Taxable, zero-rated and exempt supplies

VAT systems sort supplies into categories. The category decides two things: is output VAT charged, and can the related input VAT be recovered?

• Standard-rated — output VAT at the standard rate; related input VAT is recoverable.
• Zero-rated — a taxable supply at 0%. No output VAT is charged, but related input VAT is recoverable. Exports are the classic example: the tax is meant to be paid where the goods are consumed. A business that only zero-rates often gets regular refunds.
• Exempt — outside the VAT chain. No output VAT is charged and related input VAT is not recoverable. Typical exempt supplies are financial services earned through a margin (such as interest) and residential rents. The exempt business is treated like a final consumer of its inputs.
• Out of scope — not a supply for VAT at all (wages, dividends, compensation).

Zero-rated is better for the supplier than exempt, even though both charge the customer no VAT. The difference is entirely on the input side.

Accounting consequence. Unrecoverable input VAT is not an asset. It is part of the cost of what was bought: added to equipment or inventory, or charged to the related expense. Forgetting this overstates assets (a "recoverable" balance the tax authority will never refund) and understates cost.

Mixed businesses. A business making both taxable (standard or zero-rated) and exempt supplies must split its input VAT: 1. VAT on purchases used only for taxable supplies — recover in full. 2. VAT on purchases used only for exempt supplies — not recoverable. 3. Residual VAT on shared costs (rent of a shared office, audit fees) — recover the taxable proportion, commonly taxable supplies ÷ total supplies. Many systems use the previous year's figures and adjust later; some allow special methods with approval.

Which supplies fall in which category is set by each country's law, and the lists differ between countries and change over time. The examples in this lesson are illustrative assumptions, not a statement of any country's current rules.