VAT in the European Union is an indirect tax governed by uniform principles established in the EU Directive.
Companies operating in EU Member States, as well as their suppliers or customers from outside the EU, frequently encounter the EU VAT in their operations. It is essential for these economic agents to understand how VAT applies to cross-border transactions involving EU companies or parties based outside the EU.
This article highlights key aspects of VAT in Europe, with a focus on the supply of services.
The concept of VAT
Value Added Tax (VAT) is a widely used form of taxation on the value of a product or service added during production and distribution process. When a seller offers a product or service, he includes the VAT calculated at the applicable rate in the price. This tax is collected from the buyer at the point of sale.
The seller then remits the collected tax to the government. However, he can deduct any VAT paid when purchasing goods or services for his business. This process effectively makes VAT “neutral” at the business level, meaning that the tax burden ultimately falls on the end consumer.
The European VAT rules
Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (the Directive), which is in force in the European Union, establishes the general principles for collecting VAT that EU Member States must follow.
The EU VAT Directive determines:
- the territorial scope of the tax;
- taxable persons and transactions;
- place of supply of goods and services;
- taxable amount;
- principles for establishing tax rates;
- tax deductions;
- obligations of taxable persons, including invoicing, tax accounting rules, and other matters.
While the Directive serves as a framework for harmonizing tax legislation across Member States, it does not have the force of national law. Each Member State is responsible for detailing the specifics of their VAT taxation.
VAT-taxable persons in the EU
A taxable person for VAT purposes in the EU is defined as “any person who independently carries out any economic activity, regardless of the purpose or results of that activity”.
The term “economic activity” encompasses any activities conducted by producers, traders, or providers of services, as well as regular use of tangible or intangible assets aimed at generating profit.
VAT-taxable persons in the EU are mainly business companies, partnerships, and sole traders. In contrast, persons who purchase goods or services for personal use, rather than for business purposes, are classified as non-taxable. Typically, these are private individuals.
VAT registration (obtaining a VAT number) can be mandatory or voluntary. Reaching a certain turnover on taxable transactions may be a condition for mandatory registration for VAT. For example, this threshold is €16,500 in Cyprus, €50,000 in Latvia or Luxembourg, and €85,000 in Italy. Tax registration allows a business to use VAT deductions but requires it to keep proper records of taxable transactions and submit VAT returns.
Taxable transactions
There are four types of taxable transactions for VAT purposes in the EU:
- supply of goods;
- intra-Community (within the EU) acquisition of goods;
- supply of services;
- importation of goods.
The “supply of services” includes any transactions that do not constitute the supply of goods, including transport, telecommunications, digital and other services.
VAT rates in EU Member States
Tax rates are set independently by each EU Member State. The standard VAT rate cannot be less than 15%. The current standard VAT rates in Europe are shown in the table.
Member States are allowed to establish up to two reduced rates, with the lowest rate not falling below 5%. These reduced rates typically apply to essential items such as food, healthcare, and books, as well as services like hotel accommodations, restaurants, and various household services. Certain activities deemed socially significant are exempt from VAT. These includes banking transactions, provision of credit, insurance, transactions in securities, and rental of real estate, among others.
What country’s VAT applies?
The place of taxation depends on the place of supply of services. To determine which country will be considered the place of supply of a specific service (and, accordingly, what country’s VAT rules and rates will apply), you need to find out:
- what category does the service belong to;
- is the customer (service recipient) a business entity and a VAT taxpayer;
- in which countries the supplier and customer are established.
For these purposes, services can be divided into:
- services provided to taxable persons who are business entities (“business-to-business” or B2B services) and
- services supplied to non-taxable private consumers (“business-to-consumer” or B2C services).
Place of supply of services: the general rule
Under the general rule, the place of supply for B2B services is determined by the location of the customer. If the services are provided to a customer’s fixed establishment, then the place of supply will be the location of that fixed establishment.
The location of a business entity receiving services is identified by its place of incorporation, fixed establishment, or, in the case of a sole trader, the location of his or her permanent address or usual residence.
For B2C services, the place of supply is generally determined by the location of the supplier. However, if the services are provided by the supplier’s fixed establishment situated in a different location, then the place of supply will be the location of that fixed establishment.
Place of supply of services: special rules
The general rule mentioned above has several exceptions due to specific types of services.
| Type of services | Place of supply of services |
|---|---|
|
B2B and B2C services related to immovable property |
The place where the immovable property is located |
|
B2C transport of goods (other than transportation within the EU) |
The place where the transport takes place, proportionate to the distances covered |
|
B2C intra-Community (within the EU) transport of goods |
The place of departure (where the transportation actually starts) |
|
B2B and B2C services for the admission of cultural, artistic, sporting, educational, entertainment or similar events (other than made available virtually) |
The place where the events actually take place |
|
B2C services which are streamed or otherwise made virtually available |
The place where service recipient is established, has his permanent address or usually resides |
|
B2B and B2C restaurant and catering services (other than those carried out on board ships, aircraft or trains during the passenger transportation within the EU) |
The place where the services are physically carried out |
|
B2B and B2C restaurant and catering services carried out on board ships, aircraft or trains during the passenger transportation within the EU |
The place of the commencement of passenger transportation |
|
B2B and B2C short-term hiring of means of transport (for a period not more than 30 days or, in the case of vessels, not more than 90 days) |
The place where the means of transport are actually put at the disposal of the customer |
|
B2C hiring of means of transport (other than short-term) |
The place where service recipient is established, has his permanent address or usually resides |
|
B2C telecommunication, broadcasting and electronically supplied services |
|
|
B2C services rendered to customers located outside the EU:
|
How to determine the place of supply of services?
Reverse charge mechanism
The reverse charge mechanism applies to cross-border transactions within the EU, specifically when a company from one Member State supplies goods or services to a company in another Member State. In this scenario, the responsibility for accounting for VAT shifts from the supplier to the customer, simplifying the process for the supplier.
When the reverse charge is applied to a transaction, the supplier issues an invoice without VAT, indicating only the net cost of the service. The invoice must clearly refer to the reverse charge and include the customer’s VAT number. The customer is then responsible for calculating VAT on the transaction and reporting it in their VAT return.
As a result, no VAT is payable since the customer declares and deducts the VAT simultaneously, effectively neutralizing the tax burden (provided the customer is eligible to deduct VAT).
It is crucial to apply the reverse charge mechanism correctly, as these transactions are recorded in the EU’s common VAT reporting system, which monitors cross-border trade within the EU.
Who accounts for VAT in the EU?
VAT on B2B services within the same EU country
When services are provided between business entities in the same EU country, the supplier charges VAT at the standard rate applicable in that country.
The customer can reclaim the input VAT charged by the supplier, provided that it is registered for VAT and submits VAT returns.
VAT on cross-border B2B services within the EU
When providing services between two VAT-registered businesses located in different EU countries, no VAT is charged. However, the customer must account for VAT in its home country using the reverse charge mechanism.
| Example. A company in Cyprus, which does not have a fixed establishment in Austria, provides legal services to an Austrian company. The transaction is taxed at the location of the customer receiving the services. The Austrian company accounts for VAT under the reverse charge mechanism, applying the Austrian VAT. |
VAT on B2B services supplied to customers outside the EU
Sales of B2B services to business customers outside the EU typically do not incur VAT. The European VAT rules do not apply to non-EU customers, but they may have tax obligations under the laws of their country.
| Example. An Irish company provides services to a United States company. As the customer’s location, the USA will be considered a place of supply of the services. The supplier does not charge Irish VAT on the transaction. However, the customer may face tax implications under applicable US laws. |
B2B services supplied by non-EU providers to EU business customers
In B2B transactions where non-EU suppliers sell to EU companies, the reverse charge mechanism generally applies. This means that the EU company (the customer) is responsible for reporting and paying VAT in its own country.
| B2B services | ||
|---|---|---|
| Supplier | Customer | VAT taxation |
|
EU company |
EU company in the same country |
The supplier charges VAT on the price of the service, accounts for VAT, and pays it in his country. Subsequently, he can use the VAT deduction. |
|
EU company |
EU company in other country |
The supplier does not charge VAT on the price of the service. The customer accounts for VAT using the reverse charge mechanism. |
|
EU company |
Non-EU company |
The supplier does not charge VAT (provided that the customer is a business entity and taxpayer in their country). The customer may need to comply with his country’s tax reporting requirements. |
|
Non-EU company |
EU company |
The customer accounts for VAT and pays it in his EU country, applying the reverse charge mechanism. |
| B2C services * | ||
| Supplier | Customer | VAT taxation |
|
EU company |
Private consumer in the same or other EU country |
The supplier accounts for VAT and pays it at the rate of his EU country. |
|
EU Company |
Private consumer outside the EU |
If the place of supply of services is the supplier’s EU country, the supplier accounts for VAT. |
|
Non-EU company |
Private consumer in the EU |
If any taxes arise in the supplier’s non-EU country, the supplier is responsible for accounting for those taxes in that country. |
* General rules apply when services do not meet any exceptions. Specific rules may determine the place of supply for certain services.
VAT on digital services in the EU
The services provided electronically include:
- Website creation and hosting;
- Remote maintenance of programs and equipment;
- Software supply and updates;
- Provision of images, text, and information, as well as access to databases;
- Distribution of music, films, and games;
- Broadcasting and streaming of political, cultural, artistic, sporting, scientific, and entertainment events;
- Distance learning services.
The place of supply for B2B digital services is determined by the customer’s location, which is the general rule. For B2C digital services provided to private customers, VAT applies at the customer’s place of residence or permanent address, as outlined in Article 58 of the Directive.
B2C electronically supplied services, as well as advertising, consulting, legal, financial, telecommunications, and broadcasting services provided to private clients outside the EU, are not subject to VAT in the EU.
| Example. A Slovak company sells antivirus software via its website to a private individual living in South Africa. No Slovak VAT is charged. |
Starting from 1 July 2021, the EU updated the VAT regulations for B2C cross-border online trade in goods and services, including through marketplaces. These rules apply to services provided to EU consumers by suppliers from both EU and non-EU countries. Under the new regulations:
- The One Stop Shop (OSS) system allows online sellers to register for VAT in a single EU country. In that country, they can account for and pay VAT on all distance sales of goods and the cross-border provision of services to customers in any EU country.
- If a supplier exceeds the EU-wide annual threshold of €10,000 for B2C distance sales of goods and electronic services, he must apply the VAT rules of the country where his consumers are located.
- If the annual turnover is less than €10,000, the supplier may apply VAT of the country in which he is based.
Conclusion
It’s essential for companies that operate within the EU or work with EU partners to understand how European VAT applies to both B2B and B2C transactions. Service providers should verify the status and location of their clients, as this information determines the appropriate place and procedures for VAT taxation.
To effectively manage VAT in the EU, it is essential to issue invoices correctly, accurately record transactions, and submit VAT returns punctually. Failing to adhere to VAT regulations can lead to fines and additional tax assessments from tax authorities of the relevant countries.
The EU VAT Directive outlines general principles for tax collection. However, it is advisable to address specific VAT taxation matters, particularly in cross-border situations, with the assistance of VAT and accounting specialists who practice in EU countries.
Note: This publication is intended for informational purposes only and does not constitute tax or legal advice.