What is VAT? Value added tax explained for online sellers

VAT (value added tax) is a consumption tax on goods and services. Businesses charge it as a percentage of the sales price and collect it at every stage of production and distribution, but the final consumer bears the cost. The European Commission describes it as a consumption tax on the value added to nearly all goods and services bought and sold in and into the EU.

How VAT works

Each business in the chain charges VAT on its sales (output VAT) and deducts the VAT it paid on its own purchases (input VAT). It pays the difference to the tax authority. The EU VAT Directive puts it this way: VAT is charged on each transaction “after deduction of the amount of VAT borne directly by the various cost components.” Because of this, the total tax is the same however many businesses handle a product before it reaches the consumer.

Worked example

Take a hypothetical 20% VAT rate. A maker sells a lamp to a retailer for 100 plus 20 VAT. The retailer sells it to a consumer for 150 plus 30 VAT. The retailer pays the tax authority 30 minus 20, which is 10. The maker pays 20. In total the authority receives 30, exactly 20% of the final price of 150, and the consumer is the one who paid it.

VAT in the EU

The EU VAT Directive (2006/112/EC) sets the common rules, and each Member State sets its own rates within them. The standard rate cannot be lower than 15%. Which country's VAT applies to a sale is decided by the place of supply rules. For cross-border sales within the EU, the EU's Your Europe portal summarizes the basics:

  • Selling goods to a VAT-registered business in another EU country: you generally do not charge VAT on that sale.
  • Selling to consumers in another EU country: you may need to charge VAT at the rate that applies in their country. An EU-wide threshold of EUR 10,000 applies to these distance sales; below it, the sales may stay subject to VAT in your own country.

Sellers who charge VAT in several countries can report it through the One-Stop Shop (OSS) instead of registering in each one.

Why it matters for an online store

VAT affects your prices, your margins and your filings. If you get the rate or country wrong, the shortfall usually comes out of your margin, because you cannot go back to the customer for more.

Common mistakes

  • Treating VAT like US sales tax. Sales tax is normally charged once, at the final sale. VAT is collected at every stage and offset by deductions.
  • Charging your home rate forever. Once your cross-border sales to EU consumers go over EUR 10,000 in a calendar year, the customer's country's VAT generally applies from that point.
  • Mixing up B2B and B2C. The rules differ depending on whether the buyer is a VAT-registered business or a consumer. See B2B and B2C.

This page is general information, not tax advice. Rules have many exceptions; check with a tax adviser or your national tax authority.

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