In our work, we find that most of the questions and uncertainties arise around VAT. Should I go VAT-red or not? What does exemption mean? How does the VAT deduction work? These are all strategic questions that fundamentally determine the financial operation and pricing of a business. Our aim in this post is to clear the air and explain the basics in a clear and understandable way.
What is VAT and how does it work in practice?
Imagine VAT as a tax that is paid by the final consumer, not the entrepreneur, but collected and paid by the businesses in the distribution chain.
Every time a VAT-registered business sells a good or service, it charges VAT on the price. This amount is paid by the buyer and „retained” by the entrepreneur for the State. However, when this entrepreneur buys something for his operation (e.g. raw materials, office supplies), he can deduct the VAT content of his own purchases from the VAT he has collected from his customers. The difference between the two amounts must ultimately be declared and paid to the NAV.
This system ensures that the tax burden is not passed on to businesses, but at the end of the chain, at the final user.
The key decision: inside or outside the VAT zone?
For a start-up business, the first and most important tax decision is how to participate in the VAT system. Here there are two basic options.
1. Tax Exemption at source (AAM): the easy way
The exemption means that the entrepreneur is exempt from charging and paying VAT.
How does it work? An AAM contractor does not include VAT on its invoices, so its customers do not have to pay it. In return, they cannot claim back VAT paid on their own purchases from the state.
Who can choose? Entrepreneurs whose annual net turnover does not exceed HUF 18 million. It is important to note that for businesses starting up during the year, this amount must be pro-rated for the remaining days of the year.
Benefit: It can be a huge competitive advantage if your customer base consists mainly of private individuals or other exempt entrepreneurs, as your prices are net prices and they are not charged an extra 27%. Administration is also much simpler.
Disadvantage: If you need to make significant VAT-charged purchases for your operations (e.g. expensive machinery, software, stock), the VAT „stuck” in these will be charged to your business as a cost.
2. VAT-round operation: the professional way
This is the default mode of operation, where the entrepreneur actively participates in the VAT circuit as described above.
How does it work? The entrepreneur charges VAT on his sales and deducts it on his purchases. The difference is declared and paid at regular intervals (monthly, quarterly).
Advantages: The biggest advantage is the right to deduct VAT. If your partners are almost all VAT-registered companies, they are not liable for the VAT you charge (they can deduct it), but you can reclaim the VAT on your own costs and reduce your expenses.
Disadvantage: A significant administrative burden on the business due to regular VAT returns and accurate record keeping. For private customers, prices will be higher due to the 27% VAT content.
The most common VAT rates in Hungary
Although most people are familiar with the 27% key, it is important to know that there are several keys:
27%: The general rate that applies to most goods and services.
18%: Preferential rate, typically covering basic foodstuffs (e.g. milk, dairy products, cereals) and certain services.
5%: The most preferential rate applies to, among other things, books, medicines, new-build residential property and certain foodstuffs (e.g. pork, poultry, eggs, fish).
Which to choose when starting out?
The decision is always a matter of individual judgement, but as a rule of thumb, we recommend the following to our clients:
Opt for the exemption under the exemption scheme (AAM) if:
Its customers are predominantly private individuals.
It does not need large value-added purchases subject to VAT to operate.
You want to keep administration as simple as possible.
Consider joining the VAT circuit if:
Almost all of its customers are other companies that are also VAT circular.
Your business requires a significant initial investment or regular, high VAT costs.
It plans to exceed the HUF 18 million mark in annual revenue.
Participation in the VAT system is one of the most important strategic financial decisions. Before making a final choice, be sure to consult your accountant who will help you calculate which option is best for your business model. If you have questions, we are at your disposal to help you make the most optimal decision.