This is the most common tax mistake people make, and it is easy to see why. VAT is 20%. So to take it off, subtract 20%. That feels right. It is not.
The reason is what the 20% was added to. VAT is added to the price before tax, not to the price you see. So when you work backwards, you are dividing, not subtracting.
Adding 20% and taking away 20% do not cancel out.
The numbers
Take a price of 120 that includes 20% VAT.
| Method | Price before tax | Right? |
|---|---|---|
| Subtract 20% | 96.00 | No |
| Divide by 1.20 | 100.00 | Yes |
The wrong method is out by 4. It is always out, and always too low. On a hundred invoices that is a real gap in your books.
The shortcut worth remembering
In a price that includes 20% VAT, the tax is one sixth of the total. That is 16.67%, not 20%. So on a 120 bill, the VAT is 20 and the goods are 100.
Different rates give different fractions. At 5%, the tax is one twenty-first of the total. Rather than remember each one, divide by 1 plus the rate. For 5%, divide by 1.05.