The two sides: input VAT and output VAT
A VAT-registered business charges output VAT on its sales and pays input VAT on its purchases. Each VAT return, it pays the tax authority the difference. If input VAT exceeds output VAT (for example, after a large purchase or for an exporter) the business receives a refund.
The basic formulas
To add VAT to a net price:
Gross = Net × (1 + VAT rate)
To remove VAT from a gross price:
Net = Gross ÷ (1 + VAT rate) VAT = Gross − Net
Example with 20% VAT: a net price of £100 becomes £120 gross (£100 × 1.20). A gross price of £120 contains £20 of VAT (£120 − £120/1.20).
A worked example through the supply chain
Assume a 20% VAT rate.
- A timber mill sells wood to a furniture maker for £100 + £20 VAT. The mill remits £20 to the tax authority.
- The furniture maker builds a chair and sells it to a shop for £200 + £40 VAT. It owes £40 output VAT but reclaims £20 input VAT — net payment £20.
- The shop sells the chair to a consumer for £300 + £60 VAT. Output £60, input £40, net payment £20.
- Total VAT collected = £20 + £20 + £20 = £60 — exactly the VAT the consumer paid. That is the "value added" principle.
Standard, reduced and zero rates
- Standard rate — default rate on most goods and services (typically 17–27% in Europe).
- Reduced rate — lower rate on essentials such as food, energy, books or public transport.
- Zero-rated — taxable at 0%; input VAT can be reclaimed.
- Exempt — not taxable; input VAT generally cannot be reclaimed (e.g. financial services, insurance, healthcare).
Cross-border rules
For B2B sales between EU member states, the reverse chargeshifts the VAT obligation to the buyer. The supplier issues an invoice without VAT and the buyer self-accounts. For B2C distance sales of goods and digital services in the EU, the One Stop Shop (OSS)and Import One Stop Shop (IOSS) let a seller declare VAT for all EU countries in a single return.
Common mistakes
- Confusing 20% off (a discount) with 20% VAT removal — these are different calculations.
- Applying VAT to a gross price instead of the net.
- Forgetting that zero-rated and exempt sales are treated differently for input VAT recovery.
- Missing the registration threshold and registering late.