Value Added Tax, or VAT, is a consumption tax that is prolific throughout the world economy. Roughly 140 countries worldwide apply VAT to purchases, and they all have differing rates and guidelines. And to complicate things further, the European Union (EU) has 28 member countries that charge varying VAT rates - even though it has one centralized EU VAT policy.
If you do business with any EU-based entities, it’s important to know the EU’s VAT policy and the tax reform that took place in 2015. Make sure you are charging the correct VAT rates upfront, rather than having your customer stuck with a tax bill after the fact. Here a few questions (and answers) on EU VAT to get you started in the right direction:
What’s the general framework of EU VAT?
When the European Union was formed, the 6 initial member countries had their own VAT rates. At the time, these VAT rates were applied as cascading taxes, where the taxable amount was determined at each production stage. This process was highly prone to error, so the EU created a centralized taxation process that allowed for varying VAT rates with one major requirement: VAT rebates must be offered at the point of export.
Aside from that one requirement, EU VAT has several main principles:
- VAT applies to goods and services purchased for consumption in EU member countries.
- VAT is a tax paid by the consumer of those goods and services, NOT the seller.
- VAT exists as a percentage of the total price paid by the consumer.
- VAT is collected per transaction, rather than in bulk.
- VAT is paid by the buyer to the seller. The seller then pays VAT to the appropriate governing authority in each EU member country.
In addition, there are minimums for standard tax rates (15%) and reduced tax rates (5%), which EU member countries can apply for based on the EU VAT Directive.
Related: European Commission: What is VAT?
What changed with the 2015 EU VAT reform?
All that sounds pretty straightforward, right? If you sell products to consumers or businesses in the EU, you’re required to charge VAT per transaction and pay it to the governing authority for that EU member country. But in 2015, EU VAT legislation experienced some major reforms that primarily affected businesses selling digital goods and services to EU entities. Here are the main changes in EU VAT legislation:
- Sellers of digital goods must charge VAT based on the buyer’s EU member country. So if you are in Germany selling to consumers in France, you must use France’s VAT percentage rate (not Germany’s).
- If the buyer is a company and it is purchasing digital goods, sellers have one of two options based on the buyer’s VAT number. If the buyer’s VAT number is valid, there’s no VAT percentage charge. If the buyer’s VAT number is incorrect or invalid, the seller must charge VAT for the buyer’s EU member country.
- If sellers of digital goods sell locally in their own EU member country, they must charge the local VAT rate on those sales.
So what really changed with EU VAT? Previously, if you sold to consumers or businesses in EU countries, your VAT rate was that of your own country. However, businesses were going around their own VAT rate by incorporating in Luxembourgto take advantage of the country’s low VAT rates. The changes in 2015 eliminate that loophole by forcing businesses to pay VAT of the buyer’s EU member country, which is referred to as the “destination principle”.
The buyer was previously responsible for accounting for VAT through what’s called a “reverse charge mechanism.” And there were thresholds for small amounts - i.e., if you sold a very small volume to a specific country, you probably didn’t have to pay VAT. Most of those thresholds have been eliminated with the new EU VAT legislation.
How can you ensure you’re capturing EU VAT accurately?
With these changes to EU VAT legislation, sellers must know a lot more about buyers in order to correctly apply VAT. It might sound complex, but it’s really just gathering a few more inputs and verifying them where necessary. Here’s what you’ll need to have to correctly apply EU VAT:
- The buyer’s location
- Whether the buyer is a company or an individual
- If the buyer is a company, their VAT number
- Verification of the buyer’s VAT number (is it valid, incorrect, is there no VAT number, etc.)
- The total amount charged per transaction
- The VAT percentage for the buyer’s location
- The total amount of VAT charged
As you gather this information from buyers, your checkout mechanism will need to to provide options based on the buyer’s answers. For example, if your buyer enters their location as Switzerland, the appropriate VAT charge will be different based on whether they select “company” or “individual”. If they select company, VAT will be based on whether they enter a valid VAT number or not. For a real-world example with various workflows, take a look at The Next Web’s sample implementation.
In addition, the EU has also created what it calls the Mini One Stop Shop (MOSS) expressly to ease the collection and distribution process of VAT. MOSS allows the distribution of VAT across EU member countries through one central entity. Rather than filing with each EU member country’s governing tax authority, businesses can register with MOSS, file quarterly tax returns, and pay all VAT to MOSS for distribution to all applicable EU member countries.
Selling to EU countries means you have to comply with EU VAT. There’s just no getting around it. However, understanding the framework of EU VAT, and what’s changed with the 2015 update, will help you build a solid process for accurate collection and payment of EU VAT.