european-union

July 3rd, 2012

What is VAT and why does the European Union use it?

Understanding your customer is one of the most important rules in eCommerce.  If you are a U.S. based eCommerce company that deals with international consumers this is particularly important due to the varying rules, taxes, etc. that your customers have to deal with when shopping online.  One of the most misunderstood things to a U.S. business is VAT.  So what is VAT?

The Value Added Tax, or VAT, in the European Union (EU) is a 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. Imports are taxed to keep the system fair for EU producers so that they can compete equally 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
  • A Consumption tax because it is paid 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 does the EU use VAT?

When the European Community was created, the original six Member States 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 production 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 Member States would deliberately or accidentally subsidize their exports by overestimating the taxes refundable on exportation.

It was clear 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.

Take a look at our map of European Union VAT Rates

As mentioned earlier, understanding your customer is one of the most important rules in business.  Knowing what issues the consumer has to consider when ordering online will help you improve your service and increase sales.

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