Imagine you’re a business owner and want to buy a product in bulk. For this, you approach a supplier who quotes you $105 per unit of that product. The $105 price is after charging tax (VAT/GST) of 5%. That means the $105 includes VAT/GST of 5%. Now, you may be interested in knowing the price before charging VAT/GST. You want to remove tax from $105 and calculate the price before tax.

But why? Why do business owners need to know the price before tax? To understand the reason, we need to first understand how VAT or GST work.

VAT/GST are indirect taxes charged on the sale of goods and services. They generally work on the principle of charging tax at every stage of the sale of goods and services. That means from manufacturer to wholesaler to retailer. For example, a manufacturer needs to charge VAT/GST on the goods sold to wholesalers, and wholesalers need to charge VAT/GST on the goods sold to retailers, who then charge VAT/GST on last sales to consumers.

The interesting thing is that all parties, except the final consumer, are permitted to claim the taxes they paid on their purchase as a credit, which is then used against the VAT or GST owed to the government on their sales (that they charged and collected on their sales from their customers).

So, in our first example, for you as a business owner, the VAT/GST of 5% included in the $105 price quoted by the supplier isn’t a cost. Because you claim credit for the 5% while paying VAT/GST (that you charged and collected from your customers) to the government. Credit means getting back the 5%. Since you get the 5% back, how can that be a cost? Exactly. So, you need to know your actual cost so that you can calculate your selling price of your product accurately and also compare the supplier’s price quote with another supplier who may quote the price before charging VAT/GST.

Makes sense?

So, what’s the actual cost (or price) to you when the supplier quotes a product at $105 including 5% VAT/GST?

No, don’t deduct 5% from $105. This is a common mistake business owners make. That’s not how it works. Because VAT/GST is calculated on the price before tax and not on the price after tax ($105). So, deducting tax from the price after tax doesn’t make any sense.

If the tax before tax is $100 and you charge 5% VAT/GST on it, the final price after tax is $105. Right? How to get the $100 figure from $105? This is the crux of this article. If you deduct 5% from $105, that gives us $99.75. That’s not correct, of course.

To understand how to get the price before tax from the price after tax, first learn how to calculate the price after tax.

• Price after tax = Price before tax + (Price before tax x VAT/GST rate)
• $105 = $100 + ($100 x 5%)
• You can simplify this math formula by factoring out common elements. What’s the common element here: $100. So, we can rewrite this formula as:
• Price after tax = Price before tax x (1 + VAT/GST rate)
• $105 = $100 x (1 + 5/100)
• Or, $105 = $100 x 1.05
• Factoring is a simple process of pulling out a common piece from an equation. The aim is to simplify the equation. 5+5+5+5+5 = 25. Right? Can we simplify this with 5×5 = 25?

Taking the above equation and reversing it can help you calculate price before tax when we know price after tax.

• Price after tax = Price before tax x (1 + VAT/GST rate)
• Price before tax = Price after tax / (1 + VAT/GST rate)
• $100 = $105 / (1 + 5/100)
• Or, $100 = $105 / 1.05

So, to sum up, to calculate price after tax, you multiply price before tax by 1.05 and to calculate price before tax, you divide price after tax by 1.05.

• Price after tax = Price before tax x (1 + tax rate)
• Price before tax = Price after tax / (1 + tax rate)

Want a shortcut to remember these two formulas? Think of it like this:

• Adding tax = multiply by (1 + tax rate)
• Removing tax = divide by (1 + tax rate)

So, in our first example, the price that supplier quoted with tax was $105. If we remove tax by dividing $105 by 1.05, that gives us $100 which is nothing but price before tax.

Still have questions? Comment below.