Value-added tax: interesting facts, benefits, and tax rates

Table of content

1. Explanation and definition of sales tax
2. Tax amount and tax rates
3. Which tax rate applies in what situation?
4. Sales tax and input tax for companies and management
5. Explanation of input tax and input tax deduction
6. Example for private and intra-commercial transactions
7. Special regulations for foreign countries
8. Special regulations regarding a sales tax exemption
9. Booking of the sales tax

1. Explanation and definition of sales tax

Back to table of content

Sales tax exists in many countries outside of Germany, and it is often referred to as ‘consumption tax’, which already gives a good indication of its purpose. The state levies sales tax on consumer purchases of all kinds and only very few products are exempted from this. Whenever a commercial person, like a company or a trader, sells a product, he has to add the sales tax to the net price. The recipient of the invoice then pays the gross price, which is made up of the net price and the sales tax/value-added tax.

The legal basis for this is provided by the VAT law with its §1 UStG. The paragraph states that all services or products are subject to VAT if the recipient pays a fee for them. The VAT obligation therefore also applies to all companies domiciled in Germany, although there is a special regulation for small businesses, which will be discussed in more detail later in this article. Germany is not the only country with this tax. Consumption taxes are also levied in other countries, only with different names. For example, “VAT” (value-added tax) in the USA.

2. Tax amount and tax rates

Back to table of content

At the time of this article there are two tax rates:

– 7 % (reduced tax rate)

– 19 % (regular tax rate)

Furthermore, the tax rate was temporarily reduced to 16 % and 5 % in the second half of 2020. This reduction was an action taken by the federal government to lower prices. The intention was to boost consumption in times of the Covid 19 pandemic. According to the government, the tax rates before Covid-19 will apply again from January 2021.

For both tax rates, the net price will be used as the basis of assessment. For example, if the net price is 100 euros and the product or service is subject to the regular tax rate, then 19%, i.e. 19 euros, must be added to it. When calculating back from the gross price to the net price, it is crucial to know that the gross price then corresponds to 119 %.

3. Which tax rate applies in what situation?

Back to table of content

Usually, the rate of 19 % always applies. This only does not apply if goods and services are specifically listed in §12 UStG, which is an overview of such goods and services with a reduced tax rate. The reduced tax rate applies to many products that the state considers vital, such as various foods or generated turnover from livestock and agriculture. Some cultural activities, such as theater visits and museum tickets, are also subject to the 7% tax rate. The same applies to some dental services. Medical treatment, for example by a family doctor, is completely exempted from tax, as it is not considered consumption.

4. Sales tax and input tax for companies and management

Back to table of content

The tax levied, regardless of whether it is 7% or 19%, should be transparently presented in the invoice. The legal basis for this is provided by §14 UStG. The invoice must also contain the VAT ID No., which has no significance for private consumers, but is relevant in the exchange of goods and services between two commercial persons.

This exception needs an additional explanation. Commercially active persons are not specifically subject to value-added tax or consumption tax, as the transmission of services and products in a commercial context is not considered consumption. In practice, this means that the company must record the VAT on the invoice and the gross amount is also transferred. However, the company only manages the VAT temporarily and must return it to the tax office at a later date – after it has been calculated against input tax.

5. Explanation of input tax and input tax deduction

Back to table of content

Input tax concerns the company that pays the invoice issued by another company. The invoice contains the VAT, but the company that needs to pay only advances money. The process of the input tax deduction offsets the tax amount against the issued invoices and the accumulated VAT. If the VAT received is too high, it is transferred to the tax office regularly. This happens monthly or quarterly and is thus balanced. If the side of the input tax paid is predominant, the company that made the advance payment receives a refund from the tax office.

In a nutshell, both sales tax and input tax are of little relevance to companies if they provide services exclusively on an intra-commercial basis. For both parties, the tax levied is merely a temporary expense or a temporary gain. Calculations are therefore based exclusively on net prices for intra-commercial transactions. The turnover or value-added tax only gains relevance with the price formation if services and goods are marketed to the private consumer. This is because this private consumer cannot reclaim the tax, since its purchase is classified again as consumption.

6. Example for private and intra-commercial transactions

Back to table of content

The following example serves to illustrate the turnover, input and value-added tax, which all describe the same money.

Dealer A buys electronics from supplier B for the net amount of 10,000 Euro. Supplier B levies the 19% VAT on this, as intended. The gross amount on the invoice is 11,900 Euro, which dealer A also transfers in this way.

Dealer A sells the purchased electronics to private consumers, each individual product is subject to 19% VAT. The total net sales amount to 20,000 Euro. The dealer also received the 19% VAT (3,800 Euro) from the private consumers, so he booked a total of 23,800 Euro.

Dealer A now has the option of offsetting sales tax and input tax. He is not allowed to keep the value-added tax (3,800 Euro) but has to pay it to the tax office. However, he can reduce this amount by the input tax previously paid to the supplier (1,900 Euro) and therefore only has to pay the difference of 1,900 Euro. The profit therefore always results exclusively from the net prices in purchasing and then reselling, as the retailer cannot consider the VAT received as profit or additional margin.

In this example, the private consumer pays more than the pure net price (19% more) and has no opportunity to offset or reduce these, since his purchase is considered as consumption and the tax exists exactly for this reason. This is nevertheless beneficial for companies. For example, if they buy office equipment, they receive it 19% cheaper than the private consumer, since only companies can carry out the offsetting, while the private consumer pays the full gross price without later offsetting.

7. Special regulations for foreign countries

Back to table of content

In the case of transactions from other EU countries, rules on intra-community acquisition apply. The company that makes the purchase is obliged to calculate and pay the VAT independently. In case of transactions outside the EU zone, the import sales tax is applied, which is levied by the responsible customs authority. The supplier from a foreign country does not charge VAT, but it is incurred on the buyer’s side. In return, deliveries outside the EU are also VAT-exempt for the German supplier.

8. Special regulations regarding a sales tax exemption

Back to table of content

Small businesses are exempt from sales tax. However, small businesses must indicate this on their invoice. Small businesses may not generate more than 22,000 euros gross in the previous year and probably not more than 50,000 euros gross in subsequent years. Small businesses thus benefit from simplified accounting, but they also do not have the option of deducting input tax, which can have a severe long-term impact. In return, however, products and services can be provided without the VAT surcharge of 19%, allowing small businesses to set attractive end-consumer prices.

In addition, some professions are completely exempt from charging VAT:

– Doctors

– Dentists

– Alternative practitioners

– Similar healing activities

– Teachers at universities and private schools

9. Booking of the sales tax

Back to table of content

Sales and input taxes must be booked separately. Gross prices must also be divided into net prices and their respective taxes, i.e. sales tax or input tax. The respective amounts are recorded in double-entry accounting on accounts specially created for this purpose within the accounting system. Turnover tax and input tax are kept on separate accounts. A division is also necessary outside of double-entry accounting if the EÜR revenue surplus accounting is used.

Pending differences are regularly balanced out with the relevant tax office. In case of larger turnovers usually monthly, in case of moderate turnovers also quarterly. Depending on whether the turnover or input tax side is predominant, the business person compensates excess turnover tax by paying the tax office or, in the case of excess input tax, receives a refund to his account. This is done by the advance sales tax return, which must be created in due time and has to be transmitted digitally.