What Is VAT? Everything You Need to Know

If you plan to do business outside the United States, understanding Value-Added Tax (VAT) is essential, as it is the most common consumption tax worldwide. Nearly 200 countries worldwide impose VAT or a similar Goods and Services Tax (GST), businesses must navigate different tax rules when selling internationally. This guide will explore how VAT works, how it differs from U.S. sales tax, and what businesses need to know to stay compliant.

Understanding Value-Added Tax: What Is VAT?

Value-Added Tax (VAT) is a consumption tax applied at multiple stages of production and distribution, with businesses collecting VAT on sales and remitting it to the government. VAT is widely used around the globe, including the United Kingdom, Germany, France, China, India, Brazil, and South Africa. While VAT is common in Europe, Asia, and Latin America, the United States does not impose a federal VAT system.

Instead, the U.S. relies on sales tax, which is a single-stage tax applied only at the point of final sale to consumers. Unlike VAT, which businesses can reclaim at different stages of the supply chain, sales tax is collected by retailers and remitted to state or local governments.

This key difference makes VAT a more complex but standardized system globally, while U.S. businesses must navigate varying state and local sales tax rates instead of a nationwide consumption tax.

VAT Example

Let’s assume a standard VAT rate of 20%. Here’s how VAT works at different stages of the supply chain:

1. Manufacturer:

• Buys raw materials for €1,000 (excluding VAT).
• Pays €1,200 (including €200 VAT) to the supplier.
• Sells the finished product to a wholesaler for €2,000 plus 20% VAT (€2,400 total).
• Collects €400 VAT from the wholesaler but can reclaim the €200 VAT paid on raw materials.
• Pays the government €200 VAT (€400 output VAT - €200 input VAT).

1. Wholesaler:

• Buys the product for €2,000 (excluding VAT).
• Pays €2,400 (including €400 VAT) to the manufacturer.
• Sells to a retailer for €3,000 plus 20% VAT (€3,600 total).
• Collects €600 VAT but reclaims €400 VAT paid to the manufacturer.
• Pays the government €200 VAT (€600 output VAT - €400 input VAT).

1. Retailer:

• Buys the product for €3,000 (excluding VAT).
• Pays €3,600 (including €600 VAT) to the wholesaler.
• Sells to a customer for €5,000 plus 20% VAT (€6,000 total).
• Collects €1,000 VAT but reclaims €600 VAT paid to the wholesaler.
• Pays the government €400 VAT (€1,000 output VAT - €600 input VAT).

1. Final Consumer:

• Buys the product for €5,000 plus 20% VAT.
• Pays €6,000 total (including €1,000 VAT).
• Cannot reclaim VAT, since consumers bear the final tax burden.

What Is VAT Fraud?

VAT fraud occurs when businesses or individuals deliberately evade Value-Added Tax (VAT) obligations, either by underreporting sales, overstating input VAT claims, or engaging in fraudulent schemes. Since VAT is collected at multiple stages of the supply chain, fraudulent activities can range from simple misreporting to complex, large-scale fraud schemes that exploit tax regulations.

There are different types of VAT fraud — Missing Trader Intra-Community (MTIC), carousel fraud, cash fraud, online fraud, contra fraud, and acquisition fraud to name a few.

FAQs

Who collects VAT?

VAT is collected by businesses registered for VAT, which charge it on taxable sales and remit the collected amount to the government. Each country’s tax authority, such as HMRC in the UK or the IRS-equivalent in VAT countries, oversees VAT collection and compliance.

Do I need to register my business for VAT?

If your business exceeds the VAT registration threshold in a country that imposes VAT, you are required to register and charge VAT on sales. Some businesses may also voluntarily register to reclaim input VAT on purchases, even if they don’t meet the mandatory threshold.

Are there VAT exemptions?

Yes, certain goods and services, such as essential food items, healthcare, education, and financial services, may be zero-rated or VAT-exempt, depending on the country’s tax laws. Exempt businesses cannot charge VAT on sales or reclaim VAT on purchases, unlike zero-rated businesses that can still claim VAT refunds.

How does VAT work?

VAT is applied at each stage of the supply chain, where businesses charge output VAT on sales and deduct input VAT on purchases, remitting the difference to the government. The final consumer ultimately pays the tax, while businesses act as tax collectors.

How to file and pay VAT?

VAT-registered businesses must submit VAT returns periodically (monthly, quarterly, or annually) to report sales, purchases, and VAT collected. Payment is made directly to the tax authority.

Comparing VAT with Other Tax Types

Understanding how Value-Added Tax (VAT) differs from other tax types is crucial for businesses navigating global tax systems. While VAT is a consumption-based tax applied at multiple stages of production, other tax types, such as sales tax, income tax, and excise tax, operate differently in terms of collection and impact.

Check out the different types of taxes and how they compare with VAT.

1. Sales Tax

A single-stage tax collected at the final point of sale, where only the end consumer pays tax, unlike VAT, which is applied throughout the supply chain.

2. Income Tax

A direct tax levied on an individual’s or business’s earnings, with rates depending on income brackets and corporate tax policies.

3. Excise Tax

A specific tax on certain goods, such as alcohol, tobacco, and fuel, often included in the product price and designed to regulate consumption.

4. Corporate Tax

A tax on business revenue requiring companies to pay a percentage of their net income to the government, separate from indirect taxes like VAT or sales tax.

Each tax type serves a different purpose, affecting businesses and consumers in unique ways, making it essential to understand their implications.

How VAT Impacts Businesses

Value-Added Tax (VAT) affects businesses at every stage of operations, from pricing and cash flow management to compliance and tax reporting. Businesses must understand how VAT works to ensure proper tax collection, avoid penalties, and maintain smooth financial operations.

Here's how VAT affects businesses:

1. Compliance and Registration

Businesses that exceed the VAT registration threshold must register, charge VAT, and submit regular tax returns to the government.

2. Cash Flow Management

Since businesses collect VAT on sales but also pay VAT on purchases, they must manage cash flow carefully to ensure timely tax remittances.

3. Pricing and Profit Margins

VAT affects pricing strategies, as businesses must decide whether to include VAT in product prices or add it at checkout, impacting customer perception and competitiveness.

4. Record-Keeping and Reporting

Businesses must maintain detailed VAT invoices, transaction records, and tax filings, as failure to comply can result in audits, fines, or penalties.

How VAT Affects Businesses in the United States

Although the United States does not impose a federal VAT, U.S. businesses engaging in international trade may still be affected by VAT when selling goods and services abroad. Companies exporting to VAT-registered countries must comply with foreign VAT regulations, which can impact pricing, tax obligations, and compliance costs.

Here are the key ways VAT affects U.S. businesses:

1. VAT Registration in Foreign Markets

U.S. businesses selling into VAT-imposing countries may be required to register for VAT if they exceed the local sales threshold. For example, a U.S. e-commerce business selling to consumers in the European Union may need to register for VAT under the EU’s One Stop Shop (OSS) system.

2. Pricing and VAT-Inclusive Costs

Unlike in the U.S., where sales tax is added at checkout, many VAT countries require prices to be VAT-inclusive, meaning businesses must adjust pricing strategies. U.S. businesses must decide whether to absorb the VAT cost or pass it to consumers, affecting competitiveness.

3. VAT on Digital Goods and Services

Many countries apply VAT on digital services (e.g., software, streaming, online subscriptions), requiring U.S. companies to collect and remit VAT in the customer’s country. For example, the UK’s VAT rules require non-UK businesses selling digital services to UK consumers to register and charge VAT.

4. VAT Refunds for U.S. Businesses

U.S. businesses may be eligible to claim VAT refunds on expenses incurred in VAT-imposing countries (e.g., trade shows, business travel, or purchasing goods abroad). However, refund processes vary by country, and businesses must provide proper documentation to reclaim VAT paid.

5. Customs and Import VAT on Goods

When exporting physical goods to VAT countries, U.S. businesses may need to pay import VAT, which is charged at customs before products enter the market. Some countries allow import VAT deferment or deductions for VAT-registered businesses, while others require customers to pay upon receipt.

6. Complex VAT Compliance and Filing

U.S. businesses selling in multiple VAT jurisdictions must navigate complex VAT compliance, including local registration, invoicing rules, filing requirements, and remittance deadlines.

Let Kintsugi Take Care Of Your Sales Tax

As mentioned, there is no value-added tax in the United States, but most states levy sales tax. For businesses that need help managing sales tax, Kintsugi is the answer.

Kintsugi makes sales tax compliance effortless for U.S. businesses by providing an easy onboarding process that gets you set up in minutes. Its seamless integration with Shopify, Stripe, and other platforms ensures real-time tax collection across multiple states. With accurate tax calculations, Kintsugi automatically applies the correct sales tax rates based on changing state and local regulations, eliminating guesswork and files return to the government.

Unlike other tax solutions, Kintsugi offers transparent pricing with no hidden fees, so you always know what you’re paying for. Plus, its responsive customer support ensures that help is always available when you need it. Sign up today or book a demo to see how Kintsugi can simplify sales tax for your business.