How VAT works

Adding VAT

Multiply the net amount by the rate, then add the result to the net amount. For example, 1,000 at 20% gives 200 of VAT and a total of 1,200.

Removing VAT is a division, not a subtraction

To take VAT out, divide the total by 1 plus the rate. Say a client pays 1,200 and that includes 20% VAT. The net amount is 1,200 ÷ 1.20 = 1,000, and the VAT is the 200 left over.

Taking 20% off the 1,200 gives 960 instead, which is wrong by 40. This is because the 20% was charged on the smaller number, the 1,000. To get back to it from the larger number you have to reverse the multiplication, and applying the same percentage a second time doesn't do that. Getting this backwards puts 240 of VAT on the return instead of 200, and takes the 40 out of your own income. Going from a margin to a price has the same shape, and markup and margin works through it.

Why the figures always add up exactly

Round the net amount, then take the VAT as whatever is left. When VAT is removed, the net figure is rounded to the currency and the VAT is the difference between the total and that net figure. If you round both separately, the two lines can end up a cent off the total they sit under. The remainder goes to the VAT line because the total is what the client pays, so the total is the figure that has to stay fixed.

VAT-inclusive and VAT-exclusive prices

An exclusive price doesn't contain VAT yet, so the client pays more than the figure you quoted. An inclusive price already contains it, so the quoted figure is what they pay, and your own income is the smaller number inside it. For example, quote 1,200 meaning exclusive, and if the client reads it as inclusive, you receive 1,000 of net income instead of 1,200. Quoting one and meaning the other is a mistake you absorb, because the client owes what they were quoted. I recommend writing "plus VAT" or "including VAT" next to every price you quote.

Zero-rated, exempt and outside the scope

All three mean no VAT on the line, but they are different things:

• Zero-rated: VAT applies at a rate of 0%. The sale is still a taxable sale, it counts towards your turnover, and you can normally still reclaim the VAT you paid on what went into it.
• Exempt: VAT doesn't apply at all, and reclaiming what you paid is usually not available.
• Outside the scope: the transaction isn't a VAT matter in that country in the first place.

For the UK, HMRC sets out all three in section 3 of VAT Notice 700. Services sold to a business in another country are a common case of the last one, which invoicing clients abroad covers.

Don't work out which one applies from the fact that nothing was charged. The invoice shows 0 in all three cases, so they're easy to mix up, and the mistake shows up on the return rather than on the invoice. I'd ask your tax authority or your accountant which one applies to what you sell. It depends on the country and on the goods or services.

Rounding across several lines

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

Pick one method and use it for the whole document. Either is fine, but a VAT line that doesn't equal the total minus the net can get the invoice queried. I recommend working it out once, on the total, and letting the line amounts be what they are.