When I check social media, I hear often freelancers or small businesses complaining about having to pay the VAT they charge to their customers. In countries like in Spain, from the moment you start a business, you’re obliged to collect this tax to your customers and pay it to the tax authorities. In other countries, like Poland or Germany, you are required to have a minimum level of earnings to be liable for VAT. Below that threshold, it can be optional, but regulations change from country to country, so in this case, a tax consultant might come in handy. What we’re going to discuss in this post are the economic consequences of being VAT liable and how it affect your business.

Valued-added Tax. Is it a cost for my business?

The answer to this question might be a little complicated to answer but it’s often confusing for small businesses. The quick answer would be no, since being VAT liable usually comes with the obligation of paying a sum to the tax authorities every month or quarter and, as it represents a cash outflow, it’s logical to believe that it represents an additional cost that affects your revenue. For example, in Spain the VAT rate is usually 21% and when a business issues an invoice with a net amount of 1,000.00 Euro, applying the VAT represents an additional 210.00 Euro to collect from the customer, who finally pays 1,210.00. Then you have to pay to the tax authorities these 210.00 Euro, which it’s often misunderstood as a foregone part of the revenue. However, usually when a business is liable for VAT, it can also deduct the VAT of its purchases. If during that period you bought different things (e.g. a printer) and the paid VAT is 100,00 Euro, you owe the tax authorities only 110,00 Euro (210 less 100).

This is so because as the name of the tax indicates (value-added), the tax collects “the added value” in every part of the production process until it gets to its “final destination”, the final customer, who actually bears the cost of the tax.

How does it affect you?

Either your business is just starting or you’re already well positioned in the market, being VAT liable affects you in different ways:

• Less control over your prices: even though it is not part of your revenue and you can deduct the VAT from your purchases, you have to charge your customers with an additional price that can make you lose potential sales. Some businesses try to absorb the VAT by sacrificing part of the revenue they earn per product or service, so that they don’t lose customers (not increasing the price from 1,000 to 1,210 in our example, but leaving it at 1,000, earning 826 and VAT of 174). However, this can be tricky, because you might not be able to absorb it if your costs are high in proportion of your sales volume. This happened actually to some businesses shortly after the financial crisis of 2008 in some countries. The VAT of some products increased because the government decided to increase the rates. The affected companies lost a lot of customers (who bear the cost of the added-tax). Those which tried to absorb the increase in the final price, they had to cut down expenses and quality to stay in the market. Others had to leave.
• Less control over your cash flows: apart from paying to suppliers and receiving money from customers, every month or quarter you have to calculate the difference between the output VAT (resulting from sales) and input VAT (from purchases) and pay the difference it to the tax authorities. The problem arises basically when you receive the payment of an invoice, since you cannot directly invest that „extra cash” to work. You’ll have to pay it to the tax authorities if there is a resulting liability, even if you haven’t been paid your invoices (or paid your suppliers’).

What if I’m not VAT liable?

In this case, as you’re not issuing an invoice adding the VAT, you are not able to deduct the VAT of your purchases. In our example, an invoice issued by you that amounts to 1,000.00 Euro will stay the same. Also, you won’t have to submit any declaration and you can’t compensate any VAT. Which means, in this case, the VAT will be treated as a cost (as if you were the final „customer”).

Considerations

VAT, despite its straightforward calculation, is one of the most complex taxes that exist and regulations greatly vary from one country to another. In this article, we assumed a very simplified scenario. When it comes to taxes, it’s highly advisable that you discuss your questions with a qualified tax consultant.

If you have questions, concerns or you would like to leave your feedback, do not hesitate to drop me a message.