VAT is an abbreviation for “value-added tax” and is a type of indirect tax that applies to physical goods and services. Businesses and customers across the globe will have to consider VAT when making a purchase or completing a transaction.
Each country with VAT has its own rules and rates, making calculating VAT challenging. Here’s a guide to calculating VAT, including when to collect VAT from customers.
What’s in this article?
- What is VAT?
- How to calculate VAT
- When to collect VAT
What is VAT?
VAT is called value-added tax because it is charged whenever value is added to the product throughout the supply chain. Once the business collects the tax from the customer, it’s responsible for remitting the tax to the appropriate government agency by a set due date. Over 170 countries have adopted VAT, and in some Asia-Pacific countries, it is known as goods and services tax (GST).
How to calculate VAT
To calculate VAT, you first need to understand in which country a sale is taxable. This is relatively easy in domestic scenarios where there is no cross-border element, but it can become more difficult if more than one country is involved. For example, the buyer can be located in a country different from that of the seller, or goods can be shipped from a country where neither the buyer nor the seller are located.
Once you have determined in which country a transaction is taxable, you need to find out which VAT rate to charge. These rates vary by country, and you should research them before charging your customers VAT. Here’s an example of how to calculate VAT:
A rug manufacturer sells a rug to an online retailer for €500 at a VAT rate of 22%. The retailer pays €110 in VAT to the manufacturer, in addition to the price of the rug. The retailer then decides to sell the rug online for €600. Once a customer purchases the rug, they will pay an additional 22% in VAT, which equals €132 to be collected by the retailer in VAT. Once the transaction is complete, the retailer will end up making back the VAT they originally paid the manufacturer. When it’s time to file and remit VAT to the government, the retailer will remit €22, which is what the retailer collected from the customer (€132), minus the original VAT paid (€110) to the manufacturer.
By calculating VAT this way, VAT-registered businesses at each stage of the process will recoup the VAT they have previously paid.
When to collect VAT
In many countries with VAT, foreign businesses—also referred to as remote sellers—are required to register to collect VAT as soon as they make their first taxable transaction in the country. However, some countries (e.g., Australia, Japan, and Canada) have monetary registration thresholds. Businesses with taxable sales below the registration thresholds are not required to register and collect VAT.
The tax collection obligations vary depending on the buyer country, product sold, and buyer status (customer or business). For example, foreign businesses must collect tax on sales of digital products to customers located in the EU. But if the customer is a VAT-registered business, it is the customer’s responsibility to account for tax.