VAT is that?
General explanation of how VAT works in the EU.
Most people who are unfamiliar with Value Added Tax (“VAT”) assume it is similar to the U.S.’s sales tax but it is very different. Unlike other developed countries of the world the U.S. does not impose VAT so many U.S. businesses are unfamiliar with how VAT works. This article is meant to educate U.S. entrepreneurs on the general workings of VAT in the European Union (“EU”) and strategies to minimize exposure. All 27 countries in the EU adhere to similar VAT rules base on The Recast Sixth Directive. Each member is allowed some room to customize their VAT laws but these differences for the most part are immaterial differences. The main feature of VAT that distinguishes it from U.S. sales tax is how the sourcing of sales and who is responsible for collecting it can change based on the status of the buyer and seller. Unlike the U.S. system where the seller always collects and remits the sales tax the VAT system can force either buyers or sellers to collect VAT depending on what is sold and if they are register for VAT.
Who is required to collect VAT?
In general, a taxpayer will be subject to VAT if it has an establishment located in the EU. An establishment is not defined by The Recast Sixth Directive but it generally follows the OECD (Treaty model) that an establishment is a location where there is sufficient people and resources to run a business. Therefore, having a warehouse in the EU to store your products will not be considered an established in the EU. A taxpayer that does not have an establishment in the EU (“Non-EU Seller”) will usually not be required to collect VAT on goods (tangibles) sold in the EU. Even if a Non-EU Seller is not subject to VAT on tangible goods it will be required to pay import VAT when the goods enter the EU and get processed by customs. However, a Non-EU Seller of electronically supplied services (downloaded software) will be taxable in EU countries where it sells to non-registered EU residents (individual Europeans).
How it works?
First we need to define the different types of buyers and sellers and then we can run through some examples:
Unregistered Non-EU Seller: A taxpayer located outside the EU who is not required to register for VAT.
Registered EU Seller: A seller located (established) in the EU that is registered to collect VAT.
Registered Non-EU Seller: A taxpayer located outside the EU who is registered to collect VAT.
Unregistered EU Buyers: Individual Europeans not required registering for VAT.
Registered EU Buyers: Companies that are registered to collect VAT in the EU.
Unregistered Non-EU Buyers: Buyers located outside the EU not subject to VAT.
Example 1: Tangible goods imported and sold in the EU.
US Inc. (an unregistered non-EU seller) exports bricks to London and sells the brick to UK Inc. (a registered EU buyer) for $100. UK Inc. uses the bricks to create brick walls which it sells to France Inc. (a registered EU buyer) for $500. VAT tax in both the UK and France is 10%.
US Inc. is not required to pay VAT on sales but will be required to pay import VAT when the bricks enter London. When the bricks enter London US Inc. will need to pay $10 of import VAT ($100*10%=10).
Next, UK Inc. will purchase the bricks for $100 from US Inc. Since UK Inc. is registered for VAT it will be required to self-imposed VAT on the sale and remit $10 to the UK ($100.00*10%=10). Because US Inc. is not registered and does not file a VAT return UK Inc. will be unable to use the import VAT to offset its VAT liability.
UK Inc. then sells the brick wall to France Inc. Since France Inc. is registered for VAT it will be required to self-imposed VAT on the sale and remit $40 to France. ($500*10% = $50 less the $10 paid by UK Inc. = $40).
The total VAT paid by all three companies is $60 (US =$10, UK=$10, FR=$40).
Example 2: Tangible goods imported and sold in the EU.
Assume all the same facts except that US Inc. is a registered non-EU seller who files VAT returns.
US Inc. is registered to pay VAT and will need to pay $10 of import VAT on the bricks ($100*10%=10).
Next, UK Inc. will purchase the bricks for $100 from US Inc. Since US Inc. is registered for VAT and the bricks are bought and dispatch within the same country US Inc. will impose $10 of VAT on the sale to UK Inc. US Inc. will then remit $0 of VAT to the UK ($10 collected less the $10 of import VAT already paid).
UK Inc. then sells the brick wall to France Inc. Since France Inc. is registered for VAT it will be required to self-imposed VAT on the sale and remit $40 to France ($500*10% = $50 less the $10 paid by US Inc. = $40).
The total VAT paid by all three companies is $50 (US =$10, UK=$0, FR=$40).
Example 3: Electronically supplied services sold throughout the EU by a registered business.
UK Inc. (a registered EU seller) sells electronically delivered books over the internet. UK Inc. is established in London and manages the website and server from there. UK Inc. has sales of $1,000 from books downloaded by unregistered EU buyers located in France. UK Inc. has sales of $2,000 from books downloaded by registered EU buyers located in France. UK Inc. has sales of $10,000 from books downloaded by unregistered non-EU buyers located in Vietnam. The VAT rate is 10% all across the EU.
Since UK Inc. is registered for VAT and has an establishment located within the EU all of its downloaded book sales from unregistered EU buyers in France are sourced to the UK and it must pay VAT on these sales to its country of establishment, the UK. UK Inc. must remit VAT to the UK of $100 ($1,000*10%= $100).
The sales of downloaded books to VAT registered customers in France would be inta-euro sales sourced to France and the registered French buyers would be responsible for self-imposing the VAT. The registered French buyers would be required to remit $200 of VAT to France ($2,000*10%= $200). In this situation UK Inc. would have no VAT obligations.
Sales from books downloaded by unregistered non-EU buyers located in Vietnam would not subject UK Inc. to any VAT liabilities. If the supplier has an establishment within the EU the electronically supplied services are sourced to the provider’s country except when the sales are to non-EU buyers established outside the EU. This is done to encourage the export of services.
Although the Recast Sixth Directive uses “electronically supplied services” it is important to note that this includes downloaded software, games, movies, and music. The use of “services” can be misleading.
As of January 1st 2010 sales of electronically supplied services provided to VAT registered EU costumers are deemed supplied at the buyer’s establishment and the VAT is self-imposed by the buyer. However, when a supplier of electronically supplied services with an establishment in the EU has sales to an unregistered EU buyer the VAT is paid and sourced to the seller’s location. Therefore, if a foreign company wants to start selling electronically supplied services to unregistered EU customers they should set up an establishment in an EU country with a low VAT rate so all of their unregistered EU customer’s sales will be sourced to their low rate establishment.
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