Software-as-a-service (SaaS) businesses commonly operate on a global scale. This means that controls surrounding VAT need to be implemented to maximize compliance and ensure accuracy in reporting. The good news is that the European Union has a One-Stop Shop portal that helps both EU and non-EU businesses streamline operations.

In this article, we’ll cover everything you need to know about handling international VAT, including the potential implications of non-compliance, how to monitor countries under-reporting thresholds, and the typical registration process for OSS and IOSS.

What is VAT?

Value-added tax, known as VAT, is a consumption tax imposed on goods and services. This tax is levied on goods and services at each stage of the supply chain where value is added. For example, purchasing raw materials and turning them into finished goods would generate VAT.

VAT is calculated based on the cost of the initial product minus the cost of materials that have been previously purchased and taxed. Unlike a marginal tax system that changes based on income levels, VAT uses a flat rate to tax purchases equally.

Currently, more than 160 countries have implemented some form of VAT; however, this tax is most commonly found in the European Union (EU). It’s important to differentiate VAT from sales tax. Sales tax is only paid once when the good or service is sold to the end customer. On the contrary, VAT is paid as the product or service moves through the supply chain.

VAT for SaaS Businesses

Digital goods are also subject to VAT. The EU outlines four criteria that a good must meet to be classified as a digital good:

1. Not tangible.
2. The offering is based on IT.
3. The good is provided through the internet.

The good is fully automated or works based on minimal human intervention.

This includes online games, software, images, SaaS, site hosting services, and websites. Digital goods under the EU’s definition can also include e-services.

What Happens If You Ignore International VAT?

Ignoring your obligations to pay VAT opens the door to a slew of compliance issues, which can come with harsh financial implications. Let’s break down some of the fines, penalties, and consequences VAT non-compliance comes with.

Fines and Penalties

• Late Registration – Failure to register in the proper timeframe can result in various penalties, such as back VAT with interest.
• Late Filing – Filing late VAT returns generally results in penalties based on the outstanding VAT liability, which is commonly 5% per month of the unpaid amount.
• Late Payment – Late payments have similar penalties to late filing, with an interest percentage imposed on the late amount.
• Incorrect Invoice Filings – Submitting incorrect or incomplete invoices can lead to additional fines at the discretion of each country or agency.
• Unjustified Claimed Input Tax – Since VAT is only calculated based on the value added from one stage to the next, companies can claim an input tax credit. Without proper substantiation, the input tax credit claimed could be overturned.

Other Consequences

• Audits – Non-compliance can trigger audits and inspections that can result in additional fines and penalties.
• Damaged Reputation – The brand image of your company is crucial. Frequent non-compliance can lead to reputation damage and hinder your relationships with clients and vendors.
• Legal Action – Legal action is reserved for severe cases of intentional non-compliance. However, if the taxing authority has enough proof, they could criminally persecute your business.

The route that legal action is taken will depend on the country. However, most countries use some type of online portal to communicate fines, penalties, and legal action. For example, as of January 1, 2024, the EU uses a Central Electronic System of Payment Information (CESOP) which transmits VAT information to different jurisdictions. Any non-compliant business identified during information sharing will be flagged and reviewed, with letters sent through the online portal.

The UK follows a similar protocol when it comes to legal action, issuing letters and notifications through the company’s VAT account. In many cases, tax authorities will use numerous contact methods when pursuing legal action, such as mailing letters to the address on file, calling the number on the account, and sending notifications through online portals.

How Cross-Border Legal Action is Pursued

It’s important to understand that tax authorities can take legal action even if the country is not your home location. This is done through Mutual Legal Assistance Treaties (MLATs). These treaties are signed between two countries and allow both countries to gather and exchange information to enforce public or criminal law.

This means if your home location is the United States, but you aren’t compliant in the UK, the UK can still bring legal charges forward. Any jurisdiction that you have a VAT interest in can pursue legal action if they have sufficient evidence that you are non-compliant with regulations. For example, if the UK notices that you aren’t compliant with their VAT guidelines, they may share that information with the EU. This can lead to legal action by both the UK and the EU.

This section isn’t meant to scare you. In fact, VAT is relatively easy to maintain compliance with if you have the basics handled. In many cases, taxing authorities will be more lenient with first-time offenses, issuing warnings and lower fines. However, multiple repeat offenses can attract higher scrutiny and lead to stricter fines and penalties.

How to Handle Countries Below the VAT Threshold

Adding value to goods and services doesn’t automatically subject your business to VAT. In fact, most countries have a minimum threshold that must be met before VAT goes into effect. For example, the EU imposes an EU-wide threshold of €10,000 for sellers established in the EU and a zero threshold for non-EU sellers.

The €10,000 applies to businesses in the EU that sell to other EU customers. When under this sales threshold, businesses only need to collect VAT at their local country’s rate. However, once sales exceed this threshold, businesses will be required to register in each country and begin collecting VAT at the customer’s local rate.

This exception is not available to non-EU businesses that engage in B2C transactions in the EU. Generally, businesses registered outside of the EU need to register for VAT before their first sale.

Moreover, each country will establish its own threshold for VAT. For example, the UK has a threshold of £90,000. Differences in VAT thresholds require your business to take a practice approach to compliance, which might include the following protocols:

• Monitoring VAT Thresholds – On a regular basis, your team needs to drill down into the value added to products from each country. This will help you determine if you are nearing thresholds and need to start the registration process.
• Establishing OSS Registration – OSS registration helps you streamline your reporting, eliminating the need to file returns in every EU country. We’ll talk about OSS registration in more detail below.
• Harvesting Accurate Data – VAT is based on where your customer lives. This means you need to have the proper controls in place to source the income to each country. Ensuring you are harvesting accurate data helps you monitor when you are nearing thresholds.

Understanding EU One-Stop Shop

Along with the adjustment of the EU threshold, the EU solidified new regulations surrounding goods sold online to EU customers. Registering in each country can be a tedious and time-consuming process that opens the door to errors. As a result, the EU implemented a One-Stop Shop portal to streamline operations.

Let’s say that you are a US-based company that imports products from the Netherlands. You begin paying a 21% VAT. However, your sales team begins to expand, and you now have substantial sales in France. You will be required to register for VAT in France and impose a rate of 20%.

This can lead to the creation of numerous VAT numbers, which the EU looks to reduce with the One-Stop Shop (OSS) portal. The EU OSS eliminates the need to file returns in each European country. Instead, your business will only be subject to one VAT return and tax rate, with your local tax authority distributing the VAT revenue to other EU countries.

Registering for OSS

Businesses can register for OSS and IOSS. Here’s the information you need to know about the registration process:

Registration as a Non-European Business

Non-European businesses that sell digital products to EU customers can register for OSS and select their “home” country. Here are the steps you will follow:

• Select a “Home” Country – Typically, this will be the country with the highest amount of sales. For example, if you have $150,000 in sales to Austria and $10,000 in sales to Germany, it wouldn’t make sense to register in Germany. Another way to choose which country to register in is by user interface. Choosing the country with the most user-friendly registration portal can expedite the registration process and make reporting simpler.
• Obtain a VAT ID Number – After you choose a country, you will be given a unique VAT ID number that starts with “EU.”
• Collect VAT – Then, you will begin collecting VAT at the rate of the country you registered in.

File and Pay VAT – Next, you will remit either monthly or quarterly reports with VAT. The taxing authority you registered in will distribute the VAT accordingly.

Registering for Import One-Stop Shop

All businesses, regardless of home location, can register for Import One-Stop Shop (IOSS) if goods are sold to EU customers below €150. IOSS permits businesses to charge VAT at the customer’s local rate at the time of the sale. This eliminates the levy of VAT when goods arrive in the EU.

Like standard VAT, non-EU businesses can choose the country in which they register for IOSS. However, EU-based businesses are required to register in the country they are established in. IOSS registration isn’t required and is an optional process to further streamline VAT. The registration process is similar to the standard OSS portal, including:

• Select a “Home” Country – EU businesses will register in their respective country, while non-EU businesses can choose the country they register in.
• Obtain an IOSS ID Number – After you choose a country, you will be given a unique IOSS number.
• Collect VAT – Once a customer places an order, they will pay VAT upfront at their local rate.
• File and Pay VAT – Next, you will remit either monthly or quarterly reports through the IOSS portal.

Summary

VAT is a standard process when running an international SaaS business. The fines, penalties, and consequences of non-compliance can be severe, which is why it’s important to understand how you can simplify the process with OSS. For more information on SaaS VAT, check out our other blog posts.