VATMESS – Part 1

I launched paid plans for Loco last June and I’ve just reached the end of my first quarter. Being a small business I wouldn’t normally pay attention to quarters, but I do now because selling a digital service in the EU means compulsory VAT registration.

This post is not a political rant. Despite the title I’m going to resist the temptation to vent steam over the not-so-new EU regulations. It is what it is, and there’s unlikely to be any change for a while. If you’re planning a to start a SaaS business from the UK you might benefit from some of the things I’ve learned – many of them the hard way.

Preparing to charge for a SaaS in the EU

In this first post I’m just going to outline what I did to prepare for trading in Europe. I’m not saying I did it right, but it will at least show you what you’re up against if you want to do the same.

Cue the obligatory “I AM NOT A LAWYER” disclaimer. I’m also not an accountant, or even a very good businessman. However, I have seen combat and I’m dealing with this on a daily basis now.

The basics

If you’re in the UK and you sell a digital service to a consumer in another EU country you must charge them the VAT that applies in their country. You must do this even if you’re exempt from paying VAT in the UK.

I won’t regurgitate all the rules but these are the unavoidable facts of the matter. These rules will affect you immediately if you want to charge for your product and they will affect how you build parts of it.

In order to integrate payments into your system you’re going to be doing a bit more work than you hoped for. In my case it amounted to several additional weeks, but luckily I wasn’t paying someone else to do the coding. Let’s look at some things you’ll actually have to do before you accept your first Euro.

Understand EU VAT rates

The first thing to realise is that EU VAT rates are not the same in every country. That affects everything from here on out.

You might read that there are 70+ different VAT rates across the EU. I’m sure this is true if you’re looking for the most miserable statistic possible, but for most SaaS products you’re probably only interested in the ‘standard type. There are broadly 10 different standard rates. The lowest is Luxembourg at 17% The highest is Hungary at 27%. I’ll cover some fun edge cases in my next post. Let’s keep it simple for now.

Consider variable taxes in your pricing

I found it convenient to split my price points into GBP for domestic sales, EUR for the tricky EU sales and USD for tax-exempt exports to the rest of the world.

For the Euro price points I opted to set ‘universal’ prices that included the variable VAT whatever it might be. I wanted to charge 4.95 to everyone in Europe; not 4.95+VAT. This route means you’ll take the hit on higher VAT rates, but it might stop people bailing when they see up to 27% whacked on top of their bill. American consumers are fairly used to sales tax additions. We’re not.

If you opt for the VAT-exclusive approach you’ll probably make life easier for yourself on a technical front. It’s much easier to set fixed net prices and add variable taxes on top, particularly when it comes to integrating with some payment systems. However, I felt this route was worse for the customer.

If you opt for the VAT-inclusive approach, you could build an average overhead into your prices to cover the VAT you’ll be paying. This will probably be around the middle of the range, because although the 10 standard rates vary from 17-27%, half of EU states sit between 20-22%.  I estimated a 20% average and after the first quarter I find it to be 22%.

As a UK business, you’re already gambling on the Euro exchange rate anyway. It’s all a pretty fuzzy science. You’ll win some, you’ll lose some.

Establish place of supply

To execute a sale your system is going to have to establish the ‘place of supply‘. i.e. where the VAT is due.

It’s worth noting here (and at every step of the way) that HMRC’s guidelines are not EU legislation. In the absence of absolute clarity I’ve taken the popular view that for a web-based service the place of supply is where the customer normally resides.

To start with I take my customers current location based on their IP address. (You’re probably familiar with databases like MaxMind‘s). Make sure you log the IP with every sale and add that into your privacy policy. You’re legally required to store this as evidence.

I allow my customers to change their location in case it isn’t where they “normally reside”. (People travel. People use VPNs). I have no idea how legally binding any of this non-proof of location really is, but let’s not get distracted by reality just yet. For now, you just need to establish a country for the sale and be ready to process a payment with the right taxes.

Calculate the local VAT

If you chose to add VAT on top of your prices, you’ll probably need to calculate VAT at the point of sale. If you chose to absorb the VAT, you may be able to defer this until you issue the customer with an invoice or receipt.

Regardless of when you do it, as long as you can be sure of the customer’s location you can establish the VAT rate. This means your system is going to need some way to look up VAT rates by country code. I am currently using this database, but there are others. Be wary though, just because a VAT rate is listed doesn’t mean it applies to you. Stick to the EU VAT area plus your own country’s inclusions.

Note also that VAT rates are subject to change, so whenever your system looks up a regional rate it should be done against the date on which it must apply. One to be careful of when running reports against historical invoices.

Issuing VAT invoices

Whether or not your payment provider issues invoices, you’re going to have to. There are lots of finicky rules about when you invoice -vs- when you receive payment -vs- when you start providing the supply, etc.. But life is far too short, so I recommend all three things happen as close to the same moment as possible. Raise the invoice, provide access to the service and process the payment as quickly as possible afterwards. The date you stamp on the invoice is your ‘tax point’. This is important for producing your quarterly reports.

I have it on good authority from HMRC that SaaS subscriptions (i.e. repeat billing for an ongoing service) falls under rules for “continuous supply”. This means that every subsequent invoice establishes a new tax point. That might sound obvious, but I was worried that pro-rated changes to the service would complicate matters  (e.g. mid-month upgrades/metered usage, etc..). I was assured this was a non-issue.

Establish if the customer is a business

The rules mentioned so far all apply to purchases by consumers (or so-called ‘untaxable persons’). On the other hand, a VAT-registered business must not be charged VAT. You basically have three choices how to handle this:

  1. Treat everyone as a consumer;
  2. Treat everyone as a taxable business;
  3. Allow each customer to tell you which they are.

Choose your poison carefully. Trading only with businesses might seem a good way to avoid a lot of the compliance obligations, but personally I don’t like the idea of verifying VAT numbers on the fly and I certainly couldn’t miss out on business from private customers.

I checked with HMRC and they assured me I was under no obligation to ask a customer directly if they are in business. As long as there’s a way for them to make contact, the onus is on them to communicate the VAT number if they need to.

In the interests of a simpler user experience, I decided to assume all my customers are private and shelved the complexity of dealing with VAT numbers until someone actually sent me one for the first time. (They did). Have a strategy in place for dealing with this. It may involve correcting invoices, and possibly issuing refunds. You’ll also be legally obliged to issue VAT-exclusive invoices thereafter.

Depending on your payment provider, you may find that issuing VAT-exclusive invoices for VAT-inclusive prices poses technical problems. However, you are perfectly in your rights to issue an invoice for the full price, but include zero tax. Personally I think this is ripping off the customer, but the tax authorities will have no problem with it.

Register for MOSS

Once your system is ready to take payments, go and register for HMRC’s VAT MOSS scheme.

MOSS may bear the brunt of the fury over these EU regulations, but it’s actually a simplification scheme. In short, it saves you dealing with 28 different tax authorities. MOSS is not without its own problems, but the alternative is unthinkably awful.

Register for MOSS as soon as you possibly can. Do not leave this until the end, or even the middle of your first quarter. I’m not saying that just to be a good boy. I learned this the hard way, just take my word for it.

Beware: When you register for UK VAT and select “Supplies of Digital Services (below UK VAT threshold) under VAT MOSS arrangements” you have not registered for MOSS – you have only registered for UK VAT.

It’s as clear as mud, but until you’ve added the MOSS service to your available online tax services you cannot file a return. Do this before you start trading. If you value your sanity you don’t want to phone the HMRC helpline. Don’t say I didn’t warn you.

Easy huh?

This was just an overview of what I dealt with in getting Loco’s initial billing system up and running. There are some areas I’m still working out, but hopefully by sharing good quality information we might all stay out of prison.

In my next post I’ll go into some of the finer points I uncovered as theory turned into practice and I learned more details.