Determining VAT: mistakes to avoid
April 23, 2020
Companies selling digital products and services must comply with the VAT destination principle in 57 countries around the world. Digital content encompasses such electronic media as iTunes songs, e-books, movies on streaming platforms, images, and much more. Under VAT compliance rules, sellers that have clients in these countries pay VAT/GST. But because each country has different tax rules, thresholds, services, and means of payment, registering and filing the correct VAT amount is very complex. Thus, many companies make mistakes.
When selling goods to customers, to determine their exact location, during the transaction sellers usually can rely on such pieces of evidence as:
It is not easy to discern this data, especially since tax rules vary from country to country. A scenario like this is not unusual, especially in Europe: a customer that originally lived in Poland (billing address), now resides and works in France (IP address) but has a bank account open in Germany (bank address). Because the pieces of information are different, more data must be gathered to calculate the right VAT amount and avoid any VAT compliance issues. Sellers must do this without infringing on GDPR.
Some companies calculate VAT once the selected products are in the cart, right before check out. After receiving payment, they may also get contradictory information about the whereabouts of the customer. The solution for this is sending a notice to the client to change their data in the order.
Sometimes sellers only collect the IP address, which is not enough to properly pinpoint a customer’s location. Tax authorities also do not consider this to be sufficient. As people nowadays tend to move around more and more it is generally advised to gather at least 3 pieces of evidence to prove a client’s location to the tax authorities. Then it will be easier to file for VAT and follow VAT compliance rules.
Various companies collect money in different currencies on their website but choose to keep accounts only in their domestic currency. This can become an issue when filing VAT returns as it may have been exchanged several times until then. It is strongly advised to keep records in the currency of the payment and exchange once on the last day of the quarter.
Not every good and service has the same rate of VAT applied during the purchase, especially for unassociated services. For example, some countries have lower VAT rates for e-books than music and such. What sellers mistakenly do is using the standard highest VAT rate for all their products. That’s why it’s important to research the VAT rates in every country that you’re selling goods to. Using specially designed solutions to apply appropriate VAT rates to your products is also a good way to follow all VAT compliance rules.
Because this is an indirect tax, companies sell their products at a flat price and use a simple formula to calculate the amount of tax: the price is divided by (100 + VAT %) and multiplied by the VAT rate %. So, for example, the VAT rate is 25%. So, VAT is calculated like this: 100 € / 125 * 25 VAT = 20 €. But in some countries, this rate is applied straight. Let’s say the VAT rate is 15 %. Then VAT is calculated like this: 100 € * 15 / 100 VAT = 15 €.
These types of mistakes can lead to some serious issues later on. That’s why it’s important for companies to properly gather all the necessary information and make sure they are using the right VAT rates and applying the correct formulas to determine the right amount of tax. This way, sellers will ensure VAT compliance. But following all the different rules in each specific country is highly complex – we recommend using our automated solutions that help track them.