How to Charge EU VAT on Digital Products and Subscriptions
Accounting for EU VAT could be one of the most challenging hurdles to new software companies that want to implement compliant online payments for their digital products and subscriptions. This tutorial has an easy solution.
You’ve probably heard of it and maybe you already had to answer to a customer who demanded a VAT invoice. It’s EU VAT, the headache that started in 2015 with VAT MOSS and continues to wreak havoc to non-compliant startups, even outside the European Union.
This tutorial applies to digital goods and services. These are telecommunications, broadcasting and electronic services (TBE), or officially called electronically supplied services by the European Commission. They can be e-books, audiobooks, online courses, subscription and hosting services, basically anything that can be sold online and digitally in an automated manner.
Even if your startup is based outside the EU, whether you’re based in India, Australia, United States or on a deserted island in Indonesia, listen up.
Why is EU VAT Important for a Startup
Before we criticize taxes by default, I want to point out that the laws (or ‘directives’ as they are called) around EU VAT are actually quite progressive and forward-thinking.
You should understand that the nature of a value added tax (VAT), known in some countries as a goods and services tax (GST), isn’t to tax you as a startup, but to tax the end-consumer, your customer. In effect, you’re being held accountable as the middleman who collects tax on behalf of the tax administrations.
Germany and France were the first countries to implement VAT during World War I and more and more countries are seeing the benefits of it as over 20% of the world’s tax revenue is raised through VAT. Even the United States is discussing the implementation of a nationwide US VAT.
What If I Just Ignore EU VAT
If you, as a business, do not collect VAT from your EU customers, you’re practically assisting the customer in evading tax payments that she should have paid and you’re thereby withholding tax from tax administrations in the EU. They don’t like that at all. Since VAT a major source of income for them, prosecution can result in heavy penalties regardless whether your startup is based inside or outside the EU.
Your non-compliance could be picked up whenever one of your EU customers tries to reclaim VAT from their tax administration or sends in tax returns that involve a transaction with your startup.
When you break the rules accidentally or just because you didn’t know, tax authorities normally estimate how much tax you have due and charge you. In some countries you’ll also have to pay overdue interest. If you break the rules intentionally, that’s a tax crime and a court case. However, each member state in the EU enforces their laws their own way.
Before you panic, I have good news for you. A number of SaaS are working very hard to help you deal with VAT or even handle VAT entirely for you. I’ll get to them further below.
Who Needs to Comply with EU VAT
The short answer is: every single business in the world that sells digital products in an automated manner. There are allowances and thresholds if your business is based in the EU.
EU Businesses
In January 2019, a new threshold to ease the regulatory tax burden of micro-businesses and SMEs came into effect:
- If your annual turnover for digital products sold in the EU is below 10,000 EUR, you can charge the VAT rate of your home country.
- Once you pass the 10,000 EUR threshold, you must charge the VAT rate of your customer’s country.
Furthermore, you may neither need to register for VAT nor charge VAT if the member state you’re in offers thresholds. It would be better to consult your trusted tax advisor to discuss your individual case.
Non-EU Businesses
The rules for businesses outside the EU are much easier: There are no thresholds at all. You have to register for VAT within 10 days of the first sale of your digital product or subscription to an EU customer.
You register with the tax administration of the EU member state where your customer resides. Wait, what? There are 28 countries in the EU (27 after Brexit, but that doesn’t help) and if you have customers across the EU, this quickly becomes a bureaucratic nightmare.
That’s where VAT MOSS enters the picture. Since 2015, a so-called ‘Mini One Stop Shop’ (MOSS) scheme lets suppliers submit quarterly VAT returns to a single tax administration of their choice and that tax administration will do the distribution of funds to each EU member state. EU-based businesses simply activate their existing VAT number for VAT MOSS. Non-EU businesses will likely register for VAT MOSS with the UK or Ireland due to the language. Since Brexit, the safer option is Ireland.
How to Charge VAT and How Much
Here’s where discussions within your team should start. Once you know that you can’t escape the rules, you need to strategize how you want to implement them in your checkout process while keeping the UI/UX experience seamless for your customer.
Note that EU customers are already accustomed to being charged a VAT, although prices there are generally inclusive of VAT.
Many online businesses, however, simply add the VAT on top of their base price in order not to lose out on profits. It’s up to you, really, how you want to structure your pricing. Bottom line is that your prices are transparent for your customer and that the taxman gets his fair share.
Use a Merchant of Record (MOR)
Micro-businesses and one-man-shows that are just starting out and don’t even know whether they’ll make a buck should simply sign up with a merchant of record (MOR) and be done with it.
MORs help you brush off VAT handling entirely. Example MORs are Paddle and Gumroad. If you’re selling an e-book or an online course, Gumroad gives you a beautiful widget to embed on your website for instant purchases. I especially like that you can upload multiple files for a single product, allowing you to sell multi-part PDF courses, for example.
Paddle is the more suitable candidate if you’re offering a subscription with charges on a regular interval. I’ve heard that their customer support is terrible to non-existent, but hey, we should shape our own opinions. Both process the transaction with your customer and are contractually their trading partner. You’ll be paid out after all VAT obligations have been taken care of.
Use a Payment Processor With a 3rd Party API
Once your startup is a little bigger, Stripe is practically the status quo when it comes to online transactions and processing payments. It’s super flexible, and the latest API updates carry a number of improvements for taxes. You can add customer tax identification numbers to their profile and manage tax rates.
The drawback is that you have to know what you’re doing because international tax rules are not natively implemented (although being agnostic is also the very advantage of Stripe). Below chart in conjunction with the European Commission’s VAT rates lookup is a rough start.
It’s vastly inefficient if every business were to implement the same rules over and over, and keep them updated with regulatory changes.
I’ve come to enjoy using a 3rd party API for determining tax treatments during pre-checkout. Vatstack is an affordable add-on to use before a charge goes through. You can use their Quotes API to perform VAT calculations and it will automatically come up with the right amount to charge based on your price and the locations between you as the merchant and your customer. It also computes VAT-inclusive or VAT-exclusive prices. I can now use that information to charge the correct amount on Stripe.
I discourage you from using PayPal as they’ve remained utterly ignorant when it comes to accounting for VAT.
When Not to Charge VAT
Alright. The last part is about the exceptions. Business customers are exempt from VAT. Here’s the thing: How do you know if a customer is in fact a registered business? The answer is that you have to validate their VAT number in real-time, before the transaction occurs. You can do that with the respective government services that your customer is residing in.
In the EU, you can check VAT numbers with VIES, the VAT Information Exchange System. It’s a downright cumbersome SOAP API on quasi-WSDL definitions. I’m also using Vatstack’s Validations API for that purpose as it’s working with a much easier JSON format on REST and I combine it with the price quotations mentioned above. A unique reference ID is stored for me, an official proof that I validated a customer’s VAT number with the government.
If the number is valid, the API will reduce the VAT to zero for that sale. Take note that stating the validated VAT number on a customer invoice is now becoming mandatory as of January 2020, and you have to file an European Commission Sales List (ESL) for all transactions with your EU business customers.
Conclusion
I hope this tutorial has helped you get an overview over the complexities of handling VAT. But I also hope that I could point out a few really fantastic tools that simplify the life of a young startup and that it was able to save you a ton of time and compliance nuisances.
Please share other tools with me that you’ve come across and I’d be happy to include them in this article.
