What Is VAT Compliance?

Organizations are challenged with the task of ensuring they are compliant with all domestic and  international business tax laws. This includes the practice of charging the right amount of tax for customers who are VAT registered. By doing so, they are VAT compliant.

What is VAT compliance all about, how can an organization doing business globally process taxes according to VAT rules, and what can a company do to avoid common mistakes?

What is VAT Compliance?

To understand what VAT compliance is, one must know what VAT actually means. Value Added Tax, or VAT as it’s abbreviated, is a complex set of rules to determine the correct amount of taxes assessed, “for goods and services bought and sold for use or consumption”, by those in European Union (EU) nations. This includes individual consumers as well as trade with other EU-based organizations. VAT is also popular in other countries, even if known by another name (such as Goods & Services Tax in Canada, Australia and New Zealand). 

If you are wondering how VAT came about, it goes back to when the EU was first formed in the 1990s and the nations that were a part of this union were using different tax rates for consumer goods and services. This led to many problems for EU member nations, including unfair and confusing tax rates and practices.

This limited EU producers to compete equitably in terms of imports from outside of the EU. Plus, there was no system for keeping track of revenues and taxes, which impacted the overall economic environment of the EU collectively.

Along comes the creation of a more flexible VAT, which was enacted on January 1, 2007 to be a more efficient tax system that is based on transparency, neutrality, and fairness for EU producers. The European Commission oversees and enforces VAT compliance, including maintaining updated common rules.

Find more information about this in the VAT Directive. 

Defining VAT

Under the VAT system of taxation in the European Union, there are some definitions to note. VAT is an indirect tax, which means the seller of the goods and services ultimately pays this out of their revenues, however the buyer actually pays a fractional amount of VAT when they make the purchase.

The seller is the “taxable person”, since they have the duty to pay this tax, but they are obtaining money from the buyers. VAT is a percentage of the price of the goods and services sold and is a transparent interaction at every stage of a purchase.

In some cases, if the organization’s revenues meet a low threshold, they do not have to charge VAT on sales. 

How to be VAT Compliant

Understanding how to ensure VAT compliance can support an organization in the effort to properly calculate consumption taxes for goods and services bought and sold in the EU. This reduces risk of incorrect VAT handling and unpleasant surprises that can cost the organization. 

1. Obtain a VAT number

Organizations that fall under VAT compliance guidelines must register for a VAT number. The 9-digit VAT number must be added to all invoices. They must provide this number to anyone they do business with or provide services or goods for, with the exception of buyers or sellers outside of the EU.

They may also request the VAT number of vendors from whom they import and export goods and services. 

2. Use a VAT compliant solution

EU organizations must also ensure that they are using the right accounting solution for processing VAT taxes they must assess and those they must pay. It is recommended to use either an accounting product that is VAT compliant or outsource this responsibility to a third-party VAT accounting agency. 

3. Understand VAT rates

Since each organization has differing circumstances, their VAT rates will be unique. As a general rule, the laws in the EU have established a standard VAT of at least 15%. The reduced rate is 5% for goods and services supplied.

Some European Union countries are still using their own VAT tax rates, which is for specific types of products. Other countries charge high VAT tax rates, for example, Hungary (27%), Croatia, Denmark, Hungary and Sweden (25% each). 

4. Be mindful of deadlines 

VAT covered organizations are tasked with not only invoicing and paying the correct amount of taxes, but they also have reporting requirements to manage.

Filing refunds and paying VAT owed must be done according to each country’s rules. This must occur at least on a quarterly basis or VAT reporting will be considered late, causing the organization to rack up points and incur penalties. 

Who is Required to be VAT Compliant?

To simplify, all businesses that provide goods and services to buyers in the European Union are required to be VAT compliant. Keep in mind that international companies that sell to buyers in EU countries must also be VAT compliant, assessing the proper percentage of taxes and reporting this information.

Anytime goods or services are provided to consumers by a qualifying, other businesses or entities that are located in the EU, the VAT must be added to invoices based on that country’s VAT tax rate. 

What are Common VAT Compliance Challenges and Mistakes?

VAT compliance can present certain challenges when doing business in the European Union. It’s also possible for mistakes to occur.

The biggest challenge is not understanding how to determine the correct VAT rate when invoicing buyers from different countries, which can lead to mistakes in calculating the right rates. This can include not understanding the difference between VAT exemption and zero-rated status when invoicing. There are also cross-border VAT rates to know to ensure correct payment of VAT. 

To further make things more challenging, it is important to understand what the reduced rates for special types of goods and services are. These challenges can be overcome by seeking the support of a VAT specialist or using a VAT solution that can calculate VAT rates automatically. 

Another challenge that an organization may face when trying to be VAT compliant is the matter of maintaining records that are up-to-date and accurate. Not keeping good records is a mistake to avoid.

Filing accurate VAT reimbursements and tax returns requires having a system that is current and alerts accounting professionals to changes. Failure to pay the right VAT or paying late can result in penalties and fines which can impact business revenues. 

How Does VAT Compliance Benefit Businesses?

With all of the complex requirements of VAT, what is the benefit to businesses in the EU and other businesses in nations that conduct business with EU consumers? 

The benefits of VAT compliance are many, including establishing trust with others due to the transparency of the tax rates. This supports good business relationships and fairness in transactions, which are a boon to organizational reputation and brand. 

VAT compliance also benefits organizations by making sure that they avoid penalties and legal problems that can interfere with business goals. Invoicing and financial planning is improved so that cash flows are stable.

Organizations that adhere to VAT rules benefit by better management of finances and tax responsibilities, to include reclaiming VAT taxes on eligible goods and services purchased. Connecting with a professional VAT solution to manage transactions and reporting can help businesses enjoy these benefits and improve their status in the European Union.  

Where to Get Help with VAT Compliance 

If a business in the EU needs to seek help with VAT compliance, they can do so by using several resources. This includes getting information from the European Commission, tax consultants that are experts in VAT compliance, and professional organizations that specialize in VAT support.

Another source of help comes from VAT software providers that have support representatives and help centers to answer questions. Industry associations often have workshops, webinars, and training opportunities centered on VAT compliance topics.

Getting involved can help any business to stay current with VAT regulations and requirements. 

VAT Compliance: Your Obligations

Understanding what is involved with VAT compliance is essential for businesses operating or selling to consumers in the European Union. Being compliant with the Value Added Tax system can help organizations to avoid making mistakes or facing obstacles so that they can properly manage business tax responsibilities.

VAT compliance leads to a more streamlined approach that supports long-term business growth and a solid reputation.