Accountancy is not very exciting in general. If you arranged all the subjects within the topic of accountancy in order of excitingness, VAT would not be at the more thrilling end of the scale. This will remain the case until the end of the month, when on January 1st 2015 the European Union will introduce some changes to perk up VAT and make it much more exciting! Yay!
So, what is VAT anyway and who has to care about it? Well, VAT is short for Value Added Tax, from a consumer standpoint this name makes no sense, it just looks like a tax on the sale price, what is the “value added” bit all about? Well it starts to make a bit of sense when you think about a VAT registered business that buys things, does something to them and sells them again for more than they paid in the first place.
The VAT the business pays for the goods is “input tax” and they can claim that back from HMRC. If a business buys a widget for £12, then HMRC owes the business £2 for the VAT they paid out. The business will then typically do something to the product, which might be a manufacturing process using it in a component of a bigger product, or it might be splitting a big pack into little packs, or simply putting the product in a shop. Whatever the in between bit is, lets say this product ends up being sold on for £15+VAT. Someone walks into the shop and pays £18 and walks out with their widget. Now the business just collected £3 in VAT from the consumer, so the business owes HMRC £3, and they can offset the £2 that HMRC owe them. The net result is the business owes HMRC £1, which is a 20% tax on the £5 improvement or “value added” to the product as it passed from input to output. The chain from raw materials to consumer can be quite complicated, and HMRC collects 20% of the value added from each business in the chain, ultimately this is paid by the consumer in the purchase price, but it is shared back along the supply chain in proportion to the amount of improvement each element of the chain made to the product in terms of it’s price. You might wonder how this applies to digital goods, where there are no clear raw materials or an obvious supply chain but as VAT looks at your total inputs and total outputs, it does kind of work. If you buy a computer and a desk and a chair, these are allowable expenses for your ebook business, they are the raw materials. They each have a supply chain behind them, so the VAT you pay to HMRC is the amount you collect on the ebooks, less the amount of VAT you paid on the computer/desk/chair. You pay to HMRC a proportion of the value you added to the equipment by sitting at it and writing an ebook.
It is quite a clever system and only really gets complicated when you have international trades involved. If that happens when you are buying stuff as a business you have to do a “reverse charge supply” this means you pay the tax on things you buy at UK VAT rates to HMRC (instead of the supplier paying them out of the gross price), and then claim it straight back again as input tax. It is a paper transaction, no money changes hands, just some boxes to fill in for the VAT return. It is just like buying goods from a UK supplier except the VAT portion doesn’t get paid to the supplier, it gets paid to HMRC. If you are selling to a business overseas you sell it and don’t put VAT on it. They then have to do the reverse charge thing and pay their local VAT to their local VAT office and claim it back as input tax. The UK business then needs to fill in an EC Sales list with the VAT numbers of the customers so that it can be audited and someone can check that the customers are in fact paying and reclaiming the VAT.
Now, this is all fine, bit odd perhaps, but it works. A UK business can sell stuff with 20% VAT and pay that over to HMRC, this is always a safe thing to do. They don’t need to know who the customer is, or where they are, it is always safe to sell for one price including the VAT and hand over the collected VAT to HMRC. If the customer happens to be in Europe that is fine. If they are a business in Europe then they are paying 20% too much, and that is still fine. Slightly too much VAT is collected and nobody cares. Perhaps if a Europe VAT registered business wants to not pay UK VAT in addition to their local VAT then they can arrange to get a zero VAT invoice for the goods, but if they don’t do that, they can pay the VAT inclusive price and nothing bad happens.
“Nothing bad happens” is what we want in business. From January 1st, this position evaporates. Bad things can happen. Really bad things. There are very few ways to avoid bad things happening. The change is small, the consequences drastic. They are changing the place of supply. This means that instead of charging VAT according to where the seller is, VAT is charged according to where the purchaser is. Simples!
This tiny little change has ramifications and unintended side-effects. What they wanted was to stop multi-nationals like Amazon and Google from incorporating in Luxembourg as a flag of convenience and selling around Europe from there at the lower Luxembourg VAT rate. Nice for the Luxembourg exchequer, but really a bit unfair to everyone else. These companies manage to undercut domestic UK businesses and all the VAT paid by the UK consumer was whisked out of our economy. This change of the place of supply means that the UK taxpayer is better off, tax on stuff we buy here stays here. The huge companies have to stop hiding in Luxembourg and register in the places they actually trade and pay their taxes.
Trading with the EU is completely optional, see https://www.gov.uk/trading-in-the-eu the founding point of the EU is to make it easier to trade across the borders you decide to trade across. The internet makes it easier to trade without caring where the borders are, which goes somewhat further. This move brings things back to a requirement to have a deliberate intention of operating in a market, and then it is as easy as the EU designed it to be, but not as easy as the internet makes it. Accidental trades across borders could now shut your business down, you could get penalties from 27 separate VAT regimes.
There are in fact 75 potentially different VAT rates across the EU. Different countries have different rates for various classifications of items. (Jaffa cakes are not biscuits in the UK, for example, but they might be different elsewhere). You now need to care about all of this. Did you know about the VAT rate on ebooks in Italy? Are you preparing to change your store for the Polish VAT cut in 2016? No? Do you want to have to care about that?
In this new world order with the changing place of supply companies are supposed to capture two bits of non conflicting evidence to suggest where a customer is located, and then charge the relevant VAT. This means you need to know what the relevant VAT would be, and you need to know where the customer is prior to the payment happening. If you were hoping that you would use the paypal billing country you get after payment then you are kinda late, you have charged them the wrong price. It is a big problem and other people have written about how big a problem it is in more detail than I want to. EU VAT Action has a great list of articles expanding on the problem.
Don’t bring me problems, bring me solutions!
So yes, that is a big old mess, lots of people are very worried about the implications and practicalities of finding out where your customers are and accounting for the VAT, but is there a simple solution? Well yes, there is, and it is perhaps a bit surprising.
I propose we introduce, very soon, a new special rate of VAT. The Default EU VAT. This would be set at 30% for all member states, and would be legal (but optional) to collect on all transactions and remit to a VATMOSS. This VAT fund would then be distributed to all the member states in proportion to population (or GDP or whatever other distribution methodology they negotiate). Businesses can safely list prices and sell goods to anyone including this rate of VAT, but if a customer wants to get a lower price then the customer can provide two bits of evidence to support their claim to be in a particular member state, they will then be shown the prices including their local VAT rate and can buy things for less money. This way we retain the freedom of anonymous trades, but customers have a financial incentive to give up some of that anonymity for lower prices and a more accurate allocation of tax. Nobody need ever pay this 30% rate, it’s sole purpose is to remove the risk of collecting too little VAT when the place of supply hasn’t been established. It also means that completely anonymous trading is legal (but a bit more expensive). I belive this is a proposal that all 28 countries could agree on very quickly. Thresholds simply are not going to happen, but this could be politically agreed and implemented across Europe without delay.
Why 30%? Well it is higher than any standard VAT rate, and it is exactly double the EU statutory minimum standard VAT rate of 15% that all countries have to comply with. Setting it at double the 15% means it will automatically change if the minimum statutory rate changes.
Shouldn’t HMRC/UK Government do something?
Well they have been trying. The thing is they can’t just unilaterally fix this for us. People have been saying that HMRC should allow a de minimis threshold on it, like the £81k threshold for UK VAT. The problem that many people don’t seem to grasp is that HMRC can’t give us a threshold or exemption on German or French or any other member state’s VAT. It isn’t for HMRC to do that. Like my other proposal, this one may come as a surprise.
I propose that HMRC go on an enforcement rampage. Go out, have fun, make sure everyone complies to the letter and send as many penalty notices as possible. Just not to UK companies . . . HMRC should make sure that anyone selling a knitting pattern or a recipe pdf or a wordpress extension module anywhere in Europe that might be purchased by someone in the UK is correctly registered with their local VATMOSS and is accounting for the VAT. All of the rest of the EU owes our exchequer VAT money for the digital services stuff we buy from them. This mess won’t get fixed if the rest of Europe ignores the problem and the law abiding UK businesses close.