The EU and VAT on Goods and Services Guide
Everybody’s heard of it. Everybody pays it. As a consumer you know that it’s attached to every product or service you purchase within the UK or the European Union. But as a business owner, you may not be completely clear on how VAT applies to you, and how it pertains to goods and services sold both at home and to other EU member states. Those grappling with the many logistical considerations of running an SME have a great many considerations to attend to and delving through the HMRC website for clarification on all things pertaining to VAT can be a time consuming and bewildering ordeal. We all know that VAT accounts for 20% of the cost of goods and services that we buy as consumers and sell as a business but how does it work? Why is it necessary? Are there occasions when it is not appropriate to charge VAT. As a well informed business owner it behoves you to be able to answer those questions.
Thus, we’ve compiled this clear and concise yet comprehensive look at how VAT works and how it pertains to those who sell goods and services both within and outside of the EU…
What is VAT?
Let’s start at the very beginning. Value Added Tax is a consumption tax applied to goods and services that are traded either internally or overseas and its proportionate value is determined by the government of the country in which it is levied. It is intended to begin with raw materials and continue right the way through to retail sales. While this may imply that it only applies to physical goods it also applies to services. For example things like legal counsel, accounting services or any other consultancy will also charge VAT on the services that they provide to the general public. It also applies to the hiring or loaning of goods, the selling of business assets, commissions and finder’s fees, and anywhere where taxable supplies are bought, sold or loaned. There are however, some products and services which are VAT exempt and we will discuss those later.
How does VAT work?
Unlike in other countries such as the USA (which has a Sales Tax rather than VAT) where the sticker price of goods is not inclusive of (sales) tax and the gross value is determined at point of sale, VAT registered businesses and service providers in the UK and other EU states incorporate VAT into the sticker price of goods and services sold or hired. VAT is a destination-based tax meaning that it applies to the destination within which the goods or services will be consumed rather than any within which goods (or parts thereof) may have been produced. Hence, as EU states have VAT it applies to sales made within the EU whereas sales made to countries that eschew VAT like the US are not inclusive of VAT.
Why do we need VAT?
Like any tax, VAT is designed to generate revenue for governments to spend on essentials like defense, transportation and the building of infrastructure. In the UK, VAT accounts for more of the government’s income than corporation tax and fuel duties put together. For this reason, it is at home in a consumer capitalist economy. In theory, the frequent buying and selling of goods and services can generate economic wealth which the government can then channel into creating a healthier wider economy. While proponents say that VAT is great at facilitating economic growth, detractors claim that it merely encourages wasteful government spending.
What are my responsibilities as the owner of an SME?
If you sell products or services within the EU you have to register for VAT if you expect your earnings to exceed £85,000 per annum. However, many businesses in the UK still choose to register for VAT when their earnings are below said threshold because it benefits them to do so. When they register for VAT they can claim back the VAT that they pay on the goods and services needed to build their business infrastructure such as shopfitting costs, furniture, IT equipment etc. You may also reclaim VAT incurred in the production of goods you sell. For example, if you design and build furniture, VAT charged on the components that make a piece of furniture can be reclaimed. These are called “input” taxes.
If you choose to register for VAT you must charge it on all of your goods and services. As part of your usual business accounting, you must provide HMRC with details of how much VAT you’ve charged and how much VAT you’ve paid every 3 months through your VAT Return. You must account for VAT on the full value of what is sold even if you haven’t charged VAT to the customer. You must also account for VAT even if you receive other goods or services as remuneration (e.g. a part exchange).
Do I have to register for VAT?
If your earnings are not expected to exceed £85,000 per annum some accountants would advise you not to register for VAT. For smaller businesses and sole traders it may create more problems than it solves as it makes your accounting and bookkeeping much more complicated. There are some exceptions to this rule though. If, for example, you trade predominantly in goods that are 0% VAT such as books, baby supplies or children’s clothing it’s a good idea to be VAT registered as you will be able to reclaim VAT on your business expenses but won’t have to charge your customers VAT. However, if you deal exclusively in these goods you will not be allowed to register for VAT.
Selling to other EU Member states
Now we get to the nub of the matter. If you sell to other member states within the EU you must charge VAT on the goods and services. HMRC refers to sales made within the EU as “dispatches” or “removals” while sales made outside of the EU are classified as “exports” and dealt with slightly differently.
When selling to EU member states, it’s worth remembering that VAT also applies to consignment stocks. These are stocks which are shipped overseas but then stored for a predetermined time before eventually being supplied to a buyer in that destination country.
If you sell goods upon which excise duty is payable such as alcohol or tobacco, to someone in another EU country, VAT is dependent upon whether the customer collects them from you or you deliver them to the customer. In the former instance, UK VAT applies if they are intended for personal consumption. Otherwise VAT does not apply. If you deliver (or arrange to deliver) them, they are treated as distance sales in the destination country and you must register for VAT in the destination country no matter what the monetary value of the sale.
If you are exporting goods outside of the EU to a country that does not have VAT (e.g The United States) then VAT is not chargeable (it is “zero-rated”). While zero rating primarily refers to the selling of goods outside of the EU, there are some exceptional circumstances where goods and services sold within the EU may be zero rated. We will discuss these shortly. First, however, let’s discuss registering for VAT overseas.
Do I need to register for VAT in another country?
Depending upon where you sell your goods to, while it’s unlikely, you may have to register for VAT in the destination company where you’re selling. Most UK businesses do not have to do this because the “reverse charge” applies. This is a simplification measure designed to aid UK businesses with frequent dealings within the EU. The reverse charge applies in cases where;
- The place of supply is outside the UK.
- You and your business belong in the UK.
- The supply itself is not VAT exempt.
The reverse charge applies to virtually all B2B services. However, different countries have different “distance selling thresholds” so it’s worth researching the member states to which you trade most frequently to determine whether or not it is necessary to register for VAT in the destination country.
When is VAT not levied within the EU?
There are numerous circumstances under which VAT may not be levied on sales made to a buyer in another EU member state. The most common of which is if the buyer is also VAT registered within their native country. Let’s say, for example, that you’re a car parts manufacturer who sells a part to an overseas dealership who uses said part to make a repair on their own vehicle. Both you and the dealer are VAT registered. In this instance, the VAT on the transaction is zero-rated. In order to do this, however, the transaction must meet the following conditions;
- The recipient’s VAT registration number (including 2 digit country code) is present on the invoice.
- You dispatch the goods within 3 months of sale.
- You provide evidence of removal to HMRC.
Evidence of removal must show your business’ details and the customer details. It must provide a detailed description of the goods traded and their value. It must also show the intended destination, method of transportation and route. For inspection purposes, any of the following may be provided as acceptable evidence of removal;
- Customer orders.
- Sales invoices.
- Correspondence between yourself and the customer.
- Packing lists.
- Bank statements.
- Consignment notes.
- Statements or invoices from haulage companies.
If you offer intermediary services to a company or individual within an EU member state these may also be zero rated. If you supply a service on goods within the EU which are destined for sale outside of the EU, your fee for that service is zero rated. Likewise, goods which you send to an intermediary within the EU who processes them and then transports them for sale and consumption outside of the EU are also zero rated.
It’s worth noting that zero rated sales must still be reported to HMRC. Not only must it be included in your VAT Return (along with all sales within the EU where VAT was applicable), it must also be reported in your EC Sales List (ESL) which will be sent to your automatically by HMRC upon receipt of your VAT Return. If you sell over £250,000 worth of goods to EU customers within a year, you will also have to report your sales in an Intrastat Supplementary Declaration. If you sell goods for processing within the EU but for sale outside of the EU you must report the following to HMRC;
- The intended customer’s name and address (outside of the EU)
- Invoice number and date
- Description, quantity and value of goods
- The name and address of the EU processor
- The date by which goods must be exported
- Proof of export including the actual date of export
Goods that are VAT exempt
It’s worth remembering that some goods are VAT exempt. While this varies slightly from member state to member state, the UK’s VAT exempt goods are a reliable base line. Currently all items deemed essential to living such as food and drink, healthcare, children’s products, books, physical education and sporting activities, betting and gambling services, construction of new buildings and anything pertaining to charity. Again, however, it behoves you to check VAT exemption for your intended destination state/s.
Do I have to charge VAT on internally sold items?
Let’s say for example that your business has a small outpost in France. If you make an internal sale to a French employee, you may wonder whether this is subject to VAT. This may include the employee buying an item you supply such as an item of clothing for personal use or it may even include a sandwich she buys in the workplace canteen. In both cases, a VAT charge would be applicable. Even though the sale is made within your organisation it is still subject to normal taxation within its destination state.
The Brexit Caveat
Finally, it’s important to remember that Brexit negotiations could play a huge part in how VAT works in trade between the UK and EU member states. At present, it appears that firms will have to pay VAT upfront for their imports from within the EU (a measure which has incensed many UK businesses) but it is as yet unclear how exports will be affected. At present the situation is broadly expected to remain the same. That said, there’s no telling how a “no deal” Brexit might impact the imports and exports of UK enterprises.