How VAT Works: Adding and Removing It, and Sales Tax Compared
Value-added tax, or VAT, is a consumption tax charged as a percentage of a price. Anyone who prices goods across borders, reads an invoice or runs a small business meets the same two tasks: adding VAT to a price that excludes it, and taking VAT out of a price that includes it. The first is easy. The second is where most mistakes happen.
This guide gives the formulas, a table showing how much of a VAT-inclusive price is tax, a short example of how VAT passes along a supply chain, and a comparison with US-style sales tax. The 20% rate used throughout is an example, not a statement of any country's current rate.
Adding VAT to a net price
The net price is the price before VAT, and the gross price includes it. To go from net to gross, multiply by one plus the rate as a decimal.
gross = net × (1 + rate ÷ 100)VAT amount = net × rate ÷ 100.
Worked example: a net price of 100.00 at 20% VAT. The VAT is 100 × 0.20 = 20.00, and the gross price is 100 × 1.20 = 120.00.
Taking VAT out of a gross price
To go from gross to net, divide by one plus the rate. Do not subtract the rate from the gross figure.
net = gross ÷ (1 + rate ÷ 100)VAT amount = gross − net.
Worked example: a shelf price of 120.00 with 20% VAT. The net price is 120 ÷ 1.20 = 100.00, and the VAT is 120 − 100 = 20.00. The tempting shortcut of subtracting 20% of 120 gives 120 − 24 = 96.00, which is wrong. The 20% was added to the net price, so it is a fifth of the net, not a fifth of the gross.
VAT's share of a gross price is rate ÷ (100 + rate). At 20% that is 20 ÷ 120, or one sixth of the gross price.
| VAT rate | Share of gross price that is VAT | Net = gross ÷ |
|---|---|---|
| 5% | 4.76% | 1.05 |
| 10% | 9.09% | 1.10 |
| 20% | 16.67% | 1.20 |
| 25% | 20.00% | 1.25 |
The VAT calculator is a handy way to check an invoice. The same divide-by-the-share idea is how you find the original price before a discount or tax.
How VAT builds up along a supply chain
VAT is charged at each stage of production and sale, but a registered business normally reclaims the VAT it paid on its purchases, so only the value it adds is taxed. Take a three-step chain at 20%:
| Seller | Net sale | VAT charged | VAT paid on purchases | Sent to tax authority |
|---|---|---|---|---|
| Miller sells flour to baker | 50 | 10 | 0 | 10 |
| Baker sells bread to shop | 120 | 24 | 10 | 14 |
| Shop sells bread to customer | 200 | 40 | 24 | 16 |
The authority receives 10 + 14 + 16 = 40, which equals 20% of the final net price of 200. The businesses pass the tax along and keep none of it, so the customer, who cannot reclaim it, bears the whole 40. The customer pays 240.00 in total.
Mistakes to avoid
- Subtracting the rate from a gross price. Always divide by 1 plus the rate. At 20%, subtracting 20% of 120 leaves 96 instead of 100.
- Using one rate for everything. Many places apply a standard rate to most goods and a reduced or zero rate to some, so an invoice with mixed items may need several rates.
- Rounding too early. Work with full precision and round the final VAT amount. Rounding every line first can leave the invoice a cent or two off.
- Forgetting the direction. Before you calculate, ask whether the number you hold already includes VAT.
How sales tax compares
Sales tax, as used in the United States, is collected once, at the final sale to the customer, rather than at every stage. In many places the shelf price excludes it and the tax is added at checkout, while VAT countries commonly show prices that already include VAT. The rates and the items covered vary by location, and in the US they can differ between states and cities.
The arithmetic is the same either way. If the tag says 40.00 and the local sales tax is 8%, the total is 40 × 1.08 = 43.20. To find the pre-tax price from a receipt total of 43.20, divide: 43.20 ÷ 1.08 = 40.00.
- Tax-exclusive price: the number on the tag, before tax. Multiply by 1 + rate to get the total.
- Tax-inclusive price: the total you pay. Divide by 1 + rate to get the price before tax.
Use the percentage calculator to find a tax amount for any price and rate.
Rates, exemptions and invoicing rules differ by country and change over time. This is general education, not tax advice. Check your tax authority's guidance for your own situation.
- VAT Calculator: Pick whether you are adding VAT to a price or removing it, enter the amount and the VAT rate, and see the price and the tax portion at once.
- Percentage Calculator: Pick the question you need answered, enter two numbers and get the result instantly. The guide below shows the formula behind each mode.
This article is general information, not professional advice. See our Disclaimer and Editorial Policy.
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