If you sell digital products overseas, the European Union (EU) has passed updates to the VAT tax that will affect you and your accounting. If you are unfamiliar with the VAT, here’s a down and dirty overview. VAT stands for Value Added Tax. In this system of taxation, goods and services are taxed at each step of the production process according to the “value added” at that step of production.
How the VAT Works
For instance, if you buy a car and pay the retail price of $30,000 and pay a 10% traditional sales tax, you are charged $33,000. $30,000 for the car plus $3000 for the tax.
If you bought this same car in a country with a 10% VAT, the car company may pay the steel manufacturer $15,000 for the steel to manufacture the car. The manufacturer pays 10% on the price of the raw steel or $1500. They make the car and sell it to a dealership for $25,000 who pays tax on $10,000 of value that they added to the raw steel to make it an automobile.
The dealership therefore pays $1000 (10% of the value added by the manufacturer) on the wholesale price of the car. When the dealer sells it to you for $30,000, you pay tax only on the cost of the markup of $5000 or $500. In theory, the total cost to the consumer will be $30,500 instead of $33,000 in the sales tax model.
How this really works is the companies making and selling the cars simply pass their tax expenses through to the consumer. Instead of selling their steel to the manufacturer for $15,000, the steel mill now wants $16,500 for their raw steel ($15,000 +$1500 VAT they pay for turning the iron ore into steel). The cost for the dealership becomes $27,500 ($16,500 for the raw steel + $10,000 manufacturing costs + $1000 VAT). The dealership still wants their $5000 profit, so they sell it to you for $32,500. You still have to pay your $500 portion of the VAT which makes your total cost, $33,000, the same as if you paid the 10% sales tax yourself.
The New VAT Rules
So what does this mean to you? On January 1st, the EU applied the VAT to digital products sold to one of the countries in the Union from the United States or other countries. So if you sell e-books, digital music, video, or anything else that is downloadable to someone in one of the 28 EU countries, you now have to charge the VAT in addition to your sales price, document and account for this money, and remit it to the country in which your customer resides.
Unlike the 10% VAT we used in our example for simplicity, actual VAT rates vary from country to country and range between 17% to 27%. You can imagine that documentation and computation can become pretty daunting.
Online Help with the VAT
However, the good news is that there is online help for entrepreneurs navigating the stormy seas of the VAT. The first is called the VAT mini one-stop-shop, or VAT-MOSS. You can find it here
This is where you can register and submit your quarterly tax returns to the appropriate country.
If you are less inclined to try the DIY approach, you may want to use this second option. At The Bottom Line, we have discovered a VAT service for US companies at https://www.taxamo.com/. Taxamo will charge you a flat rate of €0,20 per transaction, which, according to the current exchange rate is about $0.22 in US dollars. (The current exchange rate is €1,00 equals $1.12.) By purchasing pre-paid packages, you can lower the costs to as little as €0,02 per transaction. We like the Taxamo API because it integrates easily with BrainTree, Stripe, and even PayPal, so whatever shopping cart plug-in you are using, Taxamo will probably be a compatible solution.
The Bottom Line
The changes made this year were specifically designed to ensure that companies selling digital products in EU member nations were not shirking their VAT responsibilities. If you have been selling digital products, you can:
- Decide the new laws are too much trouble and lose any potential European sales. Or …
- Realize that the VAT taxing system is here to stay and adjust your pricing and accounting procedures to your advantage in the lucrative European market.
If you choose the latter, take our advice and use the online resources above to make your education, administration, and compliance simple.
For more information, check out the CPA In Your Corner Podcast #3.