VAT (Value Added Tax) is a tax paid on the value added at each stage of a chain of production of goods and services. Where VAT is chargeable, each business charges VAT on its turnover. This VAT is then payable to the government, but only after deducting VAT paid on its own purchases of goods and services. Ultimately, VAT is a tax payable by the consumer of the goods or services. The businesses who charge VAT and pay it over to the government are simply acting as unpaid tax collectors.
VAT law in all EU member states is based on the EC Sixth VAT Directive. However, the detailed implementation and operation of the tax, including the rates and thresholds for registration are determined by the individual member states and can vary significantly.
The VAT registration threshold in the UK is £64,000 (approx. $126,000).
There are 0%, 5% and 17.5% rates of VAT, as well as exemptions from VAT and also sales which are outside the scope of UK VAT.
Risk Areas
Trading with customers in the EU – but with no offices in the EU
EC 13th Directive Reclaims
If you incur VAT on trips to the EU, for example when attending exhibitions or visiting potential customers, it may be possible to recover some or all of this VAT by making a reclaim under the EC 13th Directive. In the UK, claims must be submitted on or before 31 December for each year ending 30th June. If you expect such claims to be made regularly it is usually worthwhile to seek advice on the first claim so that the relevant procedures can be set up in-house.
Export of goods to the EU
Businesses will expect to pay import VAT on your goods and recover it through their VAT returns. Consumers may receive an unpleasant surprise when required to pay import VAT, quite often with a significant administration charge. If you are likely to be selling goods directly to consumers, then planning in advance may allow you to take VAT into account when pricing and reduce the final cost to your customers.
Export of Services to EU
If you supply services to businesses in the EU, they will account for VAT through their own VAT returns. There is no need to register for VAT in the EU. However, if you supply certain types of services (e.g via the internet) to individuals, then you may have to register for VAT somewhere in the EU. Advance planning will help you identify where you are at risk, assist you in distinguishing between business customers and consumers and help you decide whether you need to register for VAT.
Offices planned or already established in the EU
If you intend to establish a business in the EU, you need to take advice on how VAT will affect your business. If you apply the wrong rate of VAT to your sales, or fail to charge VAT when it should have been charged, it is possible that you could suddenly find that your cost of sales has risen substantially. It is thus essential that you take advice on how VAT will apply to your business.
Some sales of goods and services are exempt from VAT, but with the result that VAT paid on the costs of the business is not deductible. VAT paid by the business is not recoverable and it becomes an extra business cost. Proper advance planning will allow you to reduce the cost of irrecoverable VAT.
If your sales of goods or services will be subject to VAT, then each member state has a threshold, above which you are required to register for VAT. Failure to register on time can result in you having to pay penalties, interest and any VAT which should have been charged from the date when the threshold was exceeded. The UK’s threshold is the highest in the EU and one of the lowest standard rates.
Conclusions
Since VAT is a tax on turnover, it is almost impossible to correct errors made in the past. It is a tax which cannot be ignored if you are to trade in the EU. However, if you take advice and plan in advance for VAT, it is possible to ensure that you do not encounter unexpected problems, minimise your costs and potentially help to optimise your competitive position in the EU.