In more detail
Each business in the chain charges VAT on its sales (output tax) and reclaims the VAT it paid on its purchases (input tax), sending the government only the difference. The tax is therefore collected in instalments along the chain but borne by the final consumer, who cannot reclaim it. To add VAT multiply by 1 + rate; to remove it divide by 1 + rate. Rates vary by country and by product, with reduced or zero rates common for food, books or exports, and small businesses below a turnover threshold may not need to register.
Why it matters
Removing VAT by subtracting the rate from the gross price is a frequent mistake that understates the net price. For businesses, prices to other businesses are usually quoted net of VAT, while prices to consumers in many countries must include it.
Example
$120 including 20% VAT is 120 / 1.20 = $100 net plus $20 VAT; taking 20% off $120 would wrongly give $96. Along a chain:
| Step | Net price | VAT charged | VAT reclaimed | VAT paid to government |
|---|---|---|---|---|
| Wholesaler sells to retailer | $50 | $10 | $0 | $10 |
| Retailer sells to consumer | $100 | $20 | $10 | $10 |
| Total | $20 |
Common confusion
Sales tax is charged once, at the final sale; VAT is charged at every stage with credits for tax already paid.