How VAT works

Adding VAT

Multiply the net amount by the rate, then add the result to what you started with. At 20 per cent, 1,000 gives 200 of VAT and a total of 1,200. This is the direction most people get right, because it is the direction the words describe.

Removing VAT is a division, not a subtraction

Divide the VAT-inclusive total by 1 plus the rate. A 1,200 total that includes 20 per cent VAT gives 1,200 ÷ 1.20 = 1,000 before VAT, and the VAT is the 200 left over.

Taking 20 per cent off the 1,200 instead gives 960, which is wrong by 40. The percentage was charged on the smaller number, so it has to be removed from the larger one by reversing the multiplication rather than by applying the same percentage a second time. Getting this backwards on a VAT return understates what you owe. Going from a margin to a price has the same shape, which markup and margin works through.

Why the figures always add up exactly

When VAT is removed, the net amount is rounded to the currency and the VAT is taken as the difference between the total and that net figure. Rounding both separately would be the obvious way to do it, and it is the way that leaves invoices where the two lines do not sum to the total they sit under, out by a cent. The remainder goes to the VAT line because the total is the number the client actually pays.

VAT-inclusive and VAT-exclusive prices

An exclusive price does not yet contain VAT, so the client pays more than the figure quoted. An inclusive price already contains it, so the figure quoted is what they pay and your own income is the smaller number underneath. Quoting one and meaning the other is a mistake you absorb: the client owes what they were quoted.

Zero-rated, exempt and outside the scope

Three phrases that all mean “no VAT on this line” and are not the same thing. Zero-rated means VAT applies at a rate of nought: the sale is a taxable sale, it counts towards your turnover, and you can normally still reclaim the VAT you paid on what went into it. Exempt means VAT does not apply at all, and reclaiming what you paid is usually not available. Outside the scope means the transaction is not a VAT matter in that country in the first place.

The figure on the invoice is nought in all three cases, which is why they get muddled, and the consequence of muddling them lands on the return rather than on the document. Which one applies to what you sell is a question for your tax authority or your accountant, and it is worth asking once rather than inferring from the fact that nothing was charged.

Rounding across several lines

On an invoice with more than one line there are two defensible ways to work out the VAT: calculate it on each line and add those up, or add the lines up and calculate it once on the total. They disagree by a cent or two, because each per-line figure is rounded before it is added.

Neither is wrong, but mixing them on the same document is: a VAT line that does not equal the total minus the net is the kind of discrepancy that gets an invoice queried by somebody who has no other reason to query it. Work it out once, on the total, and let the line amounts be what they are.