Tax compliance is a pain for any online merchant. It’s complicated, arduous, and expensive. For those looking to expand into Europe, however, taxes get even more complex. In the US, all one has to worry about is sales tax. In Europe, though, there is a tax known as VAT (value added tax), and additional duties may or may not apply. Duty depends on two variables: where the order is being fulfilled, and where the order is being shipped.
Value Added Tax (VAT)
With US sales tax, an eCommerce platform will typically query a third-party tax service once the consumer completes the shipping address information in checkout. The tax service factors in all the order characteristics, company nexus status, shipping destination, and tax laws in the shipping destination’s jurisdiction to determine the rate to charge the consumer. This sales tax amount is added to the order total.
While VAT is contingent upon the shipping destination country, the rates are relatively static, if they apply at all. To ease administrative burdens on digital retailers, there are national VAT registration thresholds set by each EU member. Foreign (non-EU) retailers that sell below these thresholds – for example, €100,000 in Germany – do not need to VAT register.
Unlike sales tax, VAT is also baked into the price of the products sold, so when a European customer goes through checkout, they don’t see the tax itemized separately. For retailers that want to back-calculate the taxes and display them separately, VAT rates can actually be stored in a table within the eCommerce platform to enable easy analysis.
From a legal and accounting perspective, VAT is not officially applied until the order is shipped. In addition, businesses can file reclamations with the government to be reimbursed for the VAT portion of orders. As such, merchants need to supply a VAT invoice that shows the proportion of the tax charged to the customer against the regular unit price of the product sold. This documentation can be a hardcopy receipt shipped with the order and/or a PDF attached to a shipping confirmation email. A VAT registered business would use this documentation when filing their claim for reimbursement.
“While VAT rules are harmonized across the 28 European Union (EU) states, the rates and collections are still set and processed at the national level. This means online sellers must be aware of the local VAT registration rules and invoice requirements, as well as being able to complete very different VAT returns each month/quarter in local languages – there are 24 different languages in the EU. The fines for not correctly charging VAT correctly are high – often with compound interest penalties.”
Richard Asquith, VP Global Indirect Tax, Avalara
How the Value-Added Tax Works
Businesses collect the value-added tax (VAT) on their sales and pay it on their purchases from other businesses. This effectively turns them into tax-collecting agencies. The VAT moves up the production chain until consumers ultimately pay the entire cost of the VAT.
Consumers are often unaware that a tax was levied at all because the VAT is often embedded in the price of goods, This is why the VAT is often referred to as a “hidden tax.”
Suppose you sell enough to VAT register under Distance Selling thresholds, fulfill orders out of Germany, and display prices online in Euro. Your customers have the option to ship their orders throughout the Eurozone, incurring different VAT rates depending on their destination country. How, then, should you alter your pricing to account for VAT, display a customer’s exact order cost, and remain competitive on price?
One strategy is to price items around the highest VAT rate out of all the countries to which you ship. This ensures that your business won’t have to pay VAT out of pocket, but customers from countries with lower VAT rates will be taking on some of the extra cost.
A more successful strategy includes developing pricing for each different shipping destination. The site then displays pricing based on the shopper’s IP address and offers visitors the opportunity to enter their intended shipping destination to ensure accuracy. This information drives pricing site-wide.
As you can see, VAT can throw a monkey wrench into any European expansion plans for retailers selling above the Distance Selling threshold.
Duty is analogous to paying an import tariff. If an order is fulfilled in one country and shipped to another, a duty may apply to the order depending on which countries are involved.
When it comes to Europe, goods produced and sold within the EU will not incur duty. However, if goods are either A) produced outside the EU, or B) sold outside the EU, duty will most likely apply.
Duty can be collected in two different ways: Delivery Duties Paid (DDP) and Delivery Duties Unpaid (DDU).
Merchants who collect via DDP package duty into the customer’s purchase and collect during order payment. This places a larger administrative burden on your business, but ensures the order is delivered to the customer at no additional cost.
Alternatively, DDU collection passes duty responsibilities onto the customer. The order recipient pays duties when the parcel is delivered and only pays for the product up front. DDU collection is much simpler and safer for your business, but can create some very unhappy customers if it is not communicated clearly to them ahead of time.
When it comes to duty – whether following a DDP or DDU strategy – you need to clearly communicate with your customers. This means ensuring that they have accurate order and cost information before they click “buy,” and providing accessible and helpful custom service post-order.