What Is Irrecoverable VAT?

Irrecoverable VAT refers to the value-added tax that cannot be recovered due to the nature of the purchase. When understanding what irrecoverable VAT is, it's important to first cover the definition of a value-added tax (VAT). VAT is a consumption tax that's placed on products as value is added at each point in the supply chain. It is different from a standard sales tax because it is collected multiple times instead of just once.

Here is the common life cycle of VAT on a product:

  • Tax is added when a producer of raw materials sells a product to a manufacturer or factory.
  • Tax is added when the manufacturer sells the finished product to a reseller/wholesaler.
  • Tax is added when the reseller/wholesaler sells the product to a retailer.
  • Tax is added when the retailer sells the product to a customer.

How VAT Works

While common in Europe, no VAT is in place in the United States. In fact, if you pay a VAT tax, you must get your refund from the country where you paid the VAT. VAT tax rates are typically represented as percentages of total product costs. At each stage, the person in the supply chain collects the extra VAT to hold it until remitting it to the government.

The VAT is built into the cost of the product for the next person in the supply chain at every step. While each person in the supply chain pays VAT, only the end consumer ultimately "pays" because all of the other parties charge VAT as part of the built-in price of the product they are selling.

What Is Irrecoverable VAT?

Irrecoverable VAT is VAT that cannot be recovered as part of the purchase price because the buyer in the supply chain purchased items for non-business use. This typically means the end consumer.

Any person purchasing raw or finished goods for personal use instead of business use cannot recover VAT. Purchasing raw materials from a manufacturer the way that a wholesaler might when adding an addition to your home would make the VAT you pay for the goods irrecoverable VAT. However, a reseller purchasing those same supplies would qualify for recoverable VAT. In short, VAT responsibility is based on the intended purpose of a purchase instead of the type of purchase.

For charitable organizations, VAT can be complicated because entities that rely on donations to make purchases are technically unable to recover VAT costs that have been paid out. Even items that will be distributed to others for the purpose of supplying emergency aid cannot qualify for VAT recovery because they are not being sold. However, certain supplies have been determined to be exempt from VAT in various European countries that implement VAT charges.

VAT recovery can be complicated if a buyer is using goods purchased for a mix of business and non-business purposes. In this case, the goods will qualify for some VAT recovery. It will be up to the buyer to calculate the portions used on each good purchased for business and non-business purposes to determine the amount of recoverable VAT.

Dealing With VAT Rules

VAT rules can be complicated. If you're doing a high volume of selling or purchasing in a country where VAT is implemented, it's important to work with a financial professional who is familiar with the laws regarding value-added tax. Paying VAT as a seller ultimately just means collecting VAT on behalf of the government.