The sales tax structure that we are familiar with is fairly unique to the U.S.
Most of the developed countries in the world have consumption taxes, but they are structured a bit differently than the U.S. sales tax system. To the end-consumer of the products or services consumed, the difference in the systems is not that obvious; items are purchased and a tax is added to the sales price and the total is collected from the customer. Beyond that similarity, there is not a lot in common between the U.S. sales tax system and the value added tax (VAT) system used by most European countries. This post will give you an overview of what you need to know about European VAT.
European VAT 101
VAT is generally a broad based tax on goods and services that are consumed in a particular European country. There are 28 EU member states and over 75 different VAT rates!
Unlike the U.S. sales tax system, the VAT system is a multi-stage tax that is imposed at every step of the supply chain. The VAT is due in the country of consumption regardless of the country of the seller. That makes imports from the U.S. subject to VAT when consumed in Europe. Like the U.S. sales tax, the VAT rules are complex and can become very tedious when applied to specific transactions and cross-border transactions. For this blog entry, I will keep the discussion at a high level.
In most cases, VAT is due on the receipts paid for the “output” of a good or service. VAT ranges from 15% to 25% so it can be a significant element of the transactions costs. Any VAT paid by the seller on the supplies or services consumed in producing the product sold, is used as a credit against the tax that has been collected. That is, the tax paid to the government is based only on the value added by the seller at his stage of the supply chain. The process of claiming credits of VAT paid on inputs (“input credit” becomes challenging when cross border transactions are involved. In addition, the invoice must clearly show that VAT charged so that a credit can be claimed.
For 2015, significant VAT changes were implemented for seller of digital property and services. The current rules require that VAT be charged based on the location of the consumer and not the location of the selling business.
Nexus and VAT
Before a company can be held responsible for registering for VAT, the seller must have a “permanent establishment” (“PE”) in the country where the customer is located. PE is defined as:
“any establishment, other than the place of establishment of a business (the place where the functions of the business’s central administration are carried out), characterized by a sufficient degree of permanence and a suitable structure in terms of human and technical resources to enable it to receive and use the services supplied to it for its own needs and to provide the services which it supplies…”
This is more specific than the definition of “nexus” required for U.S. sales tax. As such, a U.S. company will not need to register for VAT unless it directly or indirectly has a PE in a European country. If a PE does not exist, the VAT will normally be collected from customers as part of the customs and duty process as property enters the country. As with sales tax, there are several automated solutions to collect and remit the VAT that is due in a particular country should your company establish a PE in another country.