When US companies deal with value added tax “VAT” challenges in Europe, whether newly established or well established, they often fall into the same avoidable traps. These traps include: the assumption that VAT is similar to US sales tax or GST (it is not), and a belief that VAT does not apply to non-European businesses (it does). Sometimes, it is a combination of both.
Depending on the nature of the business activities conducted in Europe, a variety of tax matters could become relevant such as corporate income tax, wage taxes and VAT. Unlike most other taxes, no physical presence in Europe is required to become VAT liable or to be charged with VAT. Therefore, the cost benefit of a cross-border business transaction should always take into account any potential VAT impact. It is important to remember that businesses are supposed to be VAT tax collectors, not tax payers. VAT is an end user tax, and businesses are not intended to serve as end users.
When expanding your business to or when you are doing business in Europe, it is essential to have a thorough understanding of the European market. Compared to the US with its 50+ states, one commonly spoken language, one currency and local and federal politics, the countries in the continent of Europe are recognised in
different terms, for instance, through the membership of the European Union (EU), the European Monetary
Union (EMU) or the European Economic Area (EEA). All of these are umbrella terms for partnerships between various countries in Europe focusing on different goals. Beside the participation in partnerships, every European country has its own politics, economy, legislation etc.
The EU is the most prominent partnership in Europe. The EU is an economic and political partnership that currently consists of 28 Member States. It is worth noting that although large European economies such as Switzerland and Norway are not part of the EU, their politics and internal regulations are very much connected with it.
Although all Member States of the EU are required to comply with the Union’s harmonised VAT legislation, the tax authorities of each Member State have a certain degree of flexibility in the implementation of VAT legislation
resulting in considerable differences between the Member States. The differences appear, for example, in rates, exemptions, reverse charge mechanisms and reporting requirements. The time to comply with local VAT regulations can also differ significantly.
Overall, it is safe to say that when US companies do business in Europe, they should not only expect a different business environment, but also differences in cultures, languages, economic conditions, political climates, legal and tax legislation and currency.
What is VAT?
Contrary to what many people believe, VAT is not the same as US sales tax.
Although both VAT and sales tax are consumption taxes, it is good to realise that where sales tax is collected on retail sales at the time of sale to the final consumer, VAT is imposed on all sales in a supply chain involving the production and the distribution of goods, and the provision of services for consumption within the territory of the EU. Hence, both goods and services are subject to VAT, and where there is consumption of these in the EU, there is a business (irrespective of the place of principal seat) liable to charge VAT.
In a supply chain VAT can never accumulate and paying VAT over VAT is prohibited. The ‘end user’ pays VAT
and the business charging it acts as the collector. Since a business cannot be considered as an end user, businesses can reclaim VAT paid on purchases. On one hand, a business that is liable for VAT should pay VAT collected from end users to the tax authority, and on the other hand a business can reclaim any VAT paid to suppliers and on import of goods at the same time. In other words, VAT should not create a cost of doing business.
When US companies encounter European VAT
When doing business in the territory of the EU a company will deal with VAT: when selling something, the company will have to charge the customer with VAT and when buying something the company will be charged with VAT. US companies often encounter European VAT when undertaking activities such as:
- importing goods into Europe for onward supply in the EU
- (importing and) holding an inventory of goods in a European location
- selling electronically delivered software, games or music to private individuals in Europe
- operating a local sales and marketing subsidiary
- importing evaluation units for demonstration and subsequent sale
What do we see in practice?
In practice a lot of questions arise in relation to the importing of goods, the possibility of submitting VAT refund requests, and compliance obligations. As aforementioned, VAT should not result in a cost when doing business.
However, to achieve that result it is important to manage compliance regulations and the cash flow effects too since VAT may not always be recovered quickly. Some key considerations from a compliance perspective are:
- Incoming invoices should meet all requirements for VAT; the payment of incorrectly charged VAT is an important issue and may result in non-reclaimable VAT.
- Outgoing invoices should correctly state the VAT amounts; incorrectly stated invoices may lead to complicated and lengthy discussions with the local tax authorities and/or payment of VAT without the ability to on charge that VAT to the customer (from a commercial perspective).
- Having a proper administration that includes all incoming and outgoing invoices, import documents and documents that record border crossing supplies of goods.
- Timely file and meeting filing deadlines (to avoid penalties).
- In case of lack of physical presence in Europe: appointing a fiscal representative for VAT to assist with local VAT compliance obligations.
- An ERP system that is aligned with the European VAT requirements.
For US companies doing business in Europe, VAT can sometimes be difficult to understand and implement and becomes time consuming to comply with retroactively. Nevertheless, VAT is manageable when dealt with
proactively beforehand. To safeguard that, it is important that the balanced VAT system (payment of VAT on sales/deduction of VAT on purchases) is correctly integrated in the business models and internal administration systems of companies.
In both existing and new situations, it has never been more important to make the time to examine the company’s VAT structure and put in place operating procedures that will enable maximisation of VAT recovery, cash flow and avoidance of penalties for non-compliance.