TL;DR: The price most businesses show to their customers should include 19% VAT. The VAT you pay on business expenses decreases your VAT payments to Finanzamt. VAT reporting and payments to Finanzamt are frequent and regular.
Understanding and managing VAT (Umsatzsteuer, USt, MwSt, Value Added Tax) is a distinct complex task for all businesses in Germany. With varying rates, exemptions, and regulations, keeping track of VAT obligations can become daunting. In this article, we'll explore the intricacies of the German VAT system and discuss practical tips for overcoming common VAT challenges faced by freelancers, creators, small businesses, and startups.
What is VAT?
Value Added Tax or Sales Tax (Mehrwertsteuer or Umsatzsteuer) is added to the price of goods and services. As a business, you collect VAT from customers and pay VAT on your purchases (Vorsteuer), remitting the difference to the Finanzamt.
Simply put, you collect VAT from your customers on the products/services you sell, and you pay VAT when you purchase products/services from vendors/contractors. The sum you owe to Finanzamt = Total VAT you collected - Total VAT you paid. Basically, you pay Value Added Tax only on the part where you added value.
⚠️ Advertised prices must always include VAT. If the price label says 20€, the customer pays 20€ including VAT.
Some goods and services can charge reduced or no VAT. You can find a complete list of all items eligible for the reduced 7% in the Umsatzsteuergesetz (§12 UStG).
Reduced VAT (7%): Some foods and beverages, museum, theatre, concert, and sports event tickets, artistic, journalistic, copyrighted work, and hotel stays.
No VAT: Medical treatments by doctors, dentists, and therapists, some teaching and social services, insurance, rent for long-term residential spaces, and buying/selling property.
When you are a small business (Kleinunternehmer), you decide if you want to charge VAT.
When your customer is in another country, you most probably shouldn't charge VAT.
The VAT algorithm looks simple on the outside:
Charge VAT on the goods and services you sell.
Pay VAT on your business expenses.
Calculate the difference between the VAT you charge and the VAT you pay.
Tell the difference to Finanzamt with a VAT return.
Pay the difference to the Finanzamt with a bank transfer. If the difference is negative, the Finanzamt pays you.
Example:
I. You make 20,000€ in sales, including 3,193€ VAT. You pay 12,000€ for tools and supplies, including 1,916€ VAT. You must give 1,277€ to the Finanzamt (3,193€ − 1,916€).
II. You make 20,000€ in sales, including 3,193€ VAT. You pay 100,000€ for new office equipment, including 15,966€ VAT. The Finanzamt must give you 12,773€ (15,966€ − 3,193€)
How the process looks in detail
I. Register for VAT
When you start your business, you must register it with the Finanzamt. This is how you get a Steuernummer and a VAT number. You must put those numbers on your invoices and start charging VAT. During the registration, you can give the Finanzamt a direct debit authorization. Finanzamt will take VAT payments directly from your bank account. It saves time and helps you avoid late fees.
II. Collect VAT from customers
You must charge VAT to all your German customers and some of your EU customers. If you forget to charge your customers VAT, you must still pay VAT to the Finanzamt. For example, if you create a 100€ invoice and forget to charge 19€ for VAT, the Finanzamt will still collect ~16€ from you. If you write incorrect invoices, you can lose money.
III. Submit VAT returns
If you charge VAT, you must submit VAT returns (Umsatzsteuervoranmeldung). They tell the Finanzamt how much VAT you owe them. How often you submit VAT returns depends on how much VAT you paid last year. If you paid under 1,000€, you can file it at the end of the year. If you paid from 1,000€ to 7,500€, you should report and pay VAT every quarter. For VAT over 7,500€, you should report and pay monthly.
You must submit your VAT return before the 10th day of the following month. If that day is a Saturday, Sunday, or a public holiday, you have time until the next business day. You pay a fine if you submit your VAT returns late (Verspätungszuschlag). The fine is up to 10% of the VAT you owe, a maximum of 25,000€.
IV. Pay VAT to the Finanzamt
After you submit your VAT return, you must pay the Finanzamt by bank transfer. Finanzamt won't send you an invoice - you must make a bank transfer. If you give the Finanzamt a direct debit authorization, they take the money automatically. If the VAT you paid is more than the VAT you charged, you get a refund from the Finanzamt.
The VAT payment is due on the same day as the VAT return: before the 10th day of the following month, but you have three more days for the bank transfer to go through. If you submit your VAT return on time, but your payment is late, you get a fine (Säumniszuschlag). The penalty is 1% of the VAT you owe for every month you wait.
V. Submit a yearly VAT declaration
You must also make a yearly VAT declaration (Umsatzsteuererklärung). If you forgot to declare something in your VAT returns, you can make corrections in your VAT declaration. The due date is May 31 of next year. If your tax advisor submits it for you, they have time until September 30. If you submit your VAT declaration late, the fine is the same as for a late VAT return: up to 10% of the VAT you owe, a maximum of 25,000€.
When to charge VAT?
You don't have to charge VAT if you are a small business (Kleinunternehmer).
Charge VAT for customers in Germany. If you sell goods or services to customers in Germany, you must charge the VAT discussed above.
VAT percent and rules for customers in the EU outside Germany depend on the type of customer and the type of product you sell.
If your customer is outside the European Union, you shouldn't charge VAT. For example, if you sell goods or services to customers in the United States, you must not charge VAT.
Common VAT challenges entrepreneurs face
Determining VAT rates: Entrepreneurs must accurately apply the appropriate VAT rates to their goods and services, considering all exemptions and special cases.
Invoicing: Proper invoicing is crucial, as entrepreneurs need to include all necessary information (such as VAT ID numbers and correct VAT rates) to ensure compliance.
Filing VAT returns: German entrepreneurs must regularly file VAT returns, which can be time-consuming and prone to errors if not managed effectively.
Reverse charge mechanism: Understanding when to apply the reverse charge mechanism, which shifts the VAT liability from the seller to the buyer, can be complex for entrepreneurs dealing with cross-border transactions.
Managing VAT refunds: Claiming VAT refunds for business expenses can be complicated, as entrepreneurs must provide accurate documentation and follow strict deadlines.
Low-informed advisors. Some tax advisors lack the knowledge and experience in VAT calculation. This is especially common for international trade operations.
Final thoughts
Mastering VAT compliance in Germany is a time black hole. Professional advisors are prone to errors and need double-checking. There are a lot of moving pieces and intricate details.
Meanwhile, it's a top 3 price component. Proper VAT calculation can make or break a business.
If you're looking for an all-in-one solution to help you navigate VAT compliance and other financial management tasks, try Norman, a financial co-pilot designed to support and empower German entrepreneurs.