- What is VAT exemption?
- Exemptions without the right to deduct
- Exemptions with the right to deduct
- Other exemptions
What is VAT exemption?
A supply of goods or services is an exempt supply if no VAT is applied to it, whether at the final stage of sale to the consumer or at some intermediate business-to-business stage.
The VAT Directive prescribes both supplies that EU countries must exempt and supplies that they may choose to exempt.
Supplies that must be exempt include certain activities in the public interest (such as medical and dental care, social services, education etc.) as well as most financial and insurance services and certain supplies of land and buildings. Exemptions also exist for intra-EU supplies and exports of goods outside the EU.
What happens to input tax for an exempt supply?
In most cases, if a supply is exempt from VAT, deduction of the VAT paid (input VAT) on goods and services purchased in order to make that supply is not allowed.
Public postal services are exempt from VAT. Consequently , people who send a parcel using the Post Office 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 postage for sending the parcel represents paying for this ‘hidden’ VAT.
Is zero-rating the same as exemption?
Whereas most exempt transactions involve no right to deduct the associated input VAT (‘exemptions without the right to deduct’), there are certain exempt transactions in respect of which suppliers are allowed to deduct their input VAT. These exemptions are used for instance for the exports of goods from the EU to third countries and also for intra EU supplies of goods dispatched from one EU country to a business in another.
Sometimes these exempt transactions are called ‘zero-rated’ transactions as the result is that there is no residual VAT in the final price. However, it is important to distinguish between these transactions, which are best described as ‘exemptions with a right to deduct’ and ‘true’ zero-rated transactions.
These latter are transactions involving certain groups of goods or services on which some EU countries are still allowed to apply a reduced rate of zero to certain groups of goods. For example, in the UK books are sold 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 that go towards producing the book are deductible, so there is no residual (or ‘hidden’) VAT in the final price.
Exceptions to the normal rules for consumers
There is yet another category of exempt transactions. Created in order to preserve EU countries’ VAT receipts in the country of consumption, rather than of sale, there are several special schemes applying to sales to consumers in another EU country. These include in particular the exemption for Sales of new means of transport dispatched or transported to the customer’s EU country. However, in this case, VAT is still collected, as it is the customer who is liable for the payment of VAT to his own EU country.
The three types of exempt supply
- Exemptions without the right to deduct (e.g. public-interest supplies)
- Exemptions with the right to deduct (e.g. exports and intra-EU supplies)
- Other exemptions (e.g. certain imports and intra-EU acquisitions)
For zero-rated supplies, see Special rates of VAT: derogations concerning reduced rates.