What is VAT and how does it work?
VAT is collected in pieces along the supply chain. Each VAT-registered business adds VAT to the price it charges (output VAT) and deducts the VAT it paid on its own business purchases (input VAT). It pays the difference to the tax authority, which is HMRC in the UK.
Here is a simple chain at the UK standard rate of 20%. The figures are hypothetical:
| Stage | Price before VAT | VAT charged | VAT reclaimed | VAT paid to the tax authority |
|---|---|---|---|---|
| Supplier sells materials to a maker | £40 | £8 | £0 | £8 |
| Maker sells the finished item to a retailer | £100 | £20 | £8 | £12 |
| Retailer sells it to a consumer | £150 | £30 | £20 | £10 |
| Total | £30 |
The tax authority receives £30 in total, exactly 20% of the £150 final price. The businesses act as collectors, and the consumer, who can't reclaim anything, pays the whole £30.
How is VAT different from US sales tax?
Both are paid by the consumer in the end, but they are collected differently:
- When it is charged. VAT is charged at every stage. US sales tax is generally charged only on the final retail sale; a business buying goods to resell typically gives its supplier a resale certificate instead.
- Reclaiming tax. VAT-registered businesses reclaim input VAT. With sales tax there is normally nothing to reclaim, because it wasn't charged on resale purchases.
- How prices are shown. In countries with VAT, consumer prices usually include it. In the US, shelf prices usually exclude sales tax, and it is added at checkout.
- Who sets the rate. VAT rates are set nationally. US sales tax rates are set by states and often by counties and cities too.
The sales tax calculator adds or removes US sales tax and VAT.
How do you add VAT to a price?
Multiply the price before VAT (the net price) by 1 plus the rate as a decimal:
Price including VAT = Net price × (1 + VAT rate) VAT = Net price × VAT rate
Example at 20%: a product with a net price of £45 sells for £45 × 1.20 = £54, of which £9 is VAT.
How do you remove VAT from a price?
Divide the VAT-inclusive (gross) price by 1 plus the rate:
Net price = Gross price ÷ (1 + VAT rate) VAT = Gross price − Net price
- At 20%: £54 ÷ 1.20 = £45 net, so the VAT is £54 − £45 = £9.
- At 5%: £63 ÷ 1.05 = £60 net, so the VAT is £3.
A shortcut for the VAT part alone is to multiply the gross price by rate ÷ (1 + rate). At 20% that is 0.2 ÷ 1.2, or one-sixth of the gross price: £54 ÷ 6 = £9. At 5% it is one twenty-first: £63 ÷ 21 = £3.
Why can't you remove VAT by subtracting the rate?
VAT is a percentage of the net price. Taking 20% off a gross figure takes 20% of a bigger number than the one the VAT was calculated on.
Using the example above, taking 20% off £54 gives £54 × 0.80 = £43.20. The real net price is £45, so the shortcut understates it by £1.80 and overstates the VAT by the same amount. Across a year of sales, that error distorts your revenue, margins and VAT records. The percentage calculator helps with these base-of-percentage questions.
How should you set VAT-inclusive prices for consumers?
Consumers in VAT countries generally see prices with VAT included, so you often pick a round shelf price and work backwards to the net amount you keep.
Suppose you sell a candle for £30 including 20% VAT, and it costs you £15 net of any VAT you can reclaim:
- Net revenue: £30 ÷ 1.20 = £25. The other £5 is VAT you pass on to the tax authority.
- Profit: £25 − £15 = £10.
- Margin: £10 ÷ £25 = 40%.
If you mistakenly calculated the margin on the full £30, you would see £15 of profit and a 50% margin, and you would overestimate your profit by half. Always work out margin and markup on the net price. The profit margin calculator and markup calculator work correctly when you enter prices before VAT.
This matters most when you first register. If you keep your shelf price at £30, you now keep £25 of it instead of £30. To keep £30 net, the shelf price would have to rise to £30 × 1.20 = £36. Our guide on how to price a product walks through building a price up from cost.
What are the standard VAT rates?
Each country sets its own rates, usually a standard rate plus lower rates for some goods and services:
| Country | Standard rate | Lower rates (examples) |
|---|---|---|
| United Kingdom | 20% | 5% reduced rate; 0% zero rate |
| Germany | 19% | 7% reduced rate |
| France | 20% | Several reduced rates |
| Ireland | 23% | Several reduced rates |
| Netherlands | 21% | Reduced rate on some goods |
Zero-rated and exempt are not the same. A zero-rated sale is taxable at 0%, so you can still generally reclaim the VAT on related purchases. An exempt sale is outside VAT altogether, and you generally can't reclaim the VAT on costs linked to it.
When do you have to register for VAT?
Most countries require you to register once your taxable sales pass a registration threshold. The amount varies by country and is reviewed from time to time, so check the current figure with the tax authority where you sell. Some countries apply different rules to sellers based abroad, and in some places, including the UK and EU countries, online marketplaces are responsible for collecting VAT on certain sales made through them.
You can often register voluntarily below the threshold to reclaim input VAT, but you must then charge VAT on your sales.
This guide is general information, not tax advice. For your own situation, speak to an accountant or the official tax authority.