Understanding VAT: A Global Tax Guide

Value-added tax is the most widespread consumption tax in the world, used by more than 160 countries to generate government revenue. Whether you run an international business, sell digital products across borders, or simply want to understand the tax line item on a receipt while traveling in Europe, knowing how VAT works gives you a practical advantage. This guide explains the mechanics of VAT, compares it to sales tax, provides formulas for calculating VAT-inclusive and VAT-exclusive prices, and surveys global VAT rates.

What Is Value-Added Tax?

Value-added tax (VAT) is a consumption tax levied on the value added to goods and services at each stage of production and distribution. Unlike a sales tax, which is applied only at the final point of sale to the consumer, VAT is collected incrementally at every stage of the supply chain. Each business in the chain charges VAT on its sales and pays VAT on its purchases. The business remits only the net difference to the government.

The end consumer bears the full economic burden of VAT because consumers cannot reclaim the tax. Businesses, in contrast, are economically neutral with respect to VAT: they collect it from customers and deduct the VAT they paid to suppliers, remitting only the balance. This multi-stage collection mechanism makes VAT self-enforcing, because each business has a financial incentive to report transactions accurately to claim its input tax credits.

How VAT Works at Each Stage

Consider a wooden table with a 20% VAT rate moving through three stages of production:

The consumer pays $300 total ($250 + $50 VAT). The government collects $50 in total VAT, which equals 20% of the final sale price. Each business in the chain only remitted tax on its own value added, not on the full sale price. This prevents the tax cascading (tax-on-tax) problem that occurs with some other multi-stage tax systems.

VAT vs. Sales Tax

Both VAT and sales tax are consumption taxes that ultimately increase the price paid by the end consumer. However, they differ in structure, collection, and enforcement:

The United States is the only OECD country that does not levy a national VAT. Instead, it uses state and local sales taxes, with combined rates ranging from 0% (in states like Oregon and Montana) to over 10% in some jurisdictions.

Calculating VAT

Adding VAT to a Price

To calculate the VAT-inclusive (gross) price from a net price:

A product with a net price of EUR 200 in Germany (19% VAT): gross price = 200 x 1.19 = EUR 238. The VAT amount is EUR 38.

Removing VAT from a Price

To extract the net price from a VAT-inclusive amount:

A receipt showing GBP 120 in the United Kingdom (20% VAT): net price = 120 / 1.20 = GBP 100. The VAT amount is GBP 20.

Global VAT Rates by Country

VAT in the European Union

The EU VAT Directive sets the framework for VAT across all member states. The minimum standard rate is 15%, with no upper limit. Member states can apply up to two reduced rates (as low as 5%) on specific categories of goods and services such as food, medicine, books, and public transport. Following the 2022 reform (Council Directive 2022/542), member states may also apply a super-reduced rate below 5% and a zero rate on up to seven categories of basic-need items.

For businesses selling digital services across EU borders, the One-Stop Shop (OSS) simplifies compliance by allowing a single VAT registration in one member state to cover sales to consumers in all 27 EU countries. Without OSS, a business would need to register for VAT in every country where it makes sales, which is prohibitively complex for small and medium enterprises.

Real-World VAT Examples

Exporting Digital Services

Sophie runs a graphic design subscription service from Berlin, Germany, with customers across Europe. When she sells a EUR 29/month subscription to a customer in France, she must charge French VAT at 20% (not German VAT at 19%) because B2C digital services are taxed in the customer's country. The customer pays EUR 34.80. Sophie remits the French VAT through the EU's OSS portal in Germany, avoiding the need to register separately with French tax authorities.

Tourist VAT Refund

David, an American tourist visiting London, purchases a GBP 500 jacket that includes 20% VAT (GBP 83.33 in VAT). He requests a tax-free shopping form from the retailer. At the airport before his flight home, David presents the form, receipt, and unworn jacket to customs. The refund service processes a refund of GBP 66.67 after deducting its processing fee. David effectively saves about 13% on the purchase price by reclaiming VAT.

Small Business VAT Registration

Amara runs a handmade ceramics business in the United Kingdom. Her annual turnover reaches GBP 85,000 and is growing. Because the UK VAT registration threshold is GBP 90,000, she is not yet required to register but anticipates crossing the threshold within the next quarter. She decides to register voluntarily now so she can begin reclaiming VAT on her clay, glaze, kiln fuel, and packaging purchases, which amount to roughly GBP 12,000 per year in input VAT. The trade-off is that she must now add 20% VAT to her prices, but since most of her competitors are also VAT-registered, customers expect VAT-inclusive pricing and the transition is seamless.

Why the United States Has No VAT

The United States is notable for being the only major economy that does not impose a national-level consumption tax. Instead, state and local governments levy sales taxes with rates and rules that vary by jurisdiction. As of 2026, combined state and local sales tax rates range from 0% (in Oregon, Montana, New Hampshire, Delaware, and Alaska, which has optional local taxes) to over 10% in parts of Louisiana, Tennessee, and Washington state.

Proposals for a U.S. federal VAT surface periodically in policy debates. Proponents argue it could simplify the tax system, reduce income tax rates, and generate substantial revenue. Opponents contend it would be regressive, create a new bureaucracy, and raise consumer prices. For the foreseeable future, the patchwork of state sales taxes remains the American approach to consumption taxation.

VAT Registration and Compliance

If your business operates in or sells to customers in VAT countries, compliance requires attention to several key areas:

• Registration thresholds. Most countries require VAT registration once annual taxable turnover exceeds a specified threshold. Monitor your revenue in each jurisdiction where you make sales.
• Invoice requirements. VAT invoices must include specific information: your VAT number, the customer's VAT number (for B2B transactions), the net amount, the VAT rate, and the VAT amount. Incorrect invoices can delay or deny input tax credits for your customers.
• Filing frequency. VAT returns are typically filed monthly or quarterly, depending on the country and your turnover level. Late filing incurs penalties and interest in most jurisdictions.
• Record keeping. Maintain detailed records of all sales and purchases, including invoices, receipts, and import/export documentation. Most countries require records to be kept for five to ten years.
• Cross-border rules. Selling goods or services across national borders triggers specific VAT rules depending on whether the customer is a business (B2B, usually reverse charge) or a consumer (B2C, usually destination-country VAT applies).

Common Mistakes to Avoid

• Confusing VAT-inclusive and VAT-exclusive prices. Always clarify whether quoted prices include VAT. B2B transactions are typically quoted net (ex-VAT), while B2C prices usually include VAT. Mixing up the two leads to pricing errors and margin miscalculations.
• Applying the wrong country's VAT rate. For B2C digital services, the VAT rate of the customer's country applies, not the seller's country. Using your home country rate when selling internationally is a common and costly compliance error.
• Missing registration deadlines. Once you cross the threshold, registration is mandatory and retroactive penalties may apply. Track your revenue against thresholds in every country where you sell.
• Failing to reclaim input VAT. Many small businesses overlook the VAT they pay on purchases. Keep all purchase invoices organized and file input tax claims on every VAT return to recover what you are owed.
• Ignoring reduced rates. Many countries tax essential items like food, medicine, and children's clothing at reduced rates. If your products qualify for a reduced rate, applying the standard rate means overcharging customers and overpaying tax.

Last updated: February 23, 2026