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A guide to value-added tax (VAT)

Coins and VAT blocks

Whether you regularly do business internationally, or you’re just getting started with global growth, there’s a pretty good chance you’ll run into “VAT”, or value-added tax, rather quickly. After all, most countries around the globe levy some form of VAT tax.

So what exactly is VAT, and what do exporters need to know to confidently enter and develop new markets while ensuring VAT compliance?

Defining VAT: sales tax vs VAT

Let’s start with a definition of VAT: what is value-added tax and how is it similar to, and different from, a sales tax?

The main difference between a sales tax and VAT is that a sales tax is only applied in the final consumption. It is the end consumer, alone, who pays a sales tax. By contrast, VAT is levied throughout the supply chain, starting with the raw materials and running through manufacturing, wholesale, and retail.

A key feature of VAT is that it’s deductible by businesses, but not by consumers. Although companies are required to charge one another VAT, they can normally claim this money back down the line.

“Since VAT is meant to be neutral for business, they can deduct the VAT they are charged by other businesses against the VAT they charge on their own sales,” explains Richard Asquith of tax compliance firm Avalara. “Only the difference is paid to the tax authorities.”

When you realize that the average VAT rate in the European Union is 21%, it quickly makes sense why getting VAT administration right is a big deal for any company subject to value-added tax.

Value-added tax: an example

Here’s an example of VAT being applied to a product as it moves through the supply chain, from raw material to end consumer.

A farm sells a sack of wheat to a bread company for €500 and charges an additional €100 in VAT. This is based on a VAT rate of 20%. The farm must pay the €100 it receives to the tax authorities, although it can eventually claim the amount back.

Next, the bread company makes loaves from the wheat. It sells all the loaves to the public for a total of €750, which it grosses up to €900 after applying €150 of VAT (20% of €750) to the batch.

When the bread company completes its VAT return, it owes the government €150, minus the €100 it already paid to the farmer when purchasing the sacks of wheat. After doing the math, it needs to make an additional VAT payment to the authorities of €50.

In this example, the tax authorities receive a total of €150, made up of €100 from the farmer and €50 from the bread company. But, ultimately, it is the consumer who pays the VAT; and unlike businesses in the supply chain, the consumer cannot get the VAT they paid back.

VAT around the world

When considering how value-added tax is applied to products and services, it’s helpful to understand how VAT works throughout the world.

Here are five things to know about VAT from the global perspective: 

  1. Currently, 168 countries apply some form of VAT, according to the latest count by the OECD. France was the first country to implement a VAT regime in the 1950s.
  2. VAT vs. GST: Despite the different acronyms, VAT and GST, which stands for goods and services tax, are very similar. In some countries, they are essentially the same consumption tax, just with different names. 
  3. Although VAT is applied differently by countries, there are many similarities across systems, particularly since China and India reformed their VAT and GST regimes in recent years. The major differences to VAT are found in the administration of the system at the country level, rather than in the principle of VAT itself.
  4. From country to country, certain products and services may be exempt from VAT or subject to a lower rate. For example, the Netherlands has a reduced VAT rate of 6%, with approximately 28 categories of goods to which the reduced VAT rate may be applied.
  5. The EU plans to implement a range of changes to its cross-border VAT rules in January 2021.  Among other items, these changes will eliminate the low value (de minimis) threshold of €22. This means that all shipments will be subject to VAT, regardless of value. On the plus side, the changes will enable shippers to register for a single VAT ID for all countries and report VAT through a One Stop Shop portal.

The European Union: VAT in action

If you’re doing business in the European Union (EU), there’s no avoiding VAT. Across the EU’s 28 member states, all countries are required to adopt its VAT directive.

This ensures a consistent framework for VAT inside the European Union. Keep in mind that certain European countries, such as Switzerland and Norway, are not members of the EU.

Although countries are required to adopt the legislation as stipulated in the EU VAT directive, they still have their own local VAT rules. The framework may be broadly harmonized, but there are still many differences that can heavily impact compliance. Even for VAT experts, the VAT rules are extremely complex.

Anticipating import tax

Import VAT is something you need to know about if you’re shipping product into the European Union.

As soon as your goods enter the EU, you will be confronted with import VAT.  This is not the sales price, but a calculation based on the customs value of your goods, which comprises the cost of goods, plus duties, transportation, insurance, commission, and so on.

When it comes to paying import VAT, it is important for sellers to be upfront with their customers about who is footing the bill.

This is especially true in B2C e-commerce transactions, where the import tax will normally be charged to the final consumer. This can quickly lead to unhappy customers who were not expecting the additional import VAT and would prefer to have known the landed cost upfront.

“It can be a nasty shock for the customer if they have to pay the import VAT and duties to get the goods from the post office or the forwarding agent,” remarks Richard Asquith of Avalara. “This often leads to customers not buying further from the seller.”

Asquith recommends that sellers consider registering for a VAT ID in the country of import and handling the VAT themselves. Importers may also benefit from the EU’s distance selling rules, which allows sellers to import up to a set amount per year (limits vary by country) without registering for a VAT ID —provided the total cost of goods sold falls under certain limits for the year. These limits will reduce to €10,000 as part of the new VAT rules for e-commerce, set to take effect in January 2021.

Registering for VAT ID: the commercial considerations

Evidently, there are various commercial reasons for companies doing business in the European Union to register for a VAT ID. But what exactly is a VAT ID and how do you obtain one?

A VAT ID (also known as a VAT registration number) is a unique number that identifies a taxable business (or person) or non-taxable legal entity that is registered for VAT.

Registering for a VAT ID may be required for your company to: 

  • avoid financial penalties
  • establish yourself as an importer
  • engage in forward-stocking of goods in a fulfillment center or warehouse
  • claim VAT refunds for returns and B2B sales
  • sell through online marketplaces

This last point is an important one. Some European Union member countries, such as Germany, have begun enforcing the requirement that online marketplaces ensure their sellers have a VAT certificate in place.

Registering for a VAT ID isn’t just about compliance. It can also improve customer experience by making it simpler for your purchasers and removing the hassle (and cost) of them having to pay import VAT before the goods can be released.

Some B2C companies that have high return rates, like those within the apparel sector, want to register for a VAT ID so they can sell under DDP terms, and pay duties and taxes for their customer. This means if they have a returned product, they can reclaim the VAT they paid on import.

How to register for VAT in the EU 

EU member states, such as France and the Netherlands, make it relatively simple for a non-resident shipper to apply for a VAT ID.

The simplest way is to go through a fiscal representative, who will handle VAT compliance requirements on your behalf, including registration. If you do not want to pay the setup fee, which is typically between €500 and €1,000, you can register by yourself.  The U.K., in particular, has a clear self-serve process available online. 

According to Avalara, while rules vary by country, the following information (among other items) is normally required to register for a VAT ID:

  • Proof of tax registration in the home country
  • An original copy of the company’s certificate of incorporation
  • A copy of the company’s Articles of Association
  • An extract from the national company registrar as proof of existence

Your fiscal representative can also advise on the limited number of instances in which VAT may not be applied to the movement of goods into the EU.

Once you have registered for VAT, you will need to file regular returns. Remember that registering for a VAT ID is not the same as incorporating in the European Union.

When you apply for a VAT ID, it is often necessary to apply for an Economic Operator Registration and Identification (EORI) number at the same time for customs purposes.

Reducing the burden of VAT compliance

VAT compliance, by its nature, involves complexity. That’s why it’s important to simplify your company’s handling of VAT wherever possible.

Appointing a fiscal representative is a good way to help with global VAT compliance. A fiscal representative can prepare your VAT filings and manage the correspondence between tax agency and shipper.

In addition, working on your behalf, a fiscal representative can: 

  • Ensure compliance with rules on VAT invoices
  • Prepare and submit VAT payments and reports as required
  • Claim back VAT on B2B shipments, including returns
  • Maintain your tax records and make them available to local tax authorities as needed

They can also advise on VAT deferral programs offered by certain EU countries. Under the terms of these programs, the seller may be eligible to make periodic VAT payments rather than payment upon import. Taking advantage of VAT deferral programs such as these can help export-import businesses better manage cash flow, especially for B2B shipments where the VAT will be reclaimed.

Navigating VAT with confidence

The world is a big place, with significant commercial opportunity for those that go after it. Don’t let apprehensions over managing VAT stand in your way. Speak to your account executive for more information about UPS’s fiscal representative program, and find out more about how UPS can help you grow your business internationally with confidence.  

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