Transatlantic Trade Monitor: Facts You Need Now | Understanding European VAT: A Guide for US Folks

By Simon Kelly, Global VAT Services, RSM US LLP

For many Americans, the concept of Value-Added Tax (VAT) might seem unfamiliar or confusing. However, understanding European VAT is essential if you are a U.S. business owner looking to expand into Europe, a traveler planning a European adventure, or someone simply curious about global economics.

In the United States, sales tax is the predominant form of consumption tax, applied at the point of sale and varying by state and locality. In contrast, VAT is a cornerstone of taxation across Europe and much of the world, functioning differently from the U.S. system.

This article will break down what VAT is, how it works, its differences from U.S. sales tax, and its implications for American consumers and businesses.

What Is VAT?

VAT, or Value-Added Tax, is a consumption tax levied on the value added to goods and services at each stage of production or distribution.

Unlike the U.S. sales tax, which is applied only at the final point of sale to the consumer, VAT is collected incrementally throughout the supply chain. It’s a tax system designed to tax the increase in value of a product as it moves from raw materials to the finished goods purchased by consumers.

Introduced in France in 1954, VAT has since become a standard tax mechanism across the European Union (EU) and beyond. As of April 2025, all 27 EU member states implement VAT, although the rates and specific rules can vary from country to country.

Globally, 175 countries use some form of VAT or a similar tax, making it one of the most widespread tax systems in the world.

How does VAT work?

To understand VAT, let’s walk through a simplified example of how it applies to a product—for example, a leather jacket produced and sold in Europe.

1. Raw material stage: A farmer sells leather to a manufacturer for 50 euros. If the VAT rate is 20%, the farmer charges the manufacturer 60 euros (50 euros for the leather plus 10 in value-added tax). The farmer then pays the 10 euros of VAT to the government through their local VAT return.
2. Manufacturing stage: The manufacturer turns the leather into a jacket and sells it to a retailer for 150 euros. With 20% VAT, the retailer pays 180 euros (150 + 30 VAT). The manufacturer sends 30 euros to the government but claims a credit for the 10 VAT already paid to the farmer, so the net payment to the government is 20 euros.
3. Retail stage: The retailer sells the jacket to a consumer for 200 euros. Adding 20% VAT, the consumer pays 240 euros (200 + 40 VAT). The retailer sends 40 euros to the government but claims a credit for the 30 euros in VAT paid to the manufacturer, resulting in a net payment of 10 euros.

In this example, the total VAT collected by the government is 40 euros (10 from the farmer + 20 from the manufacturer + 10 from the retailer), which is 20% of the final sale price of 200 euros.

Each business in the chain collects VAT from the next buyer and remits only the tax on the value they added, after deducting the VAT they’ve already paid. This multistage collection process ensures that the tax burden is spread across the supply chain but ultimately borne by the end consumer.

VAT rates in Europe

One key feature of European VAT is that rates vary by country, and sometimes even by product or service within a country. The EU sets a framework requiring a standard VAT rate of at least 15%, but member states have flexibility to set their own rates above that threshold. They can also apply reduced rates (minimum 5%) to specific goods and services, such as food, books or pharmaceuticals, and in some cases zero rates or exemptions.

As of March, 2025, here are some examples of standard VAT rates in major EU countries:

• Germany: 19%
• France: 20%
• Italy: 22%
• Spain: 21%
• Luxembourg: 17% (the lowest in the EU)
• Hungary: 27% (the highest in the EU)
• Ireland: 23%

These rates can shift slightly over time due to economic conditions or policy changes, so it’s wise to check current rates before doing business or shopping in Europe.

Reduced rates might apply to essentials. For example, in the UK, which still uses a VAT system following Brexit, children’s clothing and books carry a 0% rate, while most goods are taxed at 20%.

 

VAT vs. U.S. sales tax: Key differences

For Americans, the most immediate comparison to VAT is the sales tax system. However, there are significant differences:

Point of collection

Sales tax: Applied only at the final sale to the consumer. Businesses don’t pay sales tax on their purchases; it’s solely the end buyer’s responsibility.

VAT: Collected at every stage of production and distribution, with businesses offsetting the VAT they pay against what they collect.

Transparency

Sales tax: In the U.S., listed prices typically exclude tax, and the sales tax (ranging from 0% to greater than 10%, depending on state and local rates) is added at checkout.
VAT: In Europe, prices are usually quoted inclusive of VAT, so the sticker price is what you pay. This can surprise Americans expecting a lower total.

Administration
Sales tax: Managed at the state and local level, leading to thousands of different tax jurisdictions in the U.S.
VAT: Administered nationally in each EU country, with harmonized rules across the EU to facilitate trade.

Economic impact
Sales tax: Can incentivize businesses to avoid taxing intermediate transactions, but it is less efficient for tracking value added.
VAT: Encourages compliance through its credit system, reducing tax evasion, but it requires more bookkeeping.

Implications for US consumers
If you are an American traveling or shopping in Europe, VAT affects you directly as a consumer. When you buy goods or services—whether it’s a meal in Paris, a sweater in Stockholm, or a hotel stay in Rome—the VAT is already baked into the listed price. Unlike in the U.S., where you might calculate tax at the register, the European system means no surprises at checkout.

However, there is a silver lining for tourists: VAT refunds. Many EU countries offer nonresidents the chance to reclaim VAT on purchases when they leave the EU, typically for goods (not services) taken out of the country. Here’s how it works:

1. Minimum purchase: You often need to spend a certain amount (e.g., 100 euros in France) at a single retailer.
2. Documentation: Ask for a VAT refund form at the store, showing your passport to prove you’re not an EU resident.
3. Customs approval: Present your purchases, receipts and forms at customs when departing the EU (usually at the airport).
4. Refund: You might get cash back on the spot or a credit to your card, minus a processing fee.

For example, if you buy a 240-euro jacket in Germany (including 19% VAT, or 38.32 euros), you could reclaim that VAT charge of 38.32 euros, effectively reducing the cost to 201.68 euros. Timing matters—refunds typically expire 3-6 months after purchase—so plan accordingly.

Implications for US businesses

For American companies expanding into Europe, VAT introduces both opportunities and challenges. If you are selling goods or services in the EU, you will likely need to register for VAT in the countries where you operate, collect it from customers, and remit it to the government.

Here’s what to consider:

VAT registration

If your business exceeds a certain sales threshold in an EU country (thresholds vary), you must register for a VAT number. For example, in Germany, it is mandatory if you store goods there for sale.

Following Brexit, the UK has its own VAT system, separate from the EU.

Cross-border trade

The EU’s single market allows goods to move freely between member states, but VAT rules still apply. If you sell from the U.S. directly to EU consumers, you might need to register for VAT in a country and also under the EU’s VAT One Stop Shop (OSS) scheme, simplifying reporting across multiple countries.

Cost management

Businesses can typically reclaim VAT on business expenses in Europe (e.g., equipment, travel), reducing costs. However, this requires meticulous record-keeping and compliance with local rules.

Pricing strategy

Because European customers expect VAT-inclusive prices, a business will need to factor this into its listed pricing. A 200-euro product with 20% VAT becomes 240 euros, which could affect competitiveness.

Failure to comply with VAT obligations can lead to penalties, so many U.S. businesses seek support from professional firms and use software to navigate the system.

VAT in the Digital Age (ViDA)

The rise of e-commerce has complicated VAT further. In 2021, the EU updated its rules to ensure VAT is collected on all goods imported into the EU, even low-value items under 22 euros, which were previously exempt.

For U.S. online retailers, this means charging VAT at the point of sale for EU customers and remitting it via the Import One Stop Shop (IOSS) system. Digital services—like streaming subscriptions or software—also face VAT, based on the customer’s location instead of the seller’s.

Why does Europe use VAT?

VAT’s popularity in Europe stems from its efficiency and revenue potential. It generates substantial income, often 20-30% of government revenue in EU countries, while spreading the tax burden across the supply chain.

Its self-policing nature (businesses claim credits only if suppliers paid VAT) also reduces evasion compared to sales tax. For the EU, harmonized VAT rules support the single market, minimizing trade barriers.

Conclusion: VAT as a cornerstone of taxation in Europe

European VAT might seem daunting to Americans accustomed to sales tax, but it’s a logical system once you grasp its mechanics. For consumers, it is a hidden cost; for businesses, it’s a compliance challenge with strategic implications.

As U.S.-EU trade and travel grow, understanding VAT becomes increasingly relevant. Whether you are buying a souvenir in Lisbon or selling software to Berlin, VAT shapes the transaction—and now, you are equipped to navigate it.

 

Compliments of RSM US LLP – a Premium Member of the EACCNY