What non-EU Enterprises Need to Know about VAT

With a GDP of $16.229 trillion and a population of about 750 million people, the European Union is one of the most important business regions in the world. This vast geographical and economic area is made up of 28 independent countries. Their individual economies are joined together into the European Single Market. This common market enables the free movement of people, services, capital and goods across the countries who are members of the European Union.

Due to the benefits provided by free trade, the EU represents the unique and most populous economic commonwealth of different countries in the world. And while the general tendency of the European Commission – some sort of the government of the EU – is stronger unification of rules and regulations, some important laws and measures are left to be set by the governments of the EU-members.

This specific nature of the EU forces enterprises that have headquarters outside the European Single Market to learn more about the economic rules, both of the entire community and its individual countries. One of the most important such measures is VAT (value added tax).

After reading this piece, you’ll get a better insight into the structure of this tax and how it can affect your business.

Consumption tax paid by customers

In a nutshell,

VAT is a special tax on a consumer’s purchase, paid by customers when they buy a product or a service on the territory of a member of the European Union.

While the US taxation system is directed towards incomes and revenues, the EU and its members apply a different taxation strategy. Although there are also separate taxes on incomes and other financial transactions, VAT serves as a special leverage used by national governments to increase their budgets. This tax is usually justified by a wide range of social services that governments of the EU-members provide for their citizens.

Contrary to that, critics of this taxation model claim that it’s completely unfair. Their arguments are that both well-off and poor consumers have to pay the same tax. Moreover, there are some serious objections that excessive regulation of VAT and other taxes would put small businesses at risk.

Nevertheless, those rules are here and non-EU companies have to comply with them.

Different countries, different rates

The European Commission brings general directives when it comes to VAT and other taxes related to non-EU digital companies. Nevertheless, they don’t interfere with the local taxation policies of its members. As a result, VAT rates differ significantly from country to country. Some governments want their economies to embrace the innovations in the IT-sector and develop this of economy. For instance, Italy has a reduced 4% VAT rate for digital publications. Moreover, France keeps a low 10% VAT-rate on cable TV.

On the contrary to that, some countries lead a high-rate VAT policy. That way, the VAT rate in Hungary is 27%. Here you can see an overview of full and reduced VAT rates for all the EU-countries.

As you can see, local VAT can differ a lot, which is why non-EU business should inquire a lot before they start selling their services in EU-countries.

(VA)Taxation of digital services

The Information Revolution has been gradually changing the VAT rates and regulations throughout the Common market since the beginning of 2000s. The first major decision was brought in 2003, when it was determined that non-resident businesses are obliged to pay VAT on digital products and services sold in any of the EU-members.

In accordance with these taxation rules, the VAT rates that were to be paid were the ones valid in the country where the business was registered – there were still only 15 “old” members back then.  However, although this was an official decision, it was interpreted loosely by international businesses working in the EU (mostly US companies). To be more precise, there was a legal loophole for non-EU businesses, since VAT depended on the country of registration. Hence, companies registered in USA or any other non-EU country managed to dodge paying VAT.

As the share of the digital market in the total GDP of the EU was growing, its members had to consider new mechanisms for collecting VAT on digital goods. After more than a decade, the European Commission had to bring new regulations.

As of 1 January 2015, the VAT rate is determined by the location of the consumer. Click To Tweet

Those new conditions force non-EU businesses to take care of their financial reports and pay VAT in one of the countries in the EU.

Which digital services are taxable?

The number and range of available digital services are rapidly growing. Therefore, it’s important for every business planning to start selling their services in the EU to learn whether or not their services have to comply with the VAT regulations.

  • TV and radio services – Any audio-visual content that can be listened to or watched on different media channels by users in a particular EU-country.
  • Web streaming – Any live streaming program that’s aired at the same time via local broadcaster
  • Electronically provided services – SaaS solutions, hosting services, music, films, video games, online magazines, photos, e-books, commercial PDF-files.
  • Various forms of telecommunication – Internet-provided telephone services and any form of video calling. Voice mail, caller identification and other calling options performed via the Internet.

If your business offers any of the aforementioned services to EU-residents, you have to register in the EU-country where you offer your services and make your business accountable for VAT. Also, there are some services offered and sold via the Internet that aren’t in the VAT system. Read more about them on the website of the UK Government.

Detailed sales data for VAT documentation

So, due to the firm VAT regulations valid from January 2015, the sellers and providers of digital services and products in the EU are required to collect and keep details regarding every purchase they have in this area.

What’s more, they also need to gather data about the location of each customer that buys digital goods from them. In line with that, every non-EU business working in the field of digital services will have to use special accounting features that will be able to locate their consumers. That way, the local tax authorities in every EU-country in which the seller manages to sell a digital item will have a clear insight in the sources of the seller’s revenue. Moreover, the seller will also need to calculate its VAT liability on the basis of that revenue, so that all the figures in their reports match.

What is different, however, is the business-to-business (B2B) digital collaboration. In this case, a non-EU business can use the 0% VAT rate. This is so due to the reverse charge system. If a non-EU business wants to prove that they’ve had deals with some EU-based businesses, they have to include VAT registration numbers of each and every EU-business they worked with. That way, your business won’t be penalized, since you’ll have clear evidence for the business deals closed with other companies.

Consumer data and privacy policy

Gathering and keeping consumers’ data is a red zone when it comes to their privacy. According to the reform of the privacy law conducted by the European Commission, the European Parliament and the Council of Europe, Internet users living in the EU will have better protection from data theft in the future.

What a non-EU business owner might wonder here is how they will be able to collect and keep the data regarding their consumers if the EU authorities are preparing such a strict law concerning online privacy.

  • First of all, every online sale will include a simple form that every buyer of your digital products or services will have to fill in. They will have to give you their country of residence. Here you’ll need at least two proofs that will support their claim. It can be the IP address, the country code of their mobile phone number, the buyer’s landline phone, the billing address of the consumer, or the location of the bank through which the payment has been made.
  • Secondly, your buyers will need to type in their VAT number in that form. This is an extremely important piece of information since it will tell you whether it’s a business or a person. If it’s a business client, you can check their VAT identity with the VIES search engine.
  • Thirdly, this form will need to contain the price of the purchase, so that the total amount invoiced can be calculated.
  • Finally, the peak of this procedure is the amount of VAT charged for the purchase in question.

When your financial reports are inspected by tax authorities, those data will be thoroughly analyzed. This is why you have to make sure all of them are collected and kept in your business reports. Some software accounting tools might also come in handy, so as to automate those calculations.

On the other hand, don’t keep any other data about your consumers, such as their credit card of bank account numbers. The aforementioned privacy law will penalize companies that retain such data.

The MOSS taxation program

All the taxation features described in this piece might repel some non-EU businesses from working on its territory. Since the EU-authorities must have thought the same, they’ve also included some mechanisms that make the entire VAT-registration much easier. The most important system for both EU-based and non-EU businesses is the

The most important system for both EU-based and non-EU businesses is the Mini One Stop Shop service (also known as MOSS). In order to avoid filing a tax return in every EU-member your goods are available in, companies can use the benefits of this practical system. So, when you hand in your quarterly tax return, the VAT collected on that occasion will be distributed to all the countries where your consumers reside. This helpful mechanism reduced the financial hassle for businesses making sales in the EU.

This helpful mechanism reduced the financial hassle for businesses making sales in the EU.

Consequences of avoiding VAT

Just like in any other system, you can try to dodge some rules. However, if you decide to play that move, you need to know that it might be an expensive game. On one side, it might happen that your sales don’t catch the eye of the national tax authorities in the country you’re working in. On the other side, if you get caught, the consequences your business will have to face will be unpleasant.

Firstly, you’ll have to pay high penalties as a tax avoider. Those repercussions won’t only include the current year. On the contrary, the tax officials will go through your financial reports backwards. Therefore, you’ll have to pay all the unpaid taxes retroactively.

Secondly, your present business deals will become impossible, since you’ll spend a lot of assets to cover all the VAT debts. Such a situation will undoubtedly put your entire enterprise at risk of being swept away from the business map. For instance, Apple survived their €13 billion penalty tax violation, but a smaller and less powerful company would most probably have to close down.

What’s more, if you don’t pay the penalty, you might be sentenced to jail, as well. Since the tax regulations in the EU are getting harsher, the future will bring stricter penalties, so bear that in mind.

Every business that wants to work in the EU and sell their digital services to its citizens has to get familiar with all the rules in that vast community. From the central directives, brought by the European Commission, to individual VAT-rates and regulations of each of the EU-members, gathering information is the crucial preparatory action.

We have to accept that every business region is trying to protect their interests and make profits from companies that aren’t registered on their territory. Nonetheless, if your non-EU business offers innovative digital services and cutting-edge equipment, it won’t be a problem to find a place for your business deals within the EU surroundings. For all these reasons, don’t hesitate to start your business venture in the European Union. Just make sure you report every single sale in your tax return and enjoy long-term benefits of such business policy.

Mark Thomasson
Mark is a biz-dev hero at Invoicebus - a simple invoicing service that gets your invoices paid faster. He passionately blogs on topics that help small biz owners succeed in their business. He is also a lifelong learner who practices mindfulness and enjoys long walks in nature more than anything else.
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