Taxation and customs union

What is VAT?

The Value Added Tax, or VAT, in the European Union is a general, broadly based consumption tax assessed on the value added to goods and services. It applies more or less to all goods and services that are bought and sold for use or consumption in the European Union. Thus, goods which are sold for export or services which are sold to customers abroad are normally not subject to VAT. Conversely imports are taxed to keep the system fair for EU producers so that they can compete on equal terms on the European market with suppliers situated outside the Union.

Value added tax is

  • a general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services.  However, if the annual turnover of this person is less than a certain limit (the threshold), which differs according to the Member State, the person does not have to charge VAT on their sales.
  • a consumption tax because it is borne ultimately by the final consumer. It is not a charge on businesses.
  • charged as a percentage of price, which means that the actual tax burden is visible at each stage in the production and distribution chain.
  • collected fractionally, via a system of partial payments whereby taxable persons (i.e., VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities. This mechanism ensures that the tax is neutral regardless of how many transactions are involved.
  • paid to the revenue authorities by the seller of the goods, who is the "taxable person", but it is actually paid by the buyer to the seller as part of the price. It is thus an indirect tax.

Why do all EU countries use VAT?

  • At the time when the European Community was created, the original six EU countries were using different forms of indirect taxation, most of which were cascade taxes. These were multi-stage taxes which were each levied on the actual value of output at each stage of the productive process, making it impossible to determine the real amount of tax actually included in the final price of a particular product. As a consequence, there was always a risk that EU countries would deliberately or accidentally subsidise their exports by overestimating the taxes refundable on exportation.
  • It was evident that if there was ever going to be an efficient, single market in Europe, a neutral and transparent turnover tax system was required which ensured tax neutrality and allowed the exact amount of tax to be rebated at the point of export. As explained in VAT on imports and exports, VAT allows for the certainty that exports there are completely and transparently tax-free.

How is it charged?
The VAT due on any sale is a percentage of the sale price but from this the taxable person is entitled to deduct all the tax already paid at the preceding stage. Therefore, double taxation is avoided and tax is paid only on the value added at each stage of production and distribution. In this way, as the final price of the product is equal to the sum of the values added at each preceding stage, the final VAT paid is made up of the sum of the VAT paid at each stage.

Registered VAT traders are given a number and have to show the VAT charged to customers on invoices. In this way, the customer, if he is a registered trader, knows how much he can deduct in turn and the consumer knows how much tax he has paid on the final product. In this way the correct VAT is paid in stages and to a degree the system is self-policing.

Example

Stage 1
A mine sells iron ore to a smelter. The sale is worth €1000 and, if the VAT rate is 20%, the mine charges its customers €1200. It should pay €200 to the treasury, but as it has bought €240 worth of tools in the same accounting period, including €40 VAT, it is only required to pay €160 (€200 less €40) to the treasury. The treasury also receives the €40 and now gets €160 making €200 - which is the correct amount of VAT due on the sale of the iron ore.

  • Supply: €1000
  • VAT on supply: €200
  • VAT on purchases: €40
  • Net VAT to be paid: €160

Stage 2
The smelter has paid €200 VAT to the mine and, say, another €20 VAT on other purchases, such as furniture, stationery, etc. So when the smelter sells €2000 worth of steel it charges €2400 including €400 VAT. The smelter deducts the €220 already paid on his inputs and pays €180 to the treasury. The treasury receives this €180 from the smelter plus €160 from the mine, plus €40 paid by the supplier of tools to the mine, plus €20 paid by the furniture/stationary supplier to the smelter.

  • Supply: €2000
  • VAT on supply: €400
  • VAT on purchases: €220
  • Net VAT to be paid: €180

€180 (paid by the smelter) + €160 (paid by the mine) + €40 (paid by the supplier to the mine) + €20 (paid by the supplier to the smelter) = €400 or the correct amount of VAT on a sale worth €2000.

VAT rates
EU law only requires that the standard VAT rate must be at least 15% and the reduced rate at least 5% (only for supplies of goods and services referred to in an exhaustive list).

Actual rates applied vary between EU countries and between certain types of products. In addition, certain EU countries have retained other rates for specific products.

The most reliable source of information on current VAT rates for a specified product in a particular EU country is that country's VAT authority. An overview of the different rates applied in all EU countries is provided in the EU information document.

More about VAT rates

What is the Commission’s role in application of the EU VAT system?
The Commission is responsible for ensuring the correct application the VAT Directive. Each Member State is responsible for the transposition of these provisions into national legislation and their correct application within its territory. The role of the Commission, as the "Guardian of the Treaties", consists of ensuring that the national legislation and general practice complies with EU Law.

How do the EU countries apply VAT?
EU countries implement common rules set in VAT Directive in their national legislation. The practical application and the administrative practices of each EU country therefore vary.

More about national VAT rules

 

Can the Commission intervene in specific cases of application of VAT Directive?
The European Commission does not have competence to solve problems of particular taxpayers in their specific cases nor to give an opinion on factual findings.

The Commission may initiate an infringement procedure against a Member State concerned. However, only the Commission and the Member State are considered parties in this procedure to the exclusion of a particular taxpayer. The outcome of such a procedure does not have a direct effect on specific cases.

Therefore, the only way to seek redress in particular cases is to have recourse to the national means of redress – administrative or judicial.

More about complaints

See the detailed information on VAT rules by topic