What is a VAT exemption?
As the term suggests, supplies falling under a category exempt from VAT are sold to the buyer, normally a final consumer, without any VAT being applied to that sale. Exemptions from tax include for example, certain activities in the public interest (medical care, school education etc.) or certain insurance and financial services.
However, as the supply is exempt from VAT, deduction of the VAT paid on the inputs is not possible. For example, postal services are at present exempt from VAT. So if you send a parcel using the Post Office you are not charged VAT, but the Post Office has paid VAT on its inputs: the vans it uses, the post boxes it buys, and all the other things. It cannot reclaim or deduct this VAT. So a part of the value of the stamps you bought to send the parcel represents paying this "hidden" VAT.
What is a zero-rated good?
On the other hand there are certain exemptions whereby the supplier is allowed to deduct his input VAT. These exemptions are used for instance for the exports of goods from the Community to third countries and also for intra-Community supplies of goods despatched from one Member State to a taxable person (or identified trader) in another. Sometimes these exemptions are called zero-rate supplies as the result is that there is no residual VAT in the final price.
In addition, some Member States are still allowed to apply zero-rates of VAT to certain groups of goods. For example, in the UK books are sold domestically with a zero rate of VAT. This means that the final price charged to the consumer does not include VAT but it also means that the VAT paid on the inputs which make up the good are deducted, so there is no residual VAT in the final price.
Exceptions to the normal rules for consumers
In order to preserve Member States' VAT receipts in the country of consumption, rather than of sale, the transitional VAT System also has several special schemes applying to sales to consumers in another Member State. These include in particular the exemption for Sales of new means of transport dispatched or transported to the customer's Member State. However, the customer is liable for the payment of VAT to this Member State.