What Is VAT? How It Actually Works, From Invoice to Return

VAT is a tax on consumption, collected in instalments along the supply chain. Every business in the chain charges VAT on what it sells, reclaims VAT on what it buys, and pays the difference to the state. The tax lands, in full, on the final consumer — everyone before them is an unpaid collector.

Understanding that one sentence removes most VAT confusion, including the biggest misconception: VAT is not your money and never was.

The chain

A 21% rate, following a table from timber to living room:

Step	Sells for (net)	VAT charged	VAT reclaimed	Paid to state
Sawmill → furniture maker	100	21	0	21
Furniture maker → shop	300	63	21	42
Shop → consumer	500	105	63	42
			Total	105

The state collects 105 €, which is exactly 21% of the final 500 € price. Each business paid tax only on the value it added — 100, 200 and 200 respectively. The consumer, who cannot reclaim, bears all of it.

This is why VAT is neutral for businesses and why "we pay a lot of VAT" is usually a misunderstanding: a trading company's VAT cost is zero, and the balance owed simply reflects sales exceeding purchases.

Output VAT, input VAT, and the entries

Output VAT is what you charge customers. It is a liability from the moment the invoice is issued:

Account	Debit	Credit
2410 Trade receivables	605
5001 Service revenue		500
4492 VAT payable		105

Input VAT is what suppliers charge you. It is an asset — a claim against the state:

Account	Debit	Credit
6209 Administrative expenses	300
2441 VAT receivable	63
4430 Trade payables		363

Note that VAT never touches the income statement. Revenue is 500, the expense is 300 — both net of VAT. The tax lives entirely on the balance sheet until it is settled, which is why a company holding 2,100 € of VAT payable is holding money that was never its own.

At period end the two accounts are netted and the difference is paid or reclaimed:

VAT payable to the state = Output VAT − Input VAT

When VAT becomes due

The tax point (chargeable event) decides which period a transaction belongs to. Broadly, VAT becomes chargeable when the goods are delivered or the service performed — but issuing an invoice or receiving a prepayment can bring it forward. Under the standard accrual rules the liability arises on the invoice, whether or not the customer ever pays, which is what makes bad debt relief a separate and condition-bound process.

Some member states offer cash accounting schemes for smaller businesses, where VAT follows payment instead — which must be declared on the invoice with the literal mention "Cash accounting", one of the required invoice fields.

Rates, exemptions and zero rates

Every member state sets its own rates within EU limits: a standard rate of at least 15%, plus reduced rates for listed categories. Lithuania applies 21% standard with reduced rates; Germany 19% and 7%; Hungary 27%. The applicable rate is the destination country's for most cross-border B2C supplies, which is why rate tables matter for anyone selling across the EU.

Three things that look alike and are not:

• Zero-rated — taxable at 0%. You charge no VAT and reclaim your input VAT. Exports and intra-Community supplies work this way.
• Exempt — outside the tax. You charge no VAT and cannot reclaim related input VAT. Financial services, insurance, healthcare, education.
• Out of scope — not a VAT transaction at all in your country, typically because the place of supply is elsewhere.

The distinction is not academic: an exempt business absorbs its input VAT as a real cost, while a zero-rated one recovers it and often sits in a permanent refund position.

How Nordlet handles VAT

The treatment is resolved rather than typed. The VAT engine takes the company's country and VAT status, the customer's country and business status, the supply type and the date, and returns the applicable scheme — domestic, intra-Community B2B, reverse charge, OSS, IOSS, export, exempt or out of scope — along with the rate. That scheme drives the ledger entries, the invoice mentions and the return.

Rates come from a DB-backed table synced from the European Commission's TEDB database with effective dates, so a rate change lands as a new dated row rather than a code edit, and historical invoices keep the rate that applied on their date. Per-company overrides sit on top for cases the defaults do not fit.

Every issued invoice freezes a VAT evidence snapshot — the VIES check with its timestamp, the rate-table version, the billing-country signal and the resulting classification — so a decision made two years ago can be replayed with the inputs that existed then, rather than reconstructed from today's data.

From there the numbers flow into the VAT return for the company's country, and in Lithuania into the i.SAF invoice registers as well.

FAQ

Who actually pays VAT?

The final consumer. Businesses in the chain charge it, reclaim what they were charged, and remit the difference — so VAT is a cost only to those who cannot reclaim, chiefly consumers and exempt businesses.

What is the difference between input and output VAT?

Output VAT is what you charge customers on sales, and it is a liability to the state. Input VAT is what suppliers charge you on purchases, and it is recoverable. You pay the state the excess of output over input.

Does VAT appear in the profit and loss statement?

No. Revenue and expenses are both reported net of VAT; the tax sits on the balance sheet as a payable or receivable until settled. VAT affects cash flow and working capital, not profit.

What is the difference between zero-rated and exempt?

Zero-rated supplies are taxable at 0%, and you can still reclaim related input VAT. Exempt supplies are outside the tax and block input VAT recovery, making that VAT a genuine cost.

When is VAT due — at invoice or at payment?

Normally at the tax point, usually delivery or invoice, regardless of whether the customer pays. Some member states offer cash-accounting schemes for smaller businesses that shift it to payment, which must be stated on the invoice.