What is VAT?

Value-added tax (VAT) is a consumption tax levied on the sale of goods and services in 175 countries, including the U.K. and in the EU. It’s applied to transactions at every stage of a supply chain, from design to manufacturing to consumer sales. Businesses are responsible for charging, collecting, and paying VAT at each stage.

There are various exemptions and exclusions, and different rates and rules depend on which country you or your customers are based in or where the sale or purchase of goods or services takes place. 

At some point, practically everyone involved in the product or service supply chain is subject to VAT, even if they aren’t aware of it. For example, all U.K. consumers pay VAT within the sale price on (eligible) non-essential goods at 20%. Unless shoppers check their receipts, they may be oblivious to being included in the VAT ecosystem. That’s not the case for businesses, which are responsible for applying, charging, and paying VAT at each stage of the supply chain. 

VAT rules and rates for goods, products, and services vary from country to country. For instance, the standard rate in France is 20% while Denmark’s rate is higher at 25%. These rate fluctuations are less noticeable since the standard 15% minimum rate was introduced by the European Single Market in 1993. 

Rather, more recent changes in how VAT is calculated and applied can be attributed to e-invoicing mandates in several countries around the world. Additionally, country-specific initiatives like Making Tax Digital in the U.K. introduce new requirements for digital record keeping and the tracking of digital submissions and reporting.

A VAT rate is the percentage a business or consumer pays in tax according to the cost of the product, service, or process at that particular point in the supply chain. Rates differ depending on the standards set by independent governments, but EU members are subject to standard minimum VAT rates.

However, as with all things VAT, rates are subject to change year on year. In 2022, there were several changes to VAT rates worldwide.

In the U.K. there are three VAT rates that depend on the goods, products, or services it’s being applied to:

Standard rate: 20%
This rate applies to most goods and services.

Reduced rate: 5%
This rate applies to certain commodities like fuel and energy, charitable housing, or car seats for children.

Zero rate: 0%
This rate applies to essential commodities like children's clothes and (most) food.

It’s important to note that other countries or governments may have different laws regarding taxability rates on certain products. VAT rates may also be subject to change. For example, the U.K. recently reclassified women’s sanitary products as essential items, changing VAT from a reduced rate to a zero rate.

VAT guides by country

While rates are important, finding out what’s taxable and what’s exempt from VAT is critical for businesses across the globe. In the EU, most goods and services are eligible for VAT, such as:

• Products or services sold
• Supplies purchased for business use
• Loaning of goods to someone
• Sale of assets
• Commissions

Businesses in the U.K. trading with an EU VAT-registered business within the single market may not charge VAT on sales to the EU business. But if that product is then sold to an end consumer within the EU, VAT is charged at the rate applicable in their country.  

Tax exemptions may also apply to certain products or businesses, and items or services that fall under categories like charitable donations, education and training, insurance, finance, and credit. Businesses with a VAT taxable turnover below €85,000 are also exempt. 

Exempt items are different from zero-rate taxable items. While zero-rate items are subject to a VAT rate of 0%, exempt items are goods and services with no chargeable VAT whatsoever and include supplies for:

• Charitable organisations and fundraising events
• Energy providers
• Healthcare and medical service providers
• Education goods and services
• Services related to finance, insurance, and investments

VAT registration is key for businesses to comply with regulations, avoid penalties, and build trust with partners and consumers. VAT registration for domestic trade requires proof of business and mandatory form filing, which can differ by governing body. For example, in the U.K. the HMRC requires registration for businesses with a VAT taxable turnover of £85,000 or more be done via post or through the government online portal. 

Simplify VAT registration

You may only need to register for local VAT for domestic trade; however, it’s important to register your business in each country or economic territory where you transact business. So, if you’re trading across borders in the single market (or planning to), you’ll need to register for an EU VAT number. 

Within the EU, businesses are required to register for a VAT number if they are:

• Buying and selling goods across borders 
• Importing goods from other countries 
• Holding live conferences and events 

You can simplify this process with Import One-Stop Shop, which allows a taxable entity to register in a single member state to declare and pay EU import VAT.  

VAT filing can be a complicated, manually intensive process, whatever the scope of your business. However, it’s not all doom and gloom. Once you understand the basics and what’s required of you, there are a number of strategies you can employ to lighten the load.

A VAT return is an official tax document that contains the facts and figures relating to your business transactions, detailing all of your purchases, sales, and expenses. It’s specifically focused on your VAT-eligible transactions and other applicable taxes, and calculates what VAT your business owes and is due. 

Your VAT return will contain information like:

• The net sum of all taxable transactions, both sales and purchases
• VAT charged on all taxable sales and purchases
• Any exempt transactions 
• The total VAT due or repayable

VAT returns vary between countries, with supplementary information often required at the discretion of the governing body to whom it’s made payable. In some countries, it’s simply a difference in format such as the language of the return, how it’s submitted, or the currency used. In others, required information differs, such as the number of input boxes within a VAT return, Intrastat reports (list of goods movement between EU member states), or EC Sales Lists (declaration of total B2B cross-border activity).

Countries establish their own parameters for VAT returns, which often means dealing with different reporting schedules and deadlines. For example, Germany allows just 10 days to file before the end of the reporting period, whereas the Netherlands allows two full months. 

Reporting periods include:

VAT returns are complex, especially for overseas transactions. Automation helps streamline and document VAT returns processes. 

Avalara VAT returns

The penalties for VAT noncompliance can be severe, including substantial fines and interest charges if VAT returns are not submitted in time and according to regulation. Governing agencies like HMRC can also impose surcharge periods, which can grow penalties over time, as long as the business continues to fail to meet VAT obligations. Failure to meet obligations can trigger inspections and audits from governing bodies, which can be disruptive to your business. 

Penalties and fines aren’t the only negative consequences of noncompliance. Ignoring the strict rules of VAT in your region of trade can lead to: 

Reputational damage
When cooperating with investigators during inspections or audits, an investigator may contact suppliers or business partners to provide proof of receipt (or similar) for certain transactions. Businesses under investigation for tax purposes, or known to be receiving penalties, can suffer reputational damage resulting from other partnering businesses or even consumers. 

Barring from trading platforms or trading bans 
Both tax authorities and ecommerce providers have the power to ban trading on certain applications, or even ban trade entirely, if tax obligations are not met. This can impede or halt certain business channels and sales. 

Criminal charges
In worst-case scenarios, failing to meet VAT obligations continually can lead to criminal charges through fines or even imprisonment. 

It’s best practice to follow the rules to avoid any acts of enforcement and

• Submit VAT returns during VAT accounting periods
• Pay any VAT that is owed

Keeping up to date with changes in the VAT ecosystem is crucial to ensuring your business is compliant. In addition to staying on top of changing rates and new VAT rules for products and services, it’s important to look at how you’re submitting your VAT returns, and invoicing too. 

For example, e-invoicing is becoming mandatory for businesses around the globe. Making Tax Digital regulations in the U.K. will also penalise businesses that are not implementing digital submissions, records, and reports in the correct format. 

Read Making Tax Digital for more info

Boost your VAT vocabulary with this helpful terminology guide. 

Knowing when and where you should be charging or paying VAT can be confusing. Hopefully, you now have new insight into the overall process and a good idea of what’s required for compliance. 

From registration to returns filing to real-time reporting requirements, it’s a lot to take in — and a lot to manage. Whatever your VAT challenge, Avalara can help. Our cloud-based VAT compliance software helps you to:

• File returns more quickly
• Stay compliant when expanding across borders
• Minimise the risk of audits
• Improve efficiency throughout your business

Get our VAT guide

This guide is meant to be helpful but is not certified legal or tax advice. Consult with a qualified professional before making any business decisions. Keep in mind that customs and tax laws change often.