Germany’s reduced VAT: Everything you need to know as an Entrepreneur
On 12 June 2020, Germany’s federal government decided in favour of a temporary reduction in the nation’s value added tax, or VAT, as part of an economic stimulus package designed to mitigate the impact of the COVID-19 pandemic. From 1 July 2020 on, the normal VAT rate of 19 percent will drop to 16 percent, while the reduced VAT rate will drop from 7 to 5 percent. This reduction in both VAT rates is scheduled to remain in effect until the end of the year.
Who is set to benefit from the new and temporary VAT rates?
Consumers and entrepreneurs alike will benefit from the VAT reduction. As an entrepreneur, you will be able to get the VAT you’ve paid on purchased goods back from the tax authorities (Finanzamt) via the input tax. Of course, this presupposes that your company is entitled to deducting input tax. In contrast, private end-users must always pay VAT and cannot claim any deduction from the tax office. In other words, the current reduction in VAT is primarily aimed at companies who sell their goods and services to private customers. For business customers engaging in business among themselves, VAT is a continuous item that has no real direct impact on profit.
The idea behind the reduction in VAT is that companies pass on the full reduced rate to private customers by cutting prices at that same rate. If this leads to higher demand for the now less expensive products and services, then this, in turn, will lead to greater sales and higher company profits, which could help save many companies from bankruptcy.
On the other hand, critics fear that the VAT reduction might not actually make its way to customers, seeing as companies are not legally obliged to pass on the reduced tax rate to their customers. The following are options open to you as an entrepreneur with regard to the VAT:
- You can pass it on in full to your customers
- You can pass in on in part to your customers
- You can refrain from passing any of it on to your customers
Companies that do not change their prices and then pay the reduced tax rate to their local tax office can use the VAT reduction as a way of increasing their profit margin.However, even when the reduced tax rate is passed on to customers, the savings for the customer are marginal.In order to experience a more effective level of relief over the long term, companies would have preferred to see reductions in the so-called revenue taxes, which include income tax, corporate tax and business tax. Add to that the fact that the relatively short-term announcement regarding the reduction in VAT presented a number of companies with major challenges; in addition to the pressure on companies to implement the changeover in the space of three weeks, they are also incurring costs; once for the reduction in July, and a second time in December, when it will become necessary to switch back to the regular VAT.
Impact of the VAT reduction on companies
Companies were asked to accept the challenge of adjusting their cash registers and billing and accounting systems to the reduced VAT rates. They had to reconfigure software and make several adjustments to master data and contracts as well as to direct debit mandates. Smaller companies often lack the experience and means to undertake this shift, which can quickly lead to a sense of being overpowered by all the necessary changes. Companies that use accounting software often receive support from their providers, and many of the necessary system changes have already been made so as to take the burden off companies.
Impact of the VAT reduction on different industries
The retail sector, in particular, has come under time pressure. In addition to technical adjustments, the products in their sales areas must be re-labelled. Prices listed on shelves, in catalogues and in online shops also have to be changed. The Federal Ministry for Economic Affairs and Energy is giving retailers and service providers the option of offering flat-rate discounts, which provides a great opportunity to pass on the VAT to their customers in a manner that is as inexpensive and non-bureaucratic as possible. This exception is in line with § 9 Paragraph 2 of Germany’s Price Disclosure Ordinance (PAngV), which entitles retailers to grant their customers discounts directly at checkout without being expected to change the prices of all goods on the night before 1 July 2020.
In the restaurant and hospitality industry,the reduced VAT rate of 5 is already granted for meals that are consumed outside of the premises. Starting in July, this rate will apply to meals that are consumed in a restaurant as well. Beverages are, however, exempt from the reduced tax rate – as of July, the 16 percent VAT applies to them.
As an entrepreneur, what should you keep your eye on?
The most important thing determining which VAT rate to use is the time at which the sales tax is levied. Germany’s VAT Law (Umsatzsteuergesetz or UStG) distinguishes here between two types of services and deliveries:
- Services for which VAT is due at the end of the month in which it was levied
- Deliveries for which the VAT is levied when the invoice is issued. This includes, for example, construction work or cleaning services.
You will also need to take this question of precise time into account when selling gift certificates to your customers. In this case, a distinction is made between single-purpose and multiple-purpose gift certificates or vouchers. Single-purpose gift certificates bought before 1 July 2020 will have a VAT rate of 19 percent in accordance with § 3 Par. 14 UStG. However, if that voucher is redeemed between July and December, the service or goods will be taxed at a rate of 16 percent on the invoice. Accordingly, you will have to undertake a VAT adjustment. You can avoid having to put in this extra effort by selling multi-purpose gift certificates, which, in accordance with § 3 Par. 15 UStG, are only taxed when they are redeemed.
In the case of down payments, the VAT law distinguishes between advanced payments received and advance payments made. Here’s an example: You made a down payment prior to 1 July 2020 and received a pre-tax refund of 19 percent. But you will only actually receive the service after 1 July 2020, which means that the invoice will list a tax rate of only 16 percent VAT. In this case, you are obliged to pay back the excess pre-tax refund to your local tax office. If you received a down payment prior to 1 July, and you then paid 19 percent VAT to the tax office for a good or service that will take place after 1 July, then you’ll receive your overpaid VAT back from the tax office. In both cases, you will have to carry out an adjustment to your VAT or your input tax deduction. In contrast to down payments, the partial delivery of services leads to a final levying of the VAT.
Avoid reporting incorrect or unauthorised VAT
It remains to be seen whether the reduction in VAT will bring the desired economic upturn. At this point, it is clear that the changeover involves a considerable effort on the part of entrepreneurs who do business with private customers. There are also a number of things to consider when drawing up orders, contracts and invoices and accounting, if companies want to avoid incorrect reporting of sales tax and input tax. For example, you should pay close attention when invoicing or receiving an invoice to the time of delivery and/or the time at which a service was performed. It might also be wise to review any long-term contracts, as adjustments might be necessary in some cases.