VAT is a tax imposed at each stage of the production process on the sale of most goods and services. It is most popular in the European Union (EU) but is also implemented in many other countries worldwide.
VAT is similar to Sales Tax, but there are some notable differences. The VAT due on the sale of goods and services is a percentage of the sale price. When the seller collects the VAT from the customer, they are required to remit the VAT to the government. However, the seller can deduct VAT already paid during the preceding stages of the sale or production process.
For example, Company A is a retail furniture store. It buys a desk from a furniture wholesaler for €500 and pays VAT of €50, for a total invoice of €550. Company A places the desk in their storefront and later sells it to the customer for €900, with VAT of €90, for a total invoice of €990.
Company A has collected €90 of VAT, which it must send to the government. However, the company can reduce the €90 of VAT payable by the €50 of VAT paid on the inventory purchase. The net amount of €40 is what Company A actually pays to the government.