What is VAT and When Do I Have to Collect It?

VAT is a consumption tax applied at each stage of a product or service’s supply chain. All major European countries use VAT, and it’s becoming more common across the globe. Unlike sales tax, which is only charged at the final point of sale, VAT is collected by businesses at multiple points — whenever value is added to a product.

For example, if a manufacturer produces a good, they pay VAT on the raw materials. When a retailer buys that product, they also pay VAT. However, businesses can claim back the VAT they’ve paid, so the tax ultimately falls on the end consumer.

VAT is calculated as a percentage of the selling price and is included in the total cost a customer pays. Here’s how it works:

• A manufacturer buys raw materials for a product and pays VAT on them.
• The manufacturer sells the finished product to a wholesaler, charging VAT on the sale.
• The wholesaler sells the product to a retailer, charging VAT again.
• The retailer sells the product to a customer, who pays the final VAT amount.

Each business in the supply chain reclaims the VAT they paid, ensuring they only pay tax on the value they add. However, the final consumer cannot reclaim VAT, making them the one who ultimately bears the tax burden.

VAT and sales tax may seem similar, but they work differently. While VAT is common in over 175 countries, the United States tends to have both local (city or county) and state sales tax instead. Countries in LATAM may also have a local sales tax on top of VAT.

Understanding when you need to charge VAT depends on where your company operates, who your customers are, and what you’re selling. Not all businesses need to collect VAT, but failing to do so when required can lead to penalties and financial headaches.

If you sell within a country that has VAT, you may need to register and charge it once your revenue exceeds a certain threshold. For example:

• In the UK, businesses must register for VAT if their taxable turnover exceeds £90,000 in 12 months.
• In Germany, the threshold is €22,000.
• Some countries, like Sweden and Spain, require VAT registration for all businesses, regardless of revenue.

Once registered, businesses must charge VAT on sales and file regular tax returns to report collections and deductions.

The European Union (EU) has specific VAT rules for cross-border transactions:

• Business-to-Business (B2B) Sales: VAT is usually not charged if the buyer is VAT-registered in another EU country. Instead, the buyer reports the tax under the reverse charge mechanism.
• Business-to-Consumer (B2C) Sales: VAT must be charged based on the customer’s location. This means if you sell to consumers in different EU countries, you may need to collect VAT at the local rate.

To simplify this, the One Stop Shop (OSS) system allows businesses to register in one EU country and report VAT for all EU sales through a single portal, rather than registering in multiple countries.

Many countries require non-resident businesses to register for VAT when selling digital services. The EU VAT Mini One Stop Shop (MOSS) simplifies reporting for digital service providers.

If you sell digital products or services — such as ebooks, software, or online courses — VAT is based on the customer’s location, not your business’s location.

This means:

• A US business selling digital products to EU consumers must charge EU VAT.
• A UK business selling software to an Australian customer doesn’t charge VAT.

When selling to customers outside the EU, VAT rules vary:

• Exports: In many cases, selling goods to customers outside your country is considered an export, meaning VAT is zero-rated (0%).
• Imports: If you buy goods from abroad, you may need to pay import VAT before selling them domestically.

VAT on imports and exports depends on customs agreements, trade laws, and destination country rules. Some regions, like Latin America, have unique VAT structures that require careful compliance.

There are some cases where VAT does not apply:

• If your business operates below the registration threshold in a VAT country.
• If you sell zero-rated goods, like some medical products and books.
• If you sell to a VAT-registered B2B buyer in another EU country (they handle VAT through the reverse charge).

Once you determine where and when you need to collect VAT, the next steps are registering, charging the correct rate, and filing returns.

Once you determine when and where you need to collect VAT, the next step is ensuring compliance. Failing to follow VAT rules can lead to penalties, unexpected costs, or even restrictions on doing business in certain regions. Below are the most important factors to keep in mind.

If your sales exceed the VAT registration threshold in a country, you must register before collecting VAT. Some businesses may need to register in multiple countries, particularly those selling across borders. The One Stop Shop (OSS) system simplifies this process in the EU, allowing merchants to handle VAT for multiple countries through a single registration.

For companies selling digital services, VAT registration is often required even if you don’t have a physical presence in the country where your customers are located. This means non-EU businesses selling digital products to EU consumers must comply with local VAT rules.

VAT rates vary widely by country and product type. Some goods and services are taxed at standard rates, while others — such as food, books, and medical products — may qualify for reduced or zero-rated VAT. It’s essential to:

• Apply the correct VAT rate based on the country and product category.
• Ensure VAT is clearly displayed on invoices for transparency.
• Regularly check for rate changes, as VAT laws can be updated.

Charging the wrong VAT rate can lead to compliance issues or unexpected tax liabilities.

Once VAT is collected, it must be reported and remitted to tax authorities on time. VAT return frequency varies by country — some require monthly filings, while others allow quarterly or annual submissions.

VAT returns generally summarize:

• The VAT collected on sales.
• The VAT paid on business expenses (which can often be reclaimed).
• The net amount owed to or refundable from the tax authority.

Missing VAT deadlines can result in penalties, audits, or interest charges on unpaid amounts.

Good record-keeping is essential for VAT compliance. Most tax authorities require businesses to keep VAT records for at least five years. These should include:

• VAT invoices and receipts.
• VAT registration documents.
• Records of imports, exports, and cross-border transactions.
• Past VAT returns and payments.

Keeping well-organized records makes it easier to handle tax audits, track compliance, and avoid errors.

Even experienced merchants can run into VAT compliance issues. The most common mistakes include:

• Failing to register for VAT in countries where it’s required.
• Charging the wrong VAT rate or applying VAT when it isn’t needed.
• Not properly documenting VAT-exempt sales (for example, exports or B2B reverse charge transactions).
• Missing VAT return deadlines, leading to fines and penalties.

To stay compliant, you should regularly review VAT rules, use automated tax software where possible, and consult with tax professionals when selling across multiple jurisdictions.

VAT compliance doesn’t have to be overwhelming. By registering when required, charging the correct rates, filing returns on time, and keeping clear records, your business can avoid costly mistakes.

VAT is a critical part of doing business in many countries, and understanding when and where to collect it is essential for staying compliant. Whether you’re selling locally, across borders, or offering digital services, knowing your VAT obligations helps you avoid penalties, build customer trust, and keep operations running smoothly.

To recap:

• VAT applies at multiple points in the supply chain and varies by country.
• Merchants must collect VAT when selling in VAT-registered regions, depending on revenue thresholds and the type of sale (B2B or B2C).
• Compliance involves registering when required, charging the correct VAT rate, filing returns on time, and keeping accurate records.
• Common mistakes — like missing registrations, miscalculating VAT, or filing late — can be avoided with proper planning and tools.

Managing VAT doesn’t have to be complicated. Automated tax solutions and expert guidance can help businesses stay compliant while focusing on growth.

Interested in a EU merchant account or have more questions on VAT? Click here to learn more about our European solutions.