European value added tax system
What is VAT
As you know, value added tax or VAT (Value Added Tax, VAT) refers to indirect taxes that are included in the price of goods and services and are levied on end consumers.
Until 1967, two systems of consumption taxation were applied in European countries, namely:
- sales tax;
- value added tax.
A turnover tax or sales tax is levied at each stage of the process of supplying goods and services before reaching the final consumers. This approach leads to a significant increase in the cost of goods and services, since, in fact, taxation becomes cascading, in which the largest tax burden falls on the shoulders of end consumers.
At the same time, VAT levies exclusively on value added, that is, the difference between the sale price and the purchase price at each stage of the process of production and supply of goods or services.
The use of two different systems created many inconveniences and obstacles in trade between the countries of Western Europe.
In 1967, the general principles for the application of value added tax in the countries of the European space were laid down. They were aimed at:
- minimizing the risks of distorting competition between states;
- avoidance of circumstances hindering the free movement of goods within European countries;
- creation of a single market within the community.
An evolutionary path of intermediate directives has been passed and, as a result, in 2006 Directive 2006/112/EC was adopted. It establishes uniform principles and procedure for the taxation of value added for the entire European Community, and also regulates the territorial aspects of the application of this tax.
Territory of application of Directive 2006/112/EC
A common misconception is that if a country is part of the EU, it automatically falls under Directive 2006/112/EC. In fact, there are a number of geographical aspects to be considered for the application of this directive, which will be discussed below.
So, the provisions of the directive define the following important concepts.
- “Community” and “community territory” means the territory of the 28 countries of the European Union, which are part of the customs territory and the territory of application of the VAT Directive.
- “Third Territories” are not territories subject to the VAT Directive. This category of countries is divided into two subcategories: a) territories of the EU states that are part of the customs territory of the EU, but do not apply the VAT directive; b) the territories of the EU states that are not included in the customs territory and are not subject to the VAT directive.
- “Third countries” are not included in the list of EU states.
- “Non-third countries” are not part of the European Community, but are part of the customs territory of the EU and apply VAT according to the laws of neighboring countries. This category of countries is included in a separate paragraph. For example, the Principality of Monaco, for the purposes of applying Directive 2006/112/EC, applies French law.
We note an interesting fact. Switzerland is located in the very center of Europe, but is neither part of the Customs Union nor a member of the European Union. Accordingly, when moving goods between EU Member States and Switzerland, such operations will be treated as imports or exports of goods between the EU and a third country.
So, the territorial boundaries of the application of the European VAT have been determined. Let’s figure out who still pays VAT in the EU.
The tax burden for VAT falls on the shoulders of the end buyers or consumers, but the responsibility for its administration and payment rests with the sellers of goods and services. According to the directive, individuals and legal entities engaged in independent economic activity are taxed regardless of the purpose and results of this activity. The use of tangible or intangible assets for the purpose of generating income on a long-term basis may also be recognized as an economic activity.
For example, if individuals provide taxi services in their free time and use personal vehicles to transport passengers in order to earn money, then upon reaching a certain threshold amount of income, they are required to register as VAT payers and receive a VAT number. The income threshold is determined according to the domestic law of their country.
As a general rule, the responsibility for the administration and payment of VAT rests with the supplier of the goods or services. But situations are possible when the responsibility for transferring the tax to the state lies with the buyer. This mechanism is called “Reverse Charge”.
For example, Company A in France provides consulting services to Company B in the UK. Both the buyer and the seller are VAT payers. According to the directive, the place of supply of such services will be considered the country of registration of the recipient of the services. Accordingly, the English company is obliged to report on this operation at the rate of its country using the Reverse Charge mechanism. We will consider the features of using Reverse Charge separately.
Registering as a VAT payer is required for counterparties whose turnover for 12 months of economic activity exceeds the threshold value established by law. Each country independently sets the size of the threshold value and the time required for registration as a VAT payer. Separate thresholds may be provided for distance sales when purchasing goods and services between EU countries.
The counterparty has the right to obtain a VAT number without waiting for the threshold value to be exceeded, and to carry out voluntary registration.
The next block of questions related to the European VAT system will be devoted to taxable transactions that fall under Directive 2006/12 / EC, and such an important concept as the “place of delivery”.
In the European VAT system, taxable transactions are:
- goods supply;
- purchasing goods or services within the community;
- supply of services;
- import of goods.
Let’s take a closer look at each of the operations.
VAT on delivery of goods
The concept of “delivery of goods” arises when considering transactions related to tangible property, in which there is a transfer of ownership of this property from one counterparty to another, as well as transactions that are equated to the supply of goods.
- Transfer of goods on the basis of a financial lease agreement or a contract for the sale of goods, including on a deferred payment basis.
- The transfer of goods under a commission agreement, when the commission agent acts on his own behalf and is part of the supply chain of these goods.
- The use of property for personal purposes, and the property was acquired for business purposes and for which some or all of the tax credit was recognized.
- The supply of heat, electricity and natural gas through distribution systems is also treated as a supply of goods.
Delivery of goods is a broad concept. Operations for the supply of goods may be considered differently by the internal legislation of the EU countries, so we will dwell on the general aspects.
As a general rule, operations for the supply of goods are subject to VAT at the place of delivery, but the determination of the place of delivery depends on a number of additional conditions and factors.
- If there is a transportation or forwarding of goods, and it does not matter who carries out the transportation or forwarding, the buyer, supplier or a third party, the place of delivery of such goods is considered to be the location of the goods at the time the transportation or forwarding began.
- If transportation or movement of goods is not provided, then the place of delivery is considered to be the place of their location at the time of delivery.
- If the supplier needs to carry out installation or assembly, then the place of delivery will be considered the place of work. If the assembly or installation is carried out by the buyer himself, then the place of delivery will be considered the territory of the supplier.
Purchasing goods within the community
Operations for the supply of goods between EU countries are usually called “acquisition”. This division is necessary for separate accounting of trade operations between EU countries if there are no customs borders between countries.
The place of purchase of goods within the community is considered to be the place where the dispatch or transportation of goods to the buyer is completed.
Consider the following situation. A seller in country A delivers goods to a buyer in country B. At the same time, this product is transported to the buyer’s warehouse, which is located in country “C”. In the future, this product can be used for sales to end consumers in country C. In such a situation, the place of delivery of this product will be the territory of country “C”, since the transportation is completed there. The buyer must register for VAT in country C, calculate it and display a deduction for the same amount in the reporting. There is no actual payment of VAT.
In order to justify the application of a zero rate for intra-community trade transactions, proof of the export of goods from the country must be provided. As a rule, the goods must leave the territory of the country within 90 days from the date of sale. If during this period the seller cannot confirm the fact of receipt of goods by the buyer, then he will have to accrue and pay VAT at the rate of his country.
A common situation in intra-community purchases is when a buyer in country B purchases goods in country A and sells them to country C. At the same time, goods are moved from country “A” to country “C”. This operation is called triangulation.
The following mandatory conditions are defined for counterparties:
- all transactions take place within the EU;
- the presence of three counterparties registered as VAT payers in three different countries;
- goods are transported exclusively from country “A” to country “C”;
- the purchased goods are used for resale.
In international practice, for the convenience of VAT reporting, this transaction is formalized using a simplified procedure. At the same time, VAT is not included in the price of goods at all stages of the supply chain, and the intermediary in country B indicates in the reporting that this is a triangulation transaction.
The principle of triangulation and the features of its application will be discussed in detail in a separate block of articles on European VAT.
Import and export of goods to the EU
Import of goods into the territory of the EU countries occurs by analogy with other countries. The EU border crossing country is considered the place of delivery and import VAT must be paid there. If the goods were previously in one of the customs regimes, such as a customs warehouse, a free trade zone, temporary import or external transit, then the country in which they exit these regimes will be recognized as the place of delivery.
The amount with which VAT must be paid includes the customs value of the goods, duties and taxes other than VAT itself. Also, the taxable amount may include the cost of commissions, packaging, insurance and transportation to the destination in the importing country. Discounts and discounts provided by the supplier to the buyer do not affect the taxable base.
The amount of import tax is deductible if the importer is a VAT payer. If the importer is not a VAT payer, the import tax still has to be paid. At the same time, such a payer does not have the right to a tax credit, and the amount of VAT paid will be included in the price of goods during their further sale.
Import VAT is not paid in the following transactions:
- import of goods not subject to VAT in the importing country;
- supply of personal consumption goods, the import of which is not of a commercial nature, and their features and list are regulated by directives 69/169/EEC, 83/181/EEC, 2006/79/EC;
- supply of goods in the re-import mode;
- import of goods in accordance with diplomatic and consular agreements, as well as goods exempt from payment of import duties;
- import of goods by international institutions within the limits set for such institutions.
The list of goods exempt from taxation is determined by the internal legislation of each country. The directive dictates the general principles for the application of VAT in the EU. The responsibility for translating these principles into domestic legislation and developing the rules necessary for their implementation rests with the EU states.
If a zero VAT rate is applied when exporting goods, then the counterparty is entitled to a refund or tax deduction. Documents confirming the application of the zero rate are issued when crossing the border at the checkpoints on the territory of the European Community, they must be kept.
The last block of information concerning taxable transactions and determination of the place of supply is devoted to services. Given the intangible nature of services, in certain cases it is difficult to determine where VAT should still be paid and who is responsible for its administration.
When supplying services, basic and special rules apply to determine the place of supply of taxable transactions. It is also very important whether the recipient of services is a VAT payer or not.
Let’s look at the basic rules.
If the services are provided to a VAT payer, then the service is taxed according to the destination principle. Accordingly, the place of supply of these services will be the place of registration of the buyer’s business. By appointment, B2B services are taxed.
If the services are provided to a non-payer of VAT, then the service is taxed according to the principle of origin or Origin principle. That is, the place of supply of services will be considered the place of registration of the supplier’s business. Based on the principle of origin, B2C services are taxed.
Consider the following situation. A company in country “A” provides office cleaning services to a company in country “B”, which is a VAT payer in its country. The place of supply of the service in this example will be country “B”. Accordingly, a company in country “A” will issue an invoice without VAT, and a company in country “B” will reflect VAT at the rate of its country through the Reverse Charge mechanism.
If office cleaning services are provided to an individual in country B, then the company in country A will invoice VAT included and report it in their country.
The following special categories of services are subject to special provisions of the directive when determining the place of supply of services.
- Services related to real estate, including the services of brokers, agents, appraisers, architects and construction control and supervision firms, are subject to VAT at the location of the real estate. Example. A real estate agency registered in country A brokers an office sale for a company registered in country B. The office is located in country “C”. Accordingly, country “C” will be considered the place of supply of such services. Company “A” needs to obtain a VAT number in country “C” and pay VAT.
- Passenger transportation both B2B and B2C are subject to VAT in proportion to the distance traveled through the territory of each of the EU countries. Example. The passenger makes a bus trip from Ukraine to the countries of the European Union. European VAT will be charged in proportion to the distance traveled on the roads of each of the countries, except for Ukraine, since Ukraine is not a member of the EU.
- Intra-community transport services are subject to VAT where the transport begins. Example. The French carrier delivers goods from the UK to Germany. Accordingly, you need to report VAT for transport services in the UK.
- Cultural, artistic, sports, scientific, educational, entertainment activities, services related to movable property, such as unloading, loading or transfer services, as well as services related to the valuation of movable property, are subject to VAT at the place of their provision. Example. A company from Latvia is organizing an exhibition in Portugal. Exhibitors will be representatives from Spain and Italy. Accordingly, the invoice for payment of the cost of participation will be issued taking into account the Portuguese VAT. A company from Latvia must obtain a VAT number in Portugal and report on the operation in the country where the event takes place.
When providing the following services, the place of delivery is the place of registration of their buyer for contractors outside the EU or for VAT payers in an EU country other than the country of the supplier:
- transfer and assignment of copyrights, patents, licenses, trademarks and similar rights;
- provision of advertising and consulting services;
- banking, financial and insurance transactions, including reinsurance, except for the lease of safes;
- provision of personnel;
- lease of movable property, except for vehicles;
- providing access, transportation or transmission through gas distribution systems and electricity distribution systems.
At the same time, non-EU residents do not have to be VAT payers, but are required to provide documents confirming their status as a business entity. Otherwise, the services provided will be regarded as provided to the end user and VAT will be included in the cost of services.
Separately, it is worth dwelling on the Reverse Charge procedure.
Reverse Charge is a mechanism for accounting for VAT on transactions for the supply of services when the place of supply of such services is the country of the recipient.
To apply this mechanism between counterparties, the following conditions must be met:
- counterparties must be from different countries;
- the place of supply of services coincides with the place of registration of the recipient of services in a state that is part of the EU;
- the recipient of the services must be a VAT payer.
If these conditions are met, the service provider issues an invoice without VAT, and the obligation to report on it passes to the recipient of the service. The recipient charges VAT on the amount of the service at the rate of his country and immediately indicates it for a tax deduction. There is no actual payment of tax, the transaction is reflected only in VAT reporting.
A company from Ukraine provides consulting services to a company from the UK. The English company is a VAT payer, the place of delivery is the territory of the EU. Using the Reverse Charge mechanism, an English company calculates VAT at its own rate, puts the amount to a tax deduction and reflects the transaction only in accounting.
Since January 1, 2015, the rule for recognizing the place of supply of services to end consumers has changed for the following types of services:
- telecommunication services;
- television and radio broadcasting services;
- services delivered electronically.
A feature of the provision of such services is the transition to the principle “at the place of destination”, that is, the place of delivery of such services is the location of the recipient of the services. To simplify VAT administration and reporting, the service provider is not required to obtain a VAT number in each country, but is entitled to register and account for VAT at the rate of only one country from among those to which he supplies his services. This mode is called MOSS (Mini-one-stop-shop).
For service providers whose business is established outside the EU, but who provide services within the EU, the option to choose the country of incorporation as a VAT payer will only take effect on January 1, 2019. Until that time, a non-EU resident is required to obtain a VAT number in each of the countries where he sells.
The directive has been amended by implementing a standard definition of services provided electronically. Electronic services are provided for a fee and are based on the following criteria:
- the service is different from the physical delivery of the goods;
- based on information technology;
- provided electronically, via the Internet, copper or fiber optic cable, as well as via radio or satellite;
- delivery is fully automated, human intervention is kept to a minimum.
Electronic services (e-services) are divided into 5 categories.
1. Supply of video, music, games, lotteries and other games of chance.
- Download movies or streams on PCs, laptops and phones.
- Online or download games, including for remote players.
- Supply of music, films, rates, their broadcast.
- Melodies, ringtones, musical compositions.
2. Website Services.
- Self-help website services.
- Automatic maintenance and support of sites.
- Site hosting.
- Internet providers.
- Online data storage and memory services.
- Ad blockers.
3. Software Services.
- Software services delivered over the Internet, such as Software as a Service (SaaS) by downloading through cloud services.
- Downloads of drivers for printers and other peripheral devices.
- Firewalls and other filters for computers.
- Download of anti-virus software.
- Accounting and anti-virus packages.
4. Delivery of distance learning.
- Automated distance learning.
- Automated training programs over the Internet.
- Textbooks prepared by students on the Internet.
5. Providing text, images and databases.
- Design component downloads, etc.
- E-books such as Amazon Kindle.
- Advertising banners on the Internet.
- Subscribe to online blogs, magazines or newspapers.
- Membership fees to online clubs, magazines or dating sites.
- Internet platforms for goods and services, announcements.
- Images, screensavers and photos uploaded using your phone or PC.
- Downloads of reports, financial-analytical, market data and manuals.
- Data processing and settlements via the Internet or other electronic networks.
The European Commission has also provided some guidance on what is not an e-service. Significantly, the use of email to deliver a service does not automatically qualify the service as electronic.
The following services are not e-services for the new MOSS mode:
- services provided to businesses registered as VAT payers in the EU;
- physical goods ordered online or via email;
- DVD, CD-ROM, CDs, memory cards;
- professional advice provided by e-mail or on the Internet;
- designing covers or content for e-books, brochures and other literature;
- “live” training via the Internet;
- autonomous data services;
- tickets for “live” cultural events, theatrical performances, performances, shows purchased via the Internet.
The EU Directive defines the rules for applying value added tax rates.
EU member states can independently determine the standard VAT rate in their territories, but, according to the directive, it cannot be less than 15%. Reduced rates apply to the following categories of goods and services defined in the appendices to the directive:
- foodstuffs for people and animals;
- water supply;
- medical equipment and pharmaceuticals;
- passenger transportation services.
The reduced rates may only apply to the categories of goods and services covered by this directive. Their list and characteristics are established by the state within its jurisdiction. The reduced rate cannot be less than 5%.
Standard VAT rates in the EU states are shown in the table.
Standard VAT rate, %
This article provides a general overview of the European system of value added taxation. When structuring a business and international tax planning, it is necessary to take into account the amount of VAT in a particular country, as well as the specifics of applying the VAT directive in a particular case.
Features and important aspects of the application of the VAT Directive will be discussed in the following materials on the European VAT system.