VAT vs sales tax: why the shelf price and the bill can differ

VAT, value added tax, is usually included in the shelf price, so the tag already contains it. US-style sales tax is usually added at the till, on top of the price on the label, and its rate varies by state and city. Whichever you deal with, the sums are the same. To add a tax percentage, multiply by 1 plus the rate. To take it out of a total that already includes it, divide by 1 plus the rate. At 20%, that means dividing by 1.2, not taking 20% off.

VAT: included in the price and collected at each stage

VAT is charged at each stage of supply. A manufacturer sells to a wholesaler, the wholesaler sells to a shop, and the shop sells to you. Each business adds VAT to its own sale. In most VAT systems a business can then reclaim the VAT it paid on its own purchases, so the tax ends up falling on the final buyer. The rate, and which goods get which rate, depends on the country.

Because the tax is part of the price, the number on the shelf is normally the number you pay, and a VAT receipt usually shows how much of the total was tax. Take a 20% rate, as used in the UK at the time of writing. A £120 price includes £20 of VAT, which means £100 net plus £20 tax gives £120. Some goods are taxed at a lower rate, or not at all, so the tax on one receipt can be a different percentage from the tax on the next item. When businesses sell to each other, prices are often quoted without VAT, and the invoice adds it. That is why a business invoice usually shows the net price, the VAT and the total as separate lines.

Sales tax: added at the till

In the US, sales tax is set by each state, and local governments can add their own. A purchase in one city can carry a different total rate from the same purchase across a county line, and a few states have no statewide sales tax at all. The price on the label is usually the pre-tax price, and the tax is added when you pay. What is taxed also varies. Some places tax most goods but few services, and some exempt groceries. Check the rule for the item you are buying, not only the rate.

Here is an example with an illustrative 7% rate, which is not the rate of any real place. A $50 item plus 7% tax is $50 × 1.07 = $53.50. The label said $50, and the till total is $53.50.

Because the tax is added at the end, a US-style label is a net price, while a UK-style label already includes the tax. Comparing the two directly can mislead. Compare the total you would actually pay.

Adding and removing a percentage correctly

There are two directions, and each has one correct formula:

• To add tax to a net price, multiply by 1 plus the rate. £100 at 20% is 100 × 1.2 = £120. The tax is £20.
• To remove tax from a gross price, divide by 1 plus the rate. £120 at 20% is 120 ÷ 1.2 = £100. The tax is £20.

The common mistake is to take the rate off the gross price. Taking 20% off £120 gives £96, which is wrong, because the 20% was a percentage of the £100 net price, not of the £120. Dividing by 1.2 gives the right answer. To check it, add the tax back: £100 plus 20% is £120, the price you started with.

A basket with two rates works the same way. Take £30 of goods at 20% and £10 of goods at an example rate of 5%, both quoted net. The first line comes to £36, the second to £10.50, and the total is £46.50. Working out each line separately keeps the rates apart.

The VAT calculator has Add tax and Remove tax modes. It shows the net price, the tax amount and the gross price together, so you can check that they add up. Its quick picks cover 5%, 10%, 15%, 20% and 25%, and you can type any other rate.

The percentage calculator is handy for adding tax in one step. Its plus mode takes a starting number and adds a percentage. Its minus mode takes the percentage off the number you enter, so do not use it on a price that already includes tax. That is exactly the mistake the table above shows.

Edge cases

• Mixed rates on one receipt. Some baskets contain goods at more than one rate. Work out each line separately and then add the lines, rather than applying one rate to the whole total.
• Net or gross listings. Before comparing two prices, check whether each one is shown with or without tax. A listing without tax can look cheaper than one with tax, even when the final price is higher.
• Rounding. Tax on each line can round to the cent differently from tax on the whole invoice. If you are checking an invoice, round in the same place it does.
• Exemptions and special cases. Some goods and services are taxed at a different rate or not at all, and business buyers can treat tax differently. Check the official guidance for your case rather than relying on a general example.
• More examples. The guide to adding and removing VAT works through more worked figures.