How does VAT work in the EU and outside the EU?

At present, just over 160 countries are using a VAT system around the world. Given the different regulatory frameworks of these different nations, each value-added tax system operates with some alterations and modifications. For instance, the types of goods that are exempt and the rate that is charged will differ from one nation to the next. This is true even within the EU, despite the Union’s Directive providing a common set of rules to follow. First, let’s take a look at how the tax is handled in the European Union.

VAT in the EU

In Europe, and around the world, VAT is an indirect levy collected at each stage of the production process, assessed on the value that is added from one phase to the next. This is unlike a sales tax, where the charge is levied at the final point of sale. With this system, businesses avoid double taxation and a possible cascading effect, because each entity is able to reclaim the levy paid on the purchases of goods used in production. As a result, an entity only pays the proportion of tax charged on the items it ultimately sells.

In the EU, a value-added charge is generally applied to all goods and services. The 2006 Directive provided a comprehensive structure within which individual member states would handle the tax. For example, rates can change from one country to the next, but there are guidelines that need to be followed. The minimum standard charge is 15%, while states are allowed to have two or three other reduced rates, including a charge of 0%. The items falling into each category change throughout nations.

Some goods and services are exempt from the tax. These exceptions mostly apply to items that are of significant value to the public, but in most instances, the charge is absent only when a public institution offers the item, not when a private firm does the selling.

For an overview of all VAT rates within the European Union, feel free to check out our latest VAT Rules Map including information on deductibility on expenditure categories for reclaiming 2021 VAT.

VAT outside the EU

Outside the European Union, the framework surrounding value-added taxes is quite similar across nations. There are standard rates, reduced rates, zero-rating, and exemptions. The primary differences, however, come down to minor details changing from one place to the next. For example, the standard charge is 19% in Germany, but 10% in South Korea. Germany has three classes of rates (19%, 7%, and 0%) while South Korea has just two (10% and 0%). The goods and services falling into each category change as well. In Germany, the zero rate applies to intra-community and international transport and in South Korea, it refers to mostly exports and business services.

VAT vs GST

Some countries outside Europe are using GST, or a Goods and Services Tax system. From many perspectives, GST can be taken to be another term for a value-added tax or a type of value-added tax, but there are slight variations between the two depending on the country being discussed.

India as an example

Initially, India used a sales tax structure that created problems due to the cascading effect, basically a situation where goods and services get taxed more than once. This structure was replaced by a value-added tax to combat this issue among many others. Now, India is using GST instead of VAT, acting as a single, unified charge that replaces all other levies.

Under the previous VAT system in India, taxes would have compounded on top of each other. For example, the value-added tax would have been calculated on an item after excise duties had already been added to it. This would increase the final price of the product.

Under India’s new system, the GST, these other levies such as excise duties have been removed. There’s one single tax so that the final price to the customer is lowered.

Key takeaways

What’s clear as you look at VAT systems around the world is that the fundamental structure is the same, but the finer points are always going to be quite distinct. Consequently, keeping track of the thousands of rules and regulations isn’t a task that can be handled manually, especially when it comes to the process of reclaiming input charges. An automated recovery solution like VAT4U becomes crucial in saving your organisation time and money, ultimately improving profit margins. See how our service works and register to try it out.