Many of you start a business or move your business online. Some of you can afford an accountant, some don’t and some think they do not need one.
When you have a business that is handling VAT I recommend hiring an accountant from day one.
VAT is a complex piece of tax and if you are doing it wrong you could pay 100x in fines the amount you need to pay an accountant.
I for one hired an accountant from day one. You do not need to hire somebody full time. You can go with a company that has a team and contract them to do your taxes and paperwork for a monthly fixed fee.
Even if you hired an accountant it is better to have a brief understanding on how VAT works and how to use it as a business owner.
Well, the article below tries to clarify (from my personal point of view) what the VAT is and how to use it.
Definition
VAT stands for value added tax, which is a consumption tax put on a product any time value is added, except those products that are zero rated, like food and essential drugs or are in a way exempt, like exports.
The tax is levied at each stage of the supply chain, from production to sale point.
In the end the consumer pays the VAT because buyers in the early stages of production receive reimbursements for the previous VAT they have paid.
The value added tax is usually expressed as a percentage of the total cost.
Brief history of VAT
The origins of the VAT haven’t been decisively settled. That is due to the fact that attribution is variously accredited to one of two sources.
First to German businessman Wilhelm Von Siemens in 1918, for him the VAT was a way to resolve the cascading problems that arose in implementing gross turnover taxes and sales taxes. Second to American economist Thomas S. Adams in his writing between 1910 and 1921.
In Europe the first countries to implement VAT were Germany and France, they did so in the form of a general consumption tax used during World War I.
A new and modern variation of VAT was later implemented by France in 1954 and used in Ivory Coast colonies.
Due to its success the French government introduced it in 1958. Even though it was initially directed at large businesses in time it was extended to include all businesses sectors.
Today in France it is one of the most important sources of state finances, accounting for almost 50% of state revenues.
VAT can be seen as a relatively new tax, even though it was designed in the early 20th century the majority of the european countries adopted this tax in the 1960s and 1970s.
We can say that VAT adoption progressed in two major phases.
The first occurred mostly in Western Europe and Latin America during the years mentioned above.
The rise of the VAT in Western Europe was though accelerated by a series of EEC directives (Council directives) which required member states to adopt a harmonized VAT upon entry to the European Union.
The second phase of VAT adoption occurred from the late 1980s with the introduction of VAT in some high-profile industrialized countries outside the EU, these countries are Australia, Canada, Japan, and Switzerland.
Also this phase witnessed the massive expansion of VAT in transitional and developing economies, most notably in Africa and Asia.
Nowadays we can speak of three main varieties of VAT: the European model, the New Zealand model, and the Japanese model.
Of the three major types of VAT in existence New Zealand’s comes closest to resembling the ideal — that is, levied at a single rate on a relatively broad base.
Most jurisdictions have adopted the European-style VAT marked by multiple rates and varying degrees of exemptions.
In practice we can safely say that no two VATs look exactly alike, because they have differences in rates, thresholds, exemptions, refund, and coverage.
Moreover some VATs exist subnationally or are limited to the manufacturing or wholesale level.
Another thing to mention is the fact that governments have implemented the VAT mainly as an improved sales tax.
When it comes to the European countries, they have used VAT to reduce or eliminate other sales taxes even though they continue to maintain separate corporate income taxes.
Even though it was proposed by two people from different continents, the fate of the VAT in Europe and the U.S. has largely reflected the different motives of the tax innovators.
Germany and the rest of the Union have embraced the VAT as a better modification to sales taxes that already existed and as an adjunct to the income tax.
But by contrast the U.S. pursuit of the VAT, often a proposed substitute for the federal income tax, has remained with no results.
This comes despite studies that show the adoption of VAT is strongly linked to countries with corporatist institutions.
VAT rates across Europe
According to the EU law, EU member states are only required that the standard VAT rate must be at least 15% and the reduced rate at least 5% (this only for supplies of goods and services referred to in an exhaustive list).
Switzerland, as a non-EU country, levies the lowest VAT rate of only 7.7%, followed by Luxembourg (17%), Turkey (18%), and Germany (19%).
The countries with the highest VAT rates are Hungary (27%), and Sweden, Norway, and Denmark (all at 25%). The average VAT rate of the European countries covered is 21.3%.
The actual rates applied vary between EU countries and between certain types of products.
In addition, certain EU countries have retained other rates for specific products. That is why most European countries set thresholds for their VATs.
What it means is that a business’s revenue of taxable goods and services must be above a certain value before it is required to register and pay a VAT on its products.
This registration threshold allows small businesses to save time and expenses in compliance. However, it also believed to discriminate against larger businesses, creating economic distortions.
So if you want to learn about a certain country’s VAT the most reliable source of information on current VAT rates for a specified product in a particular EU country is that country’s VAT authority.
You can also find an overview of the different rates applied in all EU countries provided in the EU information document or check the table below.
If you’re viewing this article from a touchscreen device (mobile, tablet) for a better view please tap on the row you are visualising. If you are viewing this article from a desktop device for a better view hover over the rows.
| No. | Member state | Acronym | Super Reduced Rate | Reduced Rate | Normal Rate |
|---|---|---|---|---|---|
| 1 | Austria | AT | – | 10/13 | 20 |
| 2 | Belgium | BE | – | 6/12 | 21 |
| 3 | Bulgaria | BG | – | 9 | 20 |
| 4 | Croatia | HR | – | 5/13 | 25 |
| 5 | Cyprus | CY | – | 5/9 | 19 |
| 6 | Czech Republic | CZ | – | 10/15 | 21 |
| 7 | Denmark | DK | – | – | 25 |
| 8 | Estonia | EE | – | 9 | 20 |
| 9 | Finland | FI | – | 10/14 | 24 |
| 10 | France | FR | – | 5,5/10 | 20 |
| 11 | Germany | DE | – | 7 | 19 |
| 12 | Greece | EL | – | 6/13 | 24 |
| 13 | Hungary | HU | – | 5/18 | 27 |
| 14 | Ireland | IE | 4,8 | 9/13,5 | 23 |
| 15 | Italy | IT | 4 | 5/10 | 22 |
| 16 | Latvia | LV | – | 12 | 21 |
| 17 | Lithuania | LT | – | 5/9 | 21 |
| 18 | Luxembourg | LU | 3 | 8 | 17 |
| 19 | Malta | MT | – | 5/7 | 18 |
| 20 | Netherlands | NL | – | 6 | 21 |
| 21 | Poland | PL | – | 5/8 | 23 |
| 22 | Portugal | PT | – | 6/13 | 23 |
| 23 | Romania | RO | – | 5/9 | 19 |
| 24 | Slovakia | SK | – | 10 | 20 |
| 25 | Slovenia | SI | – | 9.5 | 22 |
| 26 | Spain | ES | 4 | 10 | 21 |
| 27 | Sweden | SE | – | 6/12 | 25 |
Due to the pandemic and the economic changes it is likely that the rates have changed and therefore you have to search on the EU site or the VAT authority of a certain country for the new rates.
Why are there different VAT rates in the EU?
You have to understand that European acts in the field of taxation have to be adopted by unanimity.
That is why the current provisions on VAT rates are thus the result of different compromises agreed by all the EU Ministers of Finance.
What is more the VAT Directive sets the framework for the VAT rates in the EU but it gives national governments freedom to set the number and level of rates they choose, all this is subject to only 2 basic rules:
Rule 1: There has to be a standard rate for all goods and services.
Rule 2: In the European Union a country can opt to apply one or two reduced rates but only to goods or services listed in the VAT Directive.
Standard VAT rate
This is the rate that EU countries have to apply to all non-exempt goods and services (you can find more in Article 96 VAT Directive). It must be no less than 15%, but there is no maximum (Article 97 VAT Directive).
Reduced rates of VAT
EU countries also have the option to apply one or two reduced rates (see more in Article 98(1) VAT Directive) which:
- may be applied to goods or services that you can see listed in Annex III of the VAT Directive but not to electronically supplied services (see more in Article 98(2) VAT Directive)
- must be no less than 5% (see Article 99 VAT Directive)
Exceptions to the rules – “special rates” of VAT
The exception to the rules above or the “Special rates” of VAT basically refers to the multiple exceptions to the basic rules.
Because of historical reasons and under certain conditions, many EU countries (in some instances, most of them) were allowed to depart from these rules for a transitional period.
The purpose of this was to allow for the gradual alignment of national laws with the VAT Directive, pending the definitive adoption of agreed VAT arrangements by all EU countries.
These exceptions enabled them to keep the “special rates” – reduced rates under 5% (including zero rates) and reduced rates for goods and services other than those listed in the directive (see more in Articles 102-128 VAT Directive).
How is it charged and how can you deduce VAT
When VAT is charged on goods or services a term like ‘taxable supplies’ could be used.
If you own a business and you supply goods or services, you normally have to:
- register with the tax authorities in the EU country where your business is established;
- charge your customer VAT and account for this to the tax authorities.
Once registered, VAT traders are given a number and have to show the VAT charged to customers on invoices.
In this way, the customer, if he is a registered trader too, knows how much he can deduct in turn, also the consumer knows how much tax he has paid on the final product.
In this way the correct VAT is paid in stages and so to a degree the system is self-policing.
Deducting VAT
Simply put deductible VAT, are expenses for business purposes that you can claim all (or partially) VAT back from.
Some examples included mobile phones, computers, or your home office.
In other words the VAT that is owned due to any sale is a percentage of the sale price.
From this percentage the taxable person is entitled to deduct all the tax already paid at the preceding stage.
Due to this system double taxation is avoided and tax is paid only on the value added at each stage of production and distribution.
We can say that the final VAT paid is basically the sum of the VAT paid at each preceding stage.
Moreover if you are in business you can usually deduct the VAT you have paid on your own business purchases from the VAT you charge your customers.
Because of that you then only need to pay the difference to the tax authorities and report these amounts to them in your periodic VAT return.
To be noted is the fact that if the purchase is purely for your business, then you can claim all VAT, but if it is a mixture of business and private use (such as a mobile phone or computer), then you can claim 50% of the purchase price and monthly bill.
Still there are times when the VAT your business has paid exceeds the VAT you have charged to your customers. If that is the case then the tax authorities should reimburse or credit you with the difference.
Just to be 100% sure, the best person to ask would be your accountant as him would be able to guide you through the process of claiming a VAT deduction.
In this way you’ll know for sure, and won’t accidentally try and claim something that it isn’t possible to deduct for.
VAT on invoices
Normally, if you are registered for VAT and you make sales to other businesses, you must issue a VAT invoice, either in paper or electronic form.
On the invoice VAT is normally added to the price of the goods or services.
Moreover your VAT identification number must be shown on all the invoices you give to your customers.
Beside this you have to show as well the amount of VAT being charged and other standard items.
Exceptions to the rule
There are some exceptions to this rule and it happens if for example you provide a service to another business that is not located in the same EU country as your company is based.
If this is the case then the VAT will be 0.
This does not mean the service is not subject to VAT, it just means that the VAT would be accounted for and paid directly by your business partner in the other EU country.
Similar to this, if you make an export of goods to a non-EU country, it is normal that your invoice will not show VAT.
That is because normally the buyer in the non-EU country will be subject to importation rules of its country.
Value-Added Tax (VAT) vs. Sales Tax
It is possible for VATs and sales taxes to raise the same amount of revenue; the difference lies in at what point the money is paid and by whom.
In the United States businesses are required to collect a sales tax of 10.00% on behalf of the government.
This they must submit to the applicable United States revenue department in a periodical VAT tax return.
The difference between VAT and sales tax is that unlike the United States’ sales tax, which is only charged on sales to end consumers, the VAT is collected on all sales – even of raw materials.
When it comes to businesses in the U.S. it may be required to register for a United States VAT number or other identifier to enable the government to track and verify VAT tax returns.
What is more, VAT collection is a responsibility of the merchant, and failure to collect and submit the appropriate tax amounts may result in severe penalties.
Another difference is that a VAT offers advantages over a national sales tax because it is much easier to track.
That can be possible because the exact tax levied at each step of production is known.
When it comes to a sales tax, the entire amount is rendered after the sale, thus making it difficult to allocate to specific production stages.
Moreover, because the VAT only taxes each value addition and not the sale of a product itself, assurance is provided that the same product is not double taxed.
VAT – good or bad?
The VAT has been criticized by many as the burden of it falls on personal end-consumers of products.
Some critics even consider it to be a regressive tax, because the poor pay more, if we talk about the percentage of their income, than the rich.
Defenders argue that relating the income of someone to the taxation levels is an arbitrary standard, and that the value-added tax is in fact a proportional tax because people with higher income pay more due to the fact that they consume more.
However, whether we think that VAT is regressive or progressive to a great extent depends on whether we believe the income or the distribution of expenses to be more indicative of economic inequality, and whether we look at VAT payments comparative to income or to expenditures.
Verify a VAT number
Since I work mainly internationally with clients all over the globe I’ve worked with my VAT number a lot since I’ve received it.
I’ve sent it to customers to verify my company, add it on invoices and on my site to show my visitors and potential customers that I’m a real business and offer them a way to verify that my business exists and that it is legit.
After you receive a VAT number from a business partner it is your obligation to verify that the VAT number is a valid one before adding it on your invoices.
You do that by using the VIES registry website.
Disclaimer: The material shared in this article is my personal understanding of VAT, is for informational purposes only and does not constitute legal advice. If you have any specific questions about the legality around Value added tax (VAT), please consult an accountant in your local area who specializes in this type of taxes.