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What Is a VAT Exemption?

John Lister
John Lister

VAT, or value added tax, is a tax charged in several countries, most notably those in Europe. It is similar to a sales tax, but is applied at every stage of the manufacturing and supply chain, rather than solely at the final sale to a consumer. Some goods have a specific VAT exemption. There are also some forms of VAT exemption available for some entire businesses.

VAT is generally charged whenever good and services are sold, whether this be to a consumer or to a business. A business that must pay VAT on its sales can claim a credit for the VAT component of any money it has itself spent on goods and services. The effect of this credit is that for each sale, the seller pays VAT based only on the profit he has made: that is, the value added. For example, a chair maker might buy some wood, turn it into a chair and sell the chair; he or she would be liable to pay VAT on the chair sale revenue but could deduct the VAT paid on the wood. VAT liability deductions are calculated for all transactions over a period of time rather being calculated for each individual transaction.

Woman holding a book
Woman holding a book

Many countries put goods into a range of categories, each with a different rate. Within the European Union, a country's highest rate must be at least 15%. A country can also have up to two additional categories, each with a maximum rate of 5%. Common examples of goods in such categories include domestic fuel.

A few countries have a category with a 0% rate. Countries that had this rate when the European Union passed laws on VAT in 2006 are allowed to maintain these categories, but new 0% categories cannot be added, and products cannot be added to an existing 0% category. Examples of goods included in some countries' 0% category include newspapers and books. The 0% category does not technically count as a VAT exemption: for accounting and administration purposes, VAT is still applied and recorded, but the amount payable is zero.

With those goods and services that qualify for VAT exemption, the transactions are not listed in VAT accounts and paperwork. These are relatively rare. Some examples include some medical services offered to the public, some forms of insurance, and some forms of education and training.

The other main form of VAT exemption is one that applies in some countries to an entire business. This means the business does not charge VAT to customers, does not pay a VAT bill, and cannot claim back the VAT component of any money it spends itself on goods and services. A company is usually exempt from VAT in this way if its turnover falls below a certain limit. A company in this position can sometimes elect to be covered by VAT, meaning it charges, pays and deducts VAT in the same way as a company that does not have the choice. Whether being covered by VAT voluntarily makes financial sense depends on the types of goods or services a company sells, the good and services it buys from suppliers, and the respective VAT rates.

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