VAT is a real monster within the European Union, a monster that very few entrepreneurs come to understand and one that, when faced with it, few know how to correctly deal with, at least without the help of specialised tax advisors.
In our article series about this topic, VAT on digital products, payment gateways and sales platforms, and this new article about VAT on the sale of goods and services, we explain everything you need to know in order to avoid getting your fingers burnt and getting into trouble. Of course, in this series, we also discussed the topic of recovering VAT paid on purchases.
In today’s article, you will learn about the basics of VAT in the European Union, particularly about VAT on services and the sale of physical goods. Just like in the other articles, we will also talk about the best strategies to deal with this 28-headed monster (well, thanks to Brexit, soon there will be one less to worry about).
Table of Contents:
- VAT basics in the EU
- VAT thresholds for exports to countries in the EU
- Shipping to yourself in the European Union, VAT with Amazon FBA
- Alternatives, avoiding VAT in the EU
- Upcoming changes and simplification of the VAT system in the EU
- Reverse charge
- Summary of VAT regulations on goods and services
The basics you should know about VAT in the EU
In a topic as complicated as European VAT, it is difficult to decide where to begin. This article is not meant to document all of the exceptions and special circumstances, but rather to give a general idea and present certain solutions.
Out of all the taxes that exist, VAT (an indirect tax) is often seen as the least harmful. It is only paid when the final customer purchases a product. In principle, business owners are not supposed to pay VAT but, in reality, this is not the case.
VAT is something that, as an entrepreneur, you must charge, deduct and declare. And sometimes, you not only have to do this in your country but also in your clients’ country, i.e. you have to process payments of the correct amounts to the authorities of other countries.
The truth is that the EU has created a monster that, in terms of accounting, is difficult, if not impossible, to understand for non-experts.
Therefore, an EU entrepreneur may not actually pay VAT, but in reality, they pay a lot, since they have to hire tax consultants and accountants and pay the licensing fees for a software that enables them to do everything correctly.
Be that as it may, for the majority of entrepreneurs, there will be no way of escaping the topic of VAT. You will have to set time aside to familiarise yourself with the basic aspects of value added tax, at least as it relates to your business since this is the only way to make use of certain loopholes and exceptions for your own benefit.
If you already have an operational business, you certainly know the basic concepts: before beginning to sell, you have to register for VAT at the appropriate tax office.
From then on, you will have to inform the state about all of your invoices and you must also process the VAT amounts in order to transfer them to the state, either quarterly or monthly. Likewise, you will have to send information about your purchases, in order for them to repay you the amount of VAT paid on your company’s purchases.
If you only sell at a national level, this process is not all that complicated. You simply charge the required percentage for the type of product or service you offer. If you are lucky enough to have your company outside of Spain and you have followed the regulations for small business, you will not even have to worry about charging and processing VAT.
However, if you sell internationally, things become much more complicated. The EU is made up of 28 states, 28 countries with their own regulations and with different VAT rates and, depending on the type of product you offer, you will have to charge VAT one way or the other.
For automated digital products, for example, it is not the country where the company is based that is relevant at the time of deciding the type of VAT that should be levied, but rather the client’s country (you can read more about this exception in the article linked above.)
For all other examples of selling in the EU, beyond your own borders, the so-called reverse charge system applies, which I will explain in detail in this article.
If you have a commerce company, there are a lot more things for you to consider. Each country in the EU has different sales thresholds, after which you are required to collect local VAT on product imports. You must make certain disclosures to the country’s tax authorities and issue invoices in accordance with certain formalities.
All of this is something that you must not ignore as an entrepreneur in the EU. The European tax authorities in many countries are ruthless and have already ruined more than one entrepreneur who did not follow the rules to the letter.
Evading VAT (an EU study from a few years ago estimated the amount of lost revenue due to VAT evasion at 160 billion euros), although quite unusual, is becoming less and less advisable. Even if you do not get into trouble with the tax office in Spain or the country where your company is based and you follow the letter of the law, the tax authorities of other countries could really put you in hot water.
The violation (even if only for lack of knowledge) of the regulations on VAT thresholds and the lack of VAT registration alone would result in fines and default interest that far exceed the VAT owed.
It is not uncommon to be charged a monthly interest rate of 0.5%. Furthermore, it is possible for the tax authorities of other countries to initiate criminal proceedings for tax offences, which you will not be able to avoid by turning yourself in. As the saying goes, being unaware does not excuse the obligation to comply with the law and, of course, does not allow you to avoid punishment within the EU.
Nor should you underestimate the EU tax authorities’ ability to monitor your compliance with VAT regulations.
For example, the German tax authorities use an Internet tracker called “Xpider” which is capable of tracking traders who do not charge VAT. According to a decision made by the German Federal Fiscal Court in 2013, the tax office can request information on sales made through Amazon or eBay.
In a particular case, information in the form of lists was requested on all accounts with a turnover of more than €17,500 (i.e. above the German special scheme for small businesses).
And Germany is not an isolated case, other countries like Austria request information on parcel and delivery services in order to know who is over the threshold. In Denmark, they simply analyse the level of sales using credit card information.
Evidently, it is important that you prepare yourself ahead of time in order to avoid problems from VAT infractions. It is not surprising that, due to this situation, many entrepreneurs prefer to sell in other markets.
VAT is a tax that, although increasingly present in the world, is still not applied on a global scale. There are countries like the United Arab Emirates and the US, for example, where VAT is not applied (in the US there are local sales taxes, the United Arab Emirates will introduce a VAT rate of 5% in 2019).
Although online companies based outside of the EU offering products and services are, in principle, much easier to administer, since they are not obligated to charge and process VAT, even they are not ultimately able to evade VAT. To be able to sell on the lucrative EU market, they have to set up a company or subsidiary in an EU member state and register it for VAT purposes.
VAT thresholds for exports to countries in the EU
Unlike what happens with services, with products applying reverse charge is not possible, something which we will talk about more below. And, in order for the different countries in the EU to be able to benefit from the VAT that (in their opinion) they are entitled to, some limitations or thresholds on sales have been implemented. Therefore, the sale of products is also regulated by the country of consumption.
In principle, traders must only declare and pay VAT in the country where they have their registered office. Put simply, if you do not export products, if you import products from outside the EU and if you pay taxes and import tariffs. You only have to process VAT if you exceed the sales threshold of the special scheme for small businesses in your country.
[By the way, the special scheme for small businesses exempts you from including VAT in your invoices, meaning you do not have to charge this tax to your clients, improving your market competitiveness. However, there are certain limitations which you can read more about here. Unfortunately, this scheme is not available in Spain, but you could make use of it if you established your company in another EU member state.]
Once the product has been introduced into the European common area, you can sell it in any EU member state without paying import taxes. Furthermore, up to a certain sales limit, you simply have to apply the VAT rate of the country where your company is based (if you have opted for the special scheme, you would, of course, not charge VAT).
However, if you exceed these thresholds, you will have to obtain a tax identification number for each country that you sell in and also accurately process and transfer the VAT amounts.
This regulation exists to avoid tax competition between EU member states, since, in addition to different special small business schemes, the VAT rate also differs significantly from one state to the other, in both the normal and reduced rates.
For example, a company registered in Luxemburg (whose VAT rate is 17%) would ultimately have a large competitive advantage over Hungarian companies (whose VAT rate is 27%). In order to avoid these competitive advantages and disadvantages in cross-border trade, some VAT thresholds have been implemented which prevent tax havens in the EU like Luxemburg, Malta and Cyprus (with VAT rates between 17% and 19%) from enticing more customers through their low rates.
This VAT threshold is normally €100,000 but the states can reduce it to €35,000 if they wish. Most states have already made use of this option. It is only the Netherlands, Luxemburg and Germany who continue to have their VAT threshold at €100,000.
Great Britain, however, has fought to remain an exception. In the United Kingdom, there is no VAT threshold, meaning sales to customers within the UK are subject to taxes from the very first euro. If we take the generous special small business scheme in the UK into account, it is clear that England wants to attract mail-order companies to the island (since, by setting up a company in the UK and staying below the €100,000 threshold, they will not have to charge VAT there).
When calculating the amounts for the VAT threshold, only the net price is calculated. The calculation includes the cost of the goods themselves, as well as the shipping and packaging costs. However, it does not include sales to other EU companies (B2B).
You must start paying VAT in the country which you are exporting to from the very first sale that exceeds the sales threshold. Until then, you will have to charge VAT in the country where your business is based.
Important: the shipping threshold is only valid for the country where the final customer is located and not in the country where the products are stored. Although the warehouses must also keep accounts and inform the tax authorities of their transactions, they are not obligated to pay taxes (as you will see in the example below). Furthermore, the threshold is per country, even if the country is supplied from two different sources (under the same company name).
An example could be a food supplier whose food products are taxed in France at a reduced rate of 5.5%. Until July, they had a turnover of €98,000 in Germany through sales from their French depot. All of these sales were taxed in France.
However, a month later, they exceeded the stipulated VAT threshold of €100,000 in Germany, but in this case, they were sending the goods from a second depot, this time in the Czech Republic. Despite having their depots in different places, the amount sold by the same company is added together and they have to tax all sales over the €98,000 with the reduced German VAT rate of 7% rather than with the 5.5% in France.
Sales over the VAT threshold are subject to VAT in the country of destination throughout the entire calendar year, as well as during the following year. This is the case even if the sales made in the following year are once again below the sales threshold.
Therefore, if our French food supplier exceeds the VAT threshold in Germany in 2018, they will have to pay this tax throughout the whole of 2019, even if their turnover in 2019 is significantly lower. The ability to apply VAT in their country of origin will not return until 2020.
Of course, there are no rules without exceptions. All goods subject to additional excise duties (like hydrocarbons, tobacco and alcohol) or new vehicles are subject to VAT in their country of destination from the very first euro.
Another thing to take into account regarding sales limits is that entrepreneurs have the option of voluntarily waiving the VAT threshold, if they wish, and directly paying VAT in the country of destination from the very first euro.
For example, a Hungarian entrepreneur who exports to Germany will be happy to be able to apply the VAT rate of the country of destination. This way, he could benefit from the German VAT rate of 19% instead of having to charge the Hungarian rate of 27%. He can do this even if he has not reached the VAT threshold of €100,000 in Germany (undoubtedly one of the reasons why Germany has a high VAT threshold is because VAT there is low in comparison to that of other EU countries).
Likewise, if the goods were stored in another country, in Poland, for example, and shipped to Germany, the Hungarian company could take advantage of 19% VAT rather than Poland’s rate of 23%.
In order to benefit from the VAT rate of the country of destination from the very first euro, you have to submit an application to the tax office of the country which is losing its right of taxation. In some cases, this can be done informally, but sometimes you need to fill out various forms and wait at least a few weeks to receive a response. You may have to prove that you are going to sell in another country (it is usually enough to show that you have a VAT identification number in another country).
Be that as it may, in the majority of cases, you will also have to continue keeping VAT accounts in the countries where you simply store your goods, even if you are not obligated to pay VAT there (see below).
Generally, if you decide to waive the VAT threshold, this is in effect during the entire calendar year, although some countries have exceptions.
As you can see, this is a complex issue. Unfortunately, it is something that greatly affects Amazon FBA retailers, since they send their goods from warehouses located in different places to different countries in the EU.
Regarding Amazon’s pan-European logistics programme, goods can currently be shipped from the Czech Republic, Poland, Germany, Spain, France, Italy and Great Britain. As part of the programme, however, you must give your consent for Amazon to move the goods at will. But, to avoid problems with this, it is essential to know how goods are handled for tax purposes within the EU.
Shipping to yourself in the European Union, VAT with Amazon FBA
Fortunately, shipments to yourself are not subject to VAT. Despite this, there are a few things that you must consider so as to avoid problems.
First of all, the products (for instance, from Amazon) could be located in a warehouse in France, for example, and moved to a different warehouse in Spain. This is a tax-free shipment, a so-called intra-community shipment. In this instance, France does not levy any taxes.
However, when the products arrive in Spain, they become subject to VAT. In Spain, this value is subject to VAT in full but is compensated with the same amount through the return of the input VAT.
This is possible because VAT information is exchanged throughout the whole of the EU. In reality, taxes are not paid, but there is additional red tape.
In our example, Spain knows that the products have come from France to Spain in order to be sold. At the end of the day, the tax offices of the different countries are, at all times, informed about where and when the goods are located at the time of their sale to the consumer, which allows the offices to know how much the VAT amounts to and which country it corresponds to.
This is done through a summary declaration (including the total of the purchase prices of all the shipped goods) which the taxpayer must submit to the tax authorities in the country of consignment.
Purchase price is used as a baseline for calculating VAT in intra-European trade which, in some cases, must still be converted to local currency.
Intra-community purchases, as well as the input VAT, must be declared in the respective countries. You must, of course, have a VAT number in each of the countries that the merchandise passes through (in order to be able to declare VAT).
Therefore, anyone who wishes to participate in the pan-European Amazon FBA programme has to register in advance and obtain a VAT number in all of the countries involved in the programme. This, unfortunately, can be complicated if you have not yet sold anything in these countries.
In principle, according to a ruling made by the European Court of Justice, retroactive taxation may be possible in the absence of a VAT number, provided that there is no intention to evade taxes.
Pro forma invoices, issued to and from yourself, could be used to prove that there are no bad intentions. This type of invoice must meet all the criteria of a normal invoice.
In addition to the summary notification, you also need to take intra-community returns into account, which must be conveyed to the appropriate authorities after reaching the maximum amounts determined in all EU member states.
Once you have made all the declarations and paid all the taxes correctly, you will have overcome all of the legal and bureaucratical barriers. Fortunately, and in spite of all the complexity, the majority of the steps described here can be automated with the appropriate software.
Alternatives, avoiding VAT in the EU
Unfortunately, a definitive way to avoid VAT does not exist. The necessary mechanisms have been created in the EU, allowing it to easily discover and expose those who evade VAT.
Non-EU companies sometimes run into great difficulties when obtaining the VAT numbers they need in the different EU member states.
Using the services of an operating agent (a company within the EU that processes VAT and sales on behalf of the non-EU company) can remedy this situation and, in some cases (for example, if you import through the port of Rotterdam), can offer liquidity advantages. There are specialist providers of this type of service, who often also have warehouses or shipping companies which can save non-EU companies a lot of trouble.
Direct shipping from a foreign country in the EU is usually unsuccessful due to customs duties that can only be processed using a VAT number in the EU. This means that if you want to sell your goods in Europe without charging VAT, you have to somehow avoid customs.
This is exactly what many low-cost Chinese shops based in Hong Kong do. They send small packages which do not have to be declared, as long as their stated value is lower than €22.
However, according to new EU proposals, this type of VAT fraud will also be tackled and the VAT-exempt amount will be reduced in order to avoid this.
Apart from smuggling, there are few other options that allow non-EU traders to sell in the EU without charging VAT. Of course, there are ways of minimising the amount of VAT charged thanks to the various tax havens in the EU. As a company, however, it will be difficult for you to escape the bureaucracy.
Changes to the system proposed by the EU
A year ago, the European Commission presented some proposals to reform the existing VAT system, particularly concerning small businesses. The expected changes are as follows.
New VAT regulations for online sales of goods and services:
Currently, online stores have to register in the different EU member states in which they sell in order to correctly process VAT. This obligation is often cited as one of the main barriers to cross-border e-commerce. The costs for companies are estimated at €8,000 for each EU country in which they sell.
A proposal has been made that companies only have to submit a simple quarterly tax return for all VAT owed in the EU and also that they can use the one-stop shop to process VAT online.
Simplification of VAT regulations for micro-companies and start-ups:
The EU is expected to introduce a new threshold of €10,000 per year for online sales of products, which will enable companies that sell outside of their country to continue applying the VAT rules of their country of origin.
The regulations for the VAT threshold of €100,000 per year will also be modified in order to make things easier for SMEs. The idea is to simplify the standards on procedures for identifying customers’ country of residence. The new limit values could be applied to electronic services as early as 2018 and to online sales of products by 2021.
Other simplifications would allow micro-companies to continue applying VAT rules that they have to follow in their country of origin with respect to invoicing and transaction records.
The proceedings would be carried out from the member state in which the company in question is based and the company accounts would stop being audited by each member state in which they sell.
Measures against VAT fraud by non-EU companies:
Small shipments with a value of less than €22 imported into the EU are currently exempt from VAT. Given the 150 million packages that are imported into the EU each year, it is clear that this system is vulnerable to fraud, which creates significant distortions of competition, in detriment to EU-based companies.
On one hand, companies within the EU are clearly at a disadvantage against their non-EU competitors, since their sales are subject to VAT from the very first cent.
On the other, false information is often provided, meaning high-costs products, such as smartphones and tablets, are imported VAT-free.
All of this has led the European Commission to decide to abolish this exemption in their proposal.
Reverse Charge System:
It is not only companies selling products that have to know the fiscal implications of VAT on their accounts. The so-called reverse charge system is particularly important for companies that offer services to foreign companies.
Reverse charge mainly exists for two reasons. Firstly, its objective is to prevent VAT fraud by making the invoice recipient pay the tax. Secondly, it also intends to simplify the provision of services within the EU, eliminating the need to register for VAT purposes in each of your clients’ countries (unlike what happens with the sale of products).
The payments are taxed according to the country in which the service is provided.
Generally, reverse charge means that, as an invoice recipient, you will have to calculate, process and pay VAT in your country. The service provider will only include the net amount on the invoice.
This does not currently apply to all services, but more and more are being added to the list. As a company, you will normally receive invoices with reverse charge. This is particularly true for e-commerce businesses.
In addition to not including more than the net amount, the company invoice of a service provider should include a phrase similar to the following: “The tax liability falls on the recipient of the service,” or “Reverse-charge system in effect.”
It is very important to know where the service is being carried out and where the company that provides it comes from. This is often a source of error and confusion.
Reverse charge only applies to EU countries and to some countries outside of it. There are some non-EU countries that do not implement the reverse charge system. Switzerland is particularly worthy of mention here.
Other third countries, such as the US, Canada and other offshore states, can issue invoices without VAT and without including a tagline. The reverse charge system does not apply and processing any type of tax is not necessary. Of course, it is doubtful that the invoice issued by an offshore company will be authorised by the tax offices of the different EU member states.
The best example of invoices without VAT are those issued by US companies, invoices that are recognised and accepted in the EU. However, VAT, as we know it in the EU, does not exist in the USA, only different local taxes. As a result, US companies cannot record a VAT identification number on the invoice, since they do not have one.
Furthermore, unlike what happens with physical products, non-automated services offered online cannot really be controlled, nor is anyone trying to change the current system and force foreign companies to charge VAT.
Even so, if your company is in the EU and you are doing business with a service provider, there are several things that must be taken into account. If the service provider has some sort of error in their invoice, you are the one accountable to the tax office and you are obligated to process the tax and ask for them to issue you a correct invoice. If you have paid them in gross (with VAT), the other company would have to pay the VAT (but note that this is something that, in reality, is not enforced).
For companies that follow small business regulations, reverse charge also applies, even if they actually did not have to pay VAT. Unfortunately, this is often overlooked.
A final summary of VAT regulations on goods and services
At the end of this lengthy article about VAT, we are going to once again demonstrate what you have to do in the different cases.
The simplest option is that of the service company that only works on a national level, in the country where the company is based. For services to companies (B2B), you do not need to charge VAT, as it is only individuals, as final customers, that have to pay this tax.
If you offer your services to foreign companies within the EU, it is their responsibility to declare and pay VAT as recipients of the service.
If you hire the services of intra-community companies, reverse charge applies and the tax liability falls on you.
Keep in mind that reverse charge only applies for sales to clients in the EU and in some other countries (such as Switzerland, for example), but generally it does not apply on invoices to countries outside of the EU.
Depending on the country in which your company is based, you will be able to make use of the VAT scheme for small businesses (not available in Spain) and therefore you will not have to charge nor process VAT on sales to your clients, provided that you are below the set turnover limits. Of course, if you make use of this scheme, the VAT paid on your company’s purchases will not be refunded to you.
VAT legislation becomes much more complicated when you have an international commerce company, as with Amazon FBA. If you only import, store and sell your products in one country, you have a lot less to take into account.
If you move your merchandise to another country in the EU, you do not have to pay taxes, but you do have to comply with certain accounting and bureaucratic obligations. You must submit a summary report, obtain a local VAT number and also issue a pro forma invoice.
When you export products to other countries within the EU, you have to take the VAT thresholds into account. With the exception of Germany, the Netherlands and Luxemburg (€100,000 in each case), the VAT thresholds are only €35,000, and in the UK you also have to count VAT from the very first pound.
You can voluntarily waive the VAT threshold (particularly interesting if the VAT rate in the country of destination is lower), but you must consider the consequences of this. It is important to know the exceptions of the thresholds (products with additional excise duties like tobacco and alcohol).
We have not addressed the topic of exports from within the EU to outside of it in this article. If your clients are located outside of the EU, the best thing you can do is directly set-up your company outside of Europe.
If you sell online and use the VAT-MOSS procedure (VAT Mini One-Stop Shop), you also have all kinds of exceptions and different procedures. Therefore, as of 2015, automated digital products are always subject to VAT in the client’s country of residence.
You can learn more about the one-stop shop in the article linked above.
And finally, below is a table that gives a small overview of the applicable VAT rates and relevant reductions. You can also read about the exceptions and special features here.
To conclude, the only thing left to say is that the European VAT system, despite its complexity and scale, is logical and, if we forget for a moment the many difficulties that it poses for entrepreneurs, we could say works surprisingly well.
The wisest thing, without a doubt, is to hire competent tax advisors or, at least, use adequate software.
Even so, there is no doubting that it is easier to do business without VAT. Particularly as a service provider, there are numerous ways for you to do this at an international level. For the sale of products at an international level, you have to plan well in order to sell in the EU without VAT.
Finally, if what you want is to avoid VAT, the easiest thing to do is opt for a different market. The USA can be a very interesting market as well as, of course, the different countries in Latin America. If you are going to sell via FBA, America can be a great alternative to the complicated European system.