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VAT 101: What you need to know about value-added tax

December 1, 2022
Top view of a desk with a calculator and laptop

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Did you know that in 2021, tax revenue accounted for over 41% of the total GDP in the entire European Union? Whether you're a business owner or consumer, it's important to understand how Value-Added Tax, or VAT, works.

This tax is something that everyone in Europe (and a total of 170 countries around the world) has to deal with, and there are a lot of questions surrounding it. What is VAT? How does it work? What are the benefits and drawbacks? 

In this comprehensive guide, we'll answer all of your questions and help you understand VAT better. Then, we'll provide you with a nifty AutoVAT tool to help you calculate VAT correctly.

What Is VAT?

Looking for a VAT definition? VAT stands for value-added tax. It's a tax imposed on the sale of goods and services. The tax is added to the price of the product or service, and the consumer pays the VAT when they purchase the item. 

VAT is a consumption tax, meaning that it is ultimately paid by the consumer. However, it's the responsibility of businesses to collect the tax and send the money to the government. 

This means that if you're a solo entrepreneur or freelancer working in a country that has value-added tax then you'll need to also consider this so you can ensure you're collecting it properly.

Overall, VAT rates can vary depending on the country, but are typically around 20%. For example, each country in the European Union sets its VAT rate, but it can't be less than 15%.

While VAT can be a complex tax, it ultimately provides revenue for governments and helps to fund public services.

How Does VAT Work?

When you go to the store, you might not think about the value-added tax (VAT) that is included in the price of your purchase. But if you look at your receipt, the tax is likely listed there.

As mentioned above, VAT is a type of consumption tax that is imposed on goods and services at each stage of the production process. In other words, it is a tax on the value that is added to a product or service at each step, from raw materials to the final retail sale. 

The amount of VAT that is paid is based on the value of the product, less any taxes that have already been paid on the materials used to make it. 

What about those who make and export products out of their own country? It ultimately depends. 

In the EU, for example, you don't pay VAT on products you export out of the EU. Instead, you pay VAT (or sales tax in the US) to the country to which you're exporting. However, if you live in France and export a product to the Netherlands, for example, you'd pay Netherlands VAT.

Basically, you pay VAT to the country wherever the final consumer will enjoy your goods. If you're offering services (let's say you're a freelancer in Germany), then you pay VAT in Germany regardless of where your clients are.

Who Pays VAT?

The final consumer who buys the goods or services pays the VAT, and the businesses that collected the tax are responsible for remitting it to the government.

So while consumers ultimately pay the VAT, it's your responsibility as the seller to ensure that the correct amount of VAT is collected. This means that, as a business owner or freelancer, you need to be mindful when creating your invoices for goods or services sold. 

This can be a bit of a hassle, but it is important to make sure that you are compliant with the law. Check out VAT rates and rules in your country of residence (or wherever you registered your business) to be sure you're collecting it correctly.

What Are the Different VAT Rates?

The VAT rate can vary depending on the country, but it is typically a few percentage points. In the EU, it varies between about 15% to 30%. 

While it's important to look at the value-added tax rate for your specific country, here are a few quick examples of VAT rates in three large European countries.

Germany

In Germany, the standard VAT rate is 19%. However, that rate goes down to 7% for items such as books and food. Typically (as is the case in other EU countries), consumers can deduct VAT charges on their income taxes each year.

Netherlands

The VAT rate in the Netherlands is slightly higher than in Germany, sitting currently at 21%. However, there is a reduced VAT rate of 9% and 0%.

The 0% tax rate only applies to foreign entrepreneurs conducting business in countries outside of the Netherlands. The 9% tax rate is similar to Germany's reduced tax rate and applies to common goods such as books, magazines, food, and medicine.

France

France's VAT rate sits directly between Germany's and the Netherlands' at 20%. However, similar to other EU countries, France reduces this tax rate to 10% for special goods.

How Do You Calculate VAT?

In most countries, you calculate VAT as a percentage of the sale price. For example, if a product is sold for €100 and the VAT rate is 20%, the total price of the product would be €120 (€100 + €20). 

Remember, VAT is always calculated on the sale price before any other discounts or taxes are applied. Or, you could just use our AutoVAT tool to help you calculate VAT correctly.

Do You Need a European VAT Number?

So, do you need a European VAT number if you're living and working in Europe? It depends. European VAT numbers are issued to businesses by the tax authorities in the European Union member state where the business is registered. 

The number is used to identify the business for value-added tax purposes. So, yes, if you have a business registered for VAT in an EU member state, you will need a European VAT number. 

You'll use this number on all invoices that you issue to customers in other EU member states. 

How do you get a European VAT number? You'll first need to register for VAT in your home country (wherever you're a legal resident). Once the application has been approved, you'll be issued a European VAT number that's valid in all EU member states.

Bank with bunq

From understanding how VAT works to getting your IBAN and setting up payment transfers, there's a lot to know about doing business in Europe.

With a bunq Business account, calculating your business’ VAT has never been easier. The app automatically calculates the VAT on your incoming and outgoing payments, and adds it to a separate account so it’s ready and waiting for you when it comes to sorting your books at end of year.

However, you don't need to be a business owner or freelancer to benefit from banking with bunq. We believe that everyone should have the opportunity to bank like a local, no matter where they are in the world. 

That's why we've created a fully mobile banking app that allows you to create your account in just a few minutes, and then start spending, saving, budgeting, and investing effortlessly from your phone.

Ready to give it a try? Sign up today.

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