understand the differences.

Pricing and cost structure

Businesses that sell exempt goods or services absorb VAT on their inputs because they can’t reclaim it. This increases their cost base and they might raise prices to keep margins intact. A school or financial service provider often pays VAT on software, equipment, or supplies, and that VAT becomes part of the cost of delivering the service. Meanwhile, zero-rated businesses sidestep this by charging customers 0% VAT, recovering VAT on inputs, and having more flexibility to keep prices competitive.

Cash flow dynamics

Zero-rated businesses frequently find themselves in refund positions. They pay VAT on inventory, packaging, shipping, or other inputs. And since they collect no VAT from customers, they often receive refunds on their periodic VAT returns. Exempt businesses don’t receive those refunds, and VAT-bearing purchases stay as expenses.

Compliance workload

Zero-rated sales usually come with full VAT compliance requirements: proper formatting for VAT invoices, detailed recordkeeping, and proof that the 0% rate applies, especially for exports. Exempt goods and services reduce this burden because the transactions fall outside the VAT system completely, although you’ll still need to invoice properly in case of audits. When a business has a mix of exempt and taxable activity, compliance can be challenging.

What rules determine whether a product or service qualifies as VAT-exempt or zero-rated?

VAT classification is dictated by each country’s laws. The same product can land in different VAT categories in different markets.

Here’s how these categories are determined.

How countries define exempt goods and services

Exemptions typically cover essential or regulated sectors such as healthcare, education, financial services, insurance, residential rent, the sale of used dwellings, and certain charitable or religious activities. The criteria are often narrow, and eligibility might depend on accreditation, the type of service provided, or the way the transaction is structured.

How countries define zero-rated goods and services

Zero-rated items span a wide range from basic food to prescription medicines, children’s clothing, printed publications, and, in some jurisdictions, public transportation. Exports are almost always zero-rated, but this can vary by jurisdiction.

Why similar products don’t always get the same treatment

Classification follows local legislation and can change on small distinctions, such as whether a book is printed or digital. Because these rules vary by country, international businesses need to check each jurisdiction’s guidance instead of assuming a single classification applies everywhere.

What accounting requirements apply to exempt vs. zero-rated transactions?

Accounting teams need to be aware of VAT classifications in every part of their workflows. Here’s what they’ll need to keep in mind:

• Invoicing and documentation: Zero-rated sales still require invoices in full VAT format, including a VAT registration number and a 0% VAT line that shows the sale is taxable. Exempt sales don’t include any VAT charge, and invoices should generally note the exemption so auditors can see why VAT wasn’t applied.

• How transactions are recorded: Zero-rated transactions flow into the taxable sales ledger and appear on VAT returns even though they generate no output VAT. Exempt sales don’t count towards taxable turnover. And any VAT paid on expenses related to those exempt sales can’t be recovered so it remains a cost on profit and loss statements.

• Partial exemption and allocations: Businesses with both exempt and taxable activity must separate the costs tied exclusively to taxable sales, those tied to exempt sales, and overhead. Many jurisdictions require periodic and annual reconciliations to confirm the right share of overhead VAT is reclaimed or disallowed.

• VAT returns: Generally, zero-rated businesses must file VAT returns even when no VAT is due. Exempt businesses typically don’t file unless they also have taxable activity, and mixed businesses file returns that reflect taxable sales (including zero-rated ones), exempt sales, input VAT recovery, and partial exemption adjustments.

What are some common challenges businesses face around exempt and zero-rated VAT rules?

Edge cases, documentation requirements, and jurisdictional differences can lead to mistakes that affect compliance and profitability. Here’s what to watch for:

• Misclassifying: A common issue is treating something as exempt when it’s actually zero-rated or vice versa. This can lead to incorrect invoicing and improper input VAT claims.

• Handling partial exemption: Businesses that sell both taxable and exempt items face more complex input VAT allocation rules. The math becomes harder as product mixes change.

• Documenting zero-rated eligibility: Zero-rated items, especially exports or goods that qualify only under specific conditions, often require evidence to support the classification. Missing paperwork can cause authorities to disallow the zero rate.

• Managing jurisdictional inconsistency: A product might be zero-rated in one country, exempt in another, and fully taxable elsewhere. This forces businesses to track multiple definitions and update systems constantly.

• Maintaining accurate systems: Product catalogs develop, pricing changes, and new services launch, but tax codes don’t always get updated at the same pace. A single incorrect tax configuration in a billing or enterprise resource planning (ERP) system can misclassify thousands of transactions.

• Keeping teams aligned: VAT rules impact sales, finance, operations, and customer support. Businesses should continually train each of these teams as rules and product lines shift.

How can businesses maintain accurate VAT treatment across their portfolios?

As product lines expand and companies enter new markets, keeping VAT treatment accurate becomes even more important—and more difficult. Here’s how to manage VAT treatment:

• Map every product and service: Conduct a thorough review of your catalog in each jurisdiction. Confirm whether each item is exempt or taxed at a zero, reduced, or standard rate.

• Keep tax codes current: Every product and service should have an accurate tax code in your invoicing, ERP, or commerce platform. This should be updated whenever laws change or new items launch.

• Train teams: Ensure finance, accounting, and billing teams understand the practical differences between exempt and zero-rated goods and services so they can spot issues early.

• Maintain strong documentation practices: Keep invoices, receipts, exemption notes, export evidence, and allocation records organized and accessible.

• Audit classifications regularly: Doing periodic reviews, either internally or with a VAT specialist, helps catch misclassifications, incorrect recovery of input VAT, or outdated tax codes early.

• Stay ahead of legislative changes: Monitor updates from tax authorities in every market where you operate so classification changes don’t surprise you.

• Use automation when the portfolio grows: Tax automation tools can apply the correct VAT treatment in real time, generate compliant invoices, and create an audit trail that’s easy to follow.

How Stripe Tax can help

Stripe Tax reduces the complexity of tax compliance so you can focus on growing your business. Stripe Tax helps you monitor your obligations and alerts you when you exceed a sales tax registration threshold based on your Stripe transactions. In addition, it automatically calculates and collects sales tax, VAT, and GST on both physical and digital goods and services—in all US states and in more than 100 countries.

Start collecting taxes globally by adding a single line of code to your existing integration, clicking a button in the Dashboard, or using our powerful application programming interface (API).

Stripe Tax can help you:

• Understand where to register and collect taxes: See where you need to collect taxes based on your Stripe transactions. After you register, switch on tax collection in a new state or country in seconds. You can start collecting taxes by adding one line of code to your existing Stripe integration or add tax collection with the click of a button in the Stripe Dashboard.

• Register to pay tax: Let Stripe manage your global tax registrations and benefit from a simplified process that prefills application details—saving you time and simplifying compliance with local regulations.

• Automatically collect tax: Stripe Tax calculates and collects the right amount of tax owed, no matter what or where you sell. It supports hundreds of products and services and is up-to-date on tax rules and rate changes.

• Simplify filing: Stripe Tax seamlessly integrates with filing partners, so your global filings are accurate and timely. Let our partners manage your filings so you can focus on growing your business.

Learn more about Stripe Tax, or get started today.