Value Added Tax (VAT): What is it and How Does it Work?

Value Added Tax (VAT) is a consumer tax on goods and services in the E.U. (including the U.K.) and other foreign countries. The United States does not impose VAT on U.S. goods; instead, the U.S. adopted a sales and use tax system. We will focus on VAT for the purposes of this discussion.

When goods or services are purchased, VAT is included in the price of the good or service. When businesses levy VAT on goods and services, it creates an additional level of accountability and obligation to the tax authorities as that tax must be remitted to the appropriate authority and not retained or considered as additional revenue by the business. Those payments are made monthly, quarterly, or annually and are calculated in concert with the business’s accountant to ensure accuracy.

Each country has a different VAT rate. In the U.K., that rate is currently 20% with certain exceptions or reduced rates categories.  Categories with reduced VAT rates can range from government work to food products to children’s car seats.

Registering for Value Added Tax

We recommend that businesses become VAT registered if they have sufficient presence in a country or are paying sufficient VAT each year, and they would like to be able to apply for a possibly refund. Why?

Say you are a widget manufacturer:

You are a seller of widgets, and a registered VAT business. In the first quarter of 2017, you sell widgets to a distributor in the U.K. for receipts of $10,000 plus 20% VAT for a total of $12,000. During the same quarter, you purchased from a U.K. supplier and were charged $2,000 plus VAT ($2,400). The amount you owe to the taxing authority is the difference between the two VATs – in our example, you would remit $1,600.

If you were not a registered VAT business, you would still be required to collect VAT, but would not be able to receive a refund for the VAT difference between what you had collected and paid. Using our example, you would have to eat the $1,600.

Complicating matters is the fact, as we stated earlier, that VAT rates vary from country to country. While the UK rate is currently 20% on most items, VAT rates vary from 17% – 27% and can change. Keeping up to date with rates and preparing and providing accurate documentation and calculations is complicated.

Smith and Howard’s tax professionals work with many clients in this area. If your business is at or approaching the VAT threshold, please call us at 404-874-6244 or email me, Kate Maxwell, for a complimentary review of your current situation. Additionally, you can contact us online.

*For a full list of reduced VAT or exempt items, visit the E.U. country’s taxing authority’s web site or call your Smith and Howard international tax professional.