Output Tax and Input Tax — What's the Difference?

What is Output Tax and What is Input Tax?

A question that comes to our desk frequently: "Why do I have two different lines in my VAT report?" The answer is simple — because output tax and input tax are two different sides of the same coin.

Output tax is the tax you charge your customers when you sell them goods or services. If you are a freelancer selling planning services, every time you send an invoice to your client — it includes output tax. The customer pays this tax, and you are required to transfer it to the Tax Authority.

Input tax, on the other hand, is the tax you pay when you purchase things for your business. If you buy office equipment, electricity services, or any other input required for your operations — the seller charges you VAT. This is your input tax.

Here's the interesting part? You can credit your input tax against your output tax. This is called VAT credit, and it is the method the Tax Authority uses to make VAT "neutral" in the production chain — the final consumer pays once in the end, not every link in the chain.

How Does VAT Credit Work in Practice?

Let's start with a concrete example that will clarify everything. Suppose you are a self-employed consultant, and your reporting period is quarterly (quarterly VAT payment).

In the first month: You sell services worth 10,000 NIS (before VAT). The VAT on this transaction is 1,700 NIS (at a rate of 17%). This is your output VAT. The client pays you 11,700 NIS in total.

In the same month, you purchase items for your business: legal review services worth 2,000 NIS (before VAT), and the VAT on this is 340 NIS. This is your input VAT. You pay 2,340 NIS in total.

When you file your VAT return for this quarter, you report: output VAT 1,700 NIS, input VAT 340 NIS. The difference is 1,360 NIS — this is what you must transfer to the Tax Authority.

If by chance your input VAT is greater than your output VAT (for example, in a period when you purchased heavy equipment or made a large investment), you can carry forward the difference to the next period. This is called a VAT carryforward.

Who Needs to Report VAT on Transactions and Input VAT?

Not every business operator reports VAT. It depends on the type of operator you are.

Licensed Operator: This is someone whom the Tax Authority has recognized as liable for VAT payment. A licensed operator collects VAT from their customers and reports it in a VAT Report on a periodic basis (monthly or quarterly, at their discretion). In return, they can credit their input VAT. This is the standard arrangement for most self-employed individuals and small businesses in Israel.

Exempt Operator: This is an operator exempted from the obligation to report VAT. Operators of certain types—such as certain licensed professions, hospitals, formal education—may be exempt. If you are an exempt operator, you do not collect VAT from customers, and generally cannot credit input VAT (although there are exceptions).

Private Limited Company: Companies are almost always required to report VAT, except for companies with very low income (below a certain threshold). The company reports transaction VAT and receives a credit for input VAT in the same manner as a licensed operator.

One point that is not always clear: if you are a licensed operator but part of your income is from exempt transactions (such as apartment rental), you still report VAT on the non-exempt portion, but not on the exempt portion. This requires an accurate allocation of input VAT.

Real-World Examples — Three Different Scenarios

First Scenario: Independent Technology Professional
Ran is a self-employed web developer. In a given month, he sells two projects: one valued at 5,000 NIS and another valued at 8,000 NIS. Total of 13,000 NIS before VAT, which is 22,100 NIS with 17% VAT. His output VAT is 2,210 NIS. In the same month, Ran purchases cloud server services for 1,500 NIS + 255 NIS VAT, and also communication storage services valued at 500 NIS + 85 NIS VAT. His total input VAT is 340 NIS. Ran must remit to the Tax Authority: 2,210 – 340 = 1,870 NIS.

Second Scenario: Small Business Owner in the Service Sector
Naama operates a small cleaning services business. In a given month, she provides services valued at 6,000 NIS (output VAT: 1,020 NIS). However, in this month she purchased new cleaning equipment valued at 4,000 NIS (input VAT: 680 NIS) and also laundry services valued at 800 NIS (input VAT: 136 NIS). Total input VAT: 816 NIS. The calculation: 1,020 – 816 = 204 NIS that Naama must remit. But if in the following month she does not generate significant sales, the balance of 612 NIS (816 – 204) will carry forward to the next month as a tax credit carryforward.

Third Scenario: Small Company with Seasonal Activity
"Green Gardens" Ltd. is a company providing landscaping services. During summer months, revenues are high (output VAT: 5,000 NIS), but during winter months, they are low (output VAT: 1,000 NIS). Nevertheless, the company purchases equipment and materials consistently throughout the year (input VAT: average 2,000 NIS per month). During summer months, the company pays VAT (5,000 – 2,000 = 3,000 NIS), but during winter months, it receives a refund (input VAT exceeds output VAT, and the balance carries forward to the following month or is received as a refund from the Tax Authority).

Common VAT Reporting Mistakes — How to Avoid Them

First Mistake: Forgetting to Claim Input VAT
Many new business owners charge VAT on transactions in good faith but forget to claim their input VAT. If you purchase items for your business and have invoices with VAT, you must claim it. This is not a "bonus" — it is your legal right.

Second Mistake: Claiming VAT on VAT-Exempt Transactions
If part of your transactions are VAT-exempt (for example, apartment rental), you cannot claim VAT on all of your input VAT. The tax authority requires proportional allocation. If 80% of your income is taxable and 20% is exempt, you can only claim 80% of the VAT on your inputs.

Third Mistake: Issuing Invoices Without VAT
If you are a registered business, you must issue invoices with VAT. Invoices without VAT are problematic — not only for you, but also for your customers who cannot claim the VAT. The tax authority monitors this.

Fourth Mistake: Claiming VAT on Personal Expenses
If you purchase something for personal use (clothing, food, fuel for a private vehicle), you cannot claim the VAT on it. VAT is only claimed on expenses directly related to the business.

Fifth Mistake: Failure to Retain Invoices
The tax authority requires you to keep all your invoices (both for VAT output transactions and VAT input) for six years. If you do not keep them, you may face an audit and lose your right to claim VAT.

What Happens When You Have a VAT Credit Balance?

A VAT credit balance occurs when the VAT on your inputs is greater than the VAT on your transactions during a particular reporting period. This happens, for example, when you purchase heavy equipment or invest in business improvements.

If you have a VAT credit balance, you have two options:

1. Carry the balance forward to the next period: You do not pay VAT in the current period, and the balance is deducted from the VAT calculation of the next period.

2. Request a refund from the Tax Authority: If the balance is large enough or if you operate a business with recurring credit balances (such as exports), you can request a direct refund of the money from the Tax Authority. This is a process that requires a formal request and review.

In short: a VAT credit balance is a good thing — it means you've made significant purchases for your business. Just keep your invoices and report correctly.

When Should You Consult an Accountant About VAT?

If you are a new business owner and are still uncertain whether you are registered or exempt — now is the time. If your business engages in exempt transactions and you need to apportion input VAT proportionally — this requires precise calculation. If you have a large VAT credit balance and believe you are entitled to a refund — this is something worth examining with a professional.

In short: VAT is complex enough that a small mistake can result in an audit and significant costs. Ben Or Kok Accountants handles all this reporting for you — tracking invoices, calculating VAT on sales and inputs, proper allocation, and timely reporting to the Tax Authority. Let's discuss your situation at a free initial consultation meeting.