VAT basics for software vendors

The dreaded VAT. Ugh. Value Added Tax (VAT) is the European equivalent of sales tax and it is a Royal Pain In The Arse. However, if you are running a business that makes sales in Europe you need to understand VAT. In particular it has important implications for your choice of payment processor, even if you are based outside the EU or below VAT registration thresholds. I have put together a few pointers here in the hope that it will help someone grappling with the complexities of VAT. But please note:

  • I am not an accountant. If you need proper advice, talk to a proper accountant.
  • The VAT rules are complex and may be interpreted differently by different people.
  • The rules may be different in different countries.
  • The rules change over time.

Only VAT registered businesses have to charge VAT. You have to register for VAT once your sales reach a certain threshold. At the time of writing,  UK-based businesses have to register for VAT if their EU sales exceed £77k in a 12 month period (technically it is UK sales, but the ‘place of supply’ for EU consumers is classified as the country of the seller). You can also choose to register for VAT before you reach the threshold. But it usually isn’t worth it, unless perhaps you think having a VAT number is essential for your credibility. Personally I waited until I couldn’t avoid it any longer.

Even if your business is not based in the EU, the EU still expect you to pay VAT on any sales inside the EU once you reach a threshold. This is controversial and it isn’t clear to me exactly what the EU can do to enforce this if you are based outside the EU. Talk to your accountant.

The VAT rate varies between countries. At the time of writing it is 20% in the UK and 19% in the Netherlands. It also varies over time, it used to be 17.5% in the UK.

The UK also has a simplified flat rate VAT scheme with a lower VAT rate. But you can’t claim back VAT on purchases. Worse still, it appears that you will effectively be paying VAT on sales outside the EU. So that doesn’t seem at all attractive.

The VAT rules are complex and depend on:

  • where you are based
  • where your customer is based
  • whether your customer is a business or a consumer
  • whether you are selling goods or services

Technically you do not have to charge VAT to an EU business, even if they aren’t registered for VAT. Apparently they are then responsible for “self-charging” the VAT. However the burden of proof is on you to show that the customer is a business. So most vendors require a VAT number as proof of business status.

There also seem to be disagreements over whether software is goods or services. What if you ship a CD?

Here is a simplified summary in pseudo-code of whether a seller needs to charge VAT on software as I understand it:

paysVAT()
{
    if ( seller registered for VAT)
        if ( customer in EU )
            if ( customer is a business )
                if ( customer in same country as you )
                    return TRUE;
                else
                    return FALSE;
            else
                return TRUE;
        else
            return FALSE;
    else
        return FALSE;
}

Except that people in Norway and Switzerland (which aren’t in the EU) pay VAT in some circumstances. Don’t ask me why. Also you don’t pay VAT on some items, e.g. postage. And outside the scope of VAT (O), not rated for VAT (N) and zero rated for VAT (Z) are all different VAT codes meaning no VAT is payable. As I said, it’s complicated. Not complicated and interesting like quantum mechanics or the love lives of celebrities. Just complicated.

The only upside of being registered for VAT is that you can claim back the VAT you pay on any purchases you have made (make sure you get a VAT receipt). Or, if you are buying from another EU country, you can tell them your VAT ID and they shouldn’t charge VAT (see above). So any equipment you buy in the EU is now 20% cheaper. This is small recompense for the giving 20% of your sales in the EU to the VAT man. Try not to think about that. Instead give yourself a pat on the back for having reached the VAT threshold. A lot of businesses never do.

Note that when you register for VAT you may be able to claim back the VAT of products purchased before you registered. When I registered I could claim back VAT paid on goods purchased within the last 3 years and services purchases within the last 6 months. So keep your VAT receipts.

Congratulations on making it this far. Here is the important bit. How you process payments has important implications for VAT. When someone pays you via a payment processor, such as PayPal, legally they are buying from you and the payment processor is just handling the payment on your behalf (like a bank cashing a cheque). So you are responsible for collecting what VAT is due and paying it to the appropriate government. This can be a major headache if you are selling hundreds or thousands of licences per month.

When you use a reseller, such as Avangate or Fastspring, legally you are selling your licence to the reseller and the reseller is then reselling it to the customer. The reseller is then responsible for deciding what VAT is due, collecting the VAT and doing the paperwork. They then pay you net of the VAT and their commission. Leaving you to sort out the VAT for their one payment to you per month.

Using a reseller is a big win if you are registered for VAT. I am registered for VAT and use Avangate as my payment processor. They do the heavy lifting in terms of calculating, collecting and paying the VAT on my sales. But if you aren’t registered for VAT be wary of using a VAT registered reseller – approximately 20% of your sales will be disappearing in VAT (which the VAT registered reseller has to charge) which you could be keeping if the customer bought from you direct. So if you aren’t registered for VAT, a reseller such as Avangate or Fastspring may not be the best solution for you. Check out e-junkie.

VAT admin is fairly straightforward. To keep the VAT man happy I have to file:

  • an EC sales list every month
  • a VAT return every quarter

My Quickbooks accounting package generates the numbers for these. It only takes a few minutes to file reports online once all the transactions and VAT codes are entered correctly into QuickBooks. The VAT man then debits (or credits) the appropriate amount from my business account each quarter. It is not too bad, as long as I don’t think about the wheelbarrow loads of cash Avangate keeps to pay the VAT man. Maybe they roll around naked in it on the last day of every quarter. I probably would.

When I first registered for VAT I tried adding the VAT onto my existing prices. But I found that sales dropped more than 20%. So I ended up keeping the gross price (including VAT) the same, whether the customer pays VAT or not (Avangate gives you this option). Whatever you do, make sure it is clear whether any prices you quote include VAT. EU consumer expect to be quoted prices inclusive of VAT and won’t appreciate it if you try to sneak on an extra 20% at the end of the purchase process. You may be legally required to quote the price including VAT in some countries.

A final note of warning. The VAT man has a lot of powers. I understand the UK VAT man can kick your door in and seize your equipment without needing even a warrant. He might not be impressed to find out that the computer you reclaimed the VAT for is an XBox. Do not mess with the VAT man.

If I have made any mistakes, missed anything out or if the rules are substantially different in your country, please add a comment.

Thanks to Marcus Tettmar of Macro Scheduler automation software for checking this through and advising me on some of the finer points.

11 thoughts on “VAT basics for software vendors

  1. Giles Farrow (@SmartSoftMarket)

    I’m not an accountant, but my understanding of the VAT flat rate scheme is different.

    I believe you exclude anything where VAT = 0 such as EU.
    And if your overheads are low you are better off, especially in the first year when you get an extra 1% off the rate.

    So you can charge customers VAT @ 20% which they may be able to claim back. And you only pay HMRC 15%

    As you say it’s complicated.

    But worth looking into flat rate if you are selling B2B software

  2. Undisclosed

    Please check:

    1. Vat is finally payed by CONSUMERS (buyers). As a supplier you don’t pay VAT, you charge and collect it: it is ADDED to your product price. If you do not pay VAT to HM you are stealing the money that consumer put in your hands (thus a PENAL issue).
    2. If you sell outside UK you do not charge and do not collect VAT. Buyers (including all EU countries) shall make an auto-invoice and collect VAT in their own country (applying LOCAL rates!)
    3. The 77K limit applies to UK not Europe: your turnover can be well over that value but if you sell less then 77K GBP you do not need a VAT ID in UK.

    1. Andy Brice Post author

      1. Whether you pay VAT or collect it from the customer and pay it on their behalf – the end result is identical, isn’t it?
      2. You have to charge (collect) VAT for consumers in the EU but not in your country.
      3. My understanding is that the ‘place of supply’ counts as the seller’s location (not the buyer’s) if you are selling to consumers.

  3. Thomas Holz

    You might add to the pseudo code:
    if (you know the company’s vat id # && it’s valid)

    If you don’t have the vat id number or it’s not valid (anymore?), then not charging vat can get you in trouble. (I implemented an online vat check for a customer recently.)

    1. Andy Brice Post author

      The advice I had was:

      “Technically you do not have to charge VAT to an EU business, even if they aren’t registered for VAT. Apparently they are then responsible for “self-charging” the VAT. However the burden of proof is on you to show that the customer is a business. So most vendors require a VAT number as proof of business status.”

      Personally I would always require a VAT ID. But I don’t check the VAT ids. If the VAT id turns out to be invalid, would the VAT man punish you? Is there an easy way to check if a VAT id is valid?

      1. Thomas Holz

        AFAIK, if you didn’t collect the VAT and if you don’t have the customers VAT id or if it was invalid and if the tax people notice and if you can’t collect the VAT afterwards from the customer, then you might be forced to pay it out of your own pocket. Yeah, lots of ‘if’s, I know.

        There a several online services for checking. Here’s a German one (requires a German VAT) which also has a XML interface. Useful for integrating.
        http://evatr.bff-online.de/eVatR/

  4. Luis Medel

    Here in Spain, you must comply with VAT from the first euro you earn and It’s mandatory you charge for VAT in every transaction you do (be for individuals or businesses).

    When you sell to EU customers, *I think* you should charge always and apply local rates, but, for overseas, it depends if there’s an agreement between the two countries to avoid double tax imposition.

    Take my words with a grain of salt. I’m better at programming that as an accountant :)

  5. Mike Sutton

    My understanding (UK) is that sales outside the EU are exempt and the VAT threshold (£77k) only applies to sales within the EU. If your total sales are over the threshold but the chargeable sales are below it you can apply to HMRC to be exempt from VAT registration.

    The implication of this is that if you use a reseller based outside the EU then all your sales to that reseller are exempt (since they’re a reseller it matters not where the eventual customer resides), you can apply for exemption, and don’t need to deal with the hassles of VAT.

    Sadly I’ve never done well enough to get to test that out for real.

    1. Andy Brice Post author

      >The implication of this is that if you use a reseller based outside the EU then all your sales to that reseller are exempt

      Yes, but *they* still have to collect VAT. So there is no VAT advantage to having your reseller outside the EU.

  6. Alessandro

    Businesses located outside the EU, that sell software downloads, subscriptions, hosting, etc…, to customers inside the EU, are expected to collect VAT from non business customers and then pay the collected amount to one of the EU tax authorities.

    This is done by registering with just one of the EU’s 25 member states’ tax authorities, for VAT on e-services (VOES). You can choose any one of the EU tax authorities and subsequently submit all your data and payments to that.
    The whole process, from registration to data submission happens online. Payments are effected through bank transfer. Data collection and payment happen at quarterly deadlines.

    For example, if you register with the UK’s HMRC for VoES but your customers are located in France, Spain, Germany and Poland, you have to deal with just the HMRC, not with 4 different agencies.

    A good place to look for more info and to register is https://secure.hmce.gov.uk/ecom/voes/. Or, google “VAT on e-services”.

    If all your customers are business, you are not required to collect VAT. Not sure what happens if you have a business customer who is not registered for VAT in their country.

    There does not seem to be a revenue threshold required for complying with this regulation.

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