What is VAT
VAT is Value Added Tax. It is a form of Sales Tax (though technically it is distinct from Sales Tax). VAT is a percentage calculated over the value a company has added to a product or service.
Value Added Tax explained
The “value added” is a slightly complex term but in simple terms it means that you pay taxes over any income that was not yet charged by another company. A simple example: a company buys TVs and sells them to consumers. The TV the company bought cost €80.000. The company sells the TVs for €100.000. The company should pay VAT over €100.000 - €80.000 = €20.000 to the Dutch Belatingdienst (that would be 21% over €20.000 = €4.200 in the Netherlands)
In reality the company from our example would never calculate VAT like this. Instead it would add up all the VAT it has paid over it’s TVs (so €80.000 x 21% = €16.800 VAT). It would also charge all its customers 21% over any TV they bought. So that would mean that on top of the €100.000, they would charge 100.000 x 21% = €21.000 VAT. The example company would then report to the Belastingdienst that they received €21.000 VAT over their sales but that they paid €16.800 VAT in expenses already. They would net their payment at €21.000 - €16.800 = €4.200. Exactly what we calculated above.
Is VAT the same as Sales Tax?
So the reason why VAT is sometimes called a Sales Tax is that you apply it as a percentage to all your sales. However the difference with a Sales Tax is that as a company you can also deduct the VAT on expenses you incurred. Therefore, unlike with a normal Sales Tax, most companies do not look at VAT when they make purchases but at the net amount. After all, they can deduct the VAT from their own tax bill. This of course does not apply to consumers that buy products and services. They are at the end of the chain and they cannot deduct VAT but have to pay VAT over the full amount that the vendor charges them. In effect increasing the price by the percentage of VAT, just like a Sales Tax would do.