Value Added Tax is
- a general tax that applies in principle to all commercial activities involving the production and distribution of goods and the provision of services.
- a consumption tax because it is borne ultimately by the final consumer. It is not a charge on businesses.
- charged as a percentage of the sales price at every stage of the production and distribution process.
- collected fractionally via a system of partial payments whereby taxable persons (i.e., VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities.
- neutral as the tax borne by the final consumer is the same regardless of how many transactions are involved.
- an indirect tax as it is collected from customers (the buyers) as part of the price paid to their suppliers of goods or services (the sellers) who will remit this tax to the revenue authorities. The suppliers of goods or services are considered the "taxable person" for VAT purposes although the tax is paid by the customer.
- VAT is also an important own resource for the EU budget.
How does VAT work?
All VAT registered traders are given a VAT number. They must provide customers with an invoice that shows how much VAT has been charged. Thus, the customer knows how much VAT they have paid. If they are a registered trader, they can then deduct this amount from the VAT they collected, paying the rest to their national tax authority.
With this system, double taxation is avoided, and tax is paid only on the value added at each stage of production and distribution. The final VAT paid is thus the sum of VAT paid at each stage.
Example
Stage 1: from the perspective of an iron ore mine
An iron mine buys €200 worth of helmets with a VAT rate of 20%, for a total cost of €240.
The mine then sells iron ore to a smelter. The ore is worth €1,000 and the VAT rate is 20%, so the smelter pays the mine €1,200.
The mine then deducts the €40 VAT it paid from the €200 VAT it collected and pays the treasury €160.
The treasury, having received €40 from the helmet seller and €160 from the mine, has thus successfully collected €200 worth of VAT.
Stage 2: from the perspective of the smelter
The smelter has now paid €200 VAT to the mine. In addition, it paid a furniture company €20 VAT (€120 total cost) for some chairs.
The smelter sells €2,000 worth of steel plus 20% VAT for a total of €2,400.
The smelter then deducts the €200 VAT it paid to the mine and the €20 VAT it paid to the furniture company from the €400 it collected from the sale of its steel, thus paying the treasury €180.
The treasury, having received €180 from the smelter, €160 from the mine, €40 from the helmet seller and €20 from the furniture company, has successfully collected €400 VAT on the sale of steel worth €2,000.
The Commission, as ‘guardian of the treaties’, is responsible for ensuring the correct application of EU VAT legislation throughout the EU. Member States are in turn responsible for transposing these provisions into national legislation and correctly applying it within their territory.
The practical application of VAT and its administrative practices vary from one EU country to another – but all countries are bound by common rules set in the VAT Directive. Please consult your national tax authority’s website for more information.
The European Commission does not have the competence to solve problems of individual taxpayers in their specific cases, nor to give an opinion on factual findings. The Commission may, however, initiate an infringement procedure against a Member State.
The only way to seek redress in particular cases is to take administrative or judicial action within your country. SOLVIT, a free service provided by national administrations in each EU country (as well as Iceland, Liechtenstein and Norway), can help you in doing so.
When the European Community was created, the original six EU countries were using different forms of indirect taxation, mostly cascade taxes. These were multi-stage taxes levied on the value of output at each stage of the production process, making it impossible to determine the real amount of tax included in the final price of a particular product.
As a consequence, there was always a risk that EU countries would deliberately or accidentally subsidise their exports by overestimating the taxes refundable on exportation.
To create an efficient single market in Europe, a transparent turnover tax system which ensures tax neutrality and allows the exact amount of tax to be rebated at the point of export was needed.
Legal texts
- VAT Directive (2006/112/EC).
- VAT Implementing Regulation - Council Regulation (EU) No 282/2011
- The VAT Administrative Cooperation Regulation - Council Regulation (EU) No 904/2010
- VAT derogations
- VAT Refund – EU business - Directive 2008/9/EC
- VAT Refund – non-EU business - Directive 86/560/EEC
- VAT-free importation - Directive 2009/132/EC
- Private consignments - Directive 2006/79/EC
- Travellers' allowances - Directive 2007/74/EC