One of many sparks to create this series of blog posts arrived when reading confessions from fellow entrepreneurs stating that they have no idea how to calculate value added tax (VAT), not even after over a decade in business. We need to fix this right now! This is a blog post in our beginner-level series First Steps Into Accounting on accounting and bookkeeping.
In This Blog Post
We will cover the following in this post:
- Product Pricing
- Adding Tax
- Working Out VAT-Free Price
- Putting Products On Sale
- Removing Sale
- VAT In Online Sales To EU Customers
- Digital Products
- Online Sales Within The EU
- Wrapping Up
Disclaimer: We are no tax experts, so read the contents of this post as commentary only. Always consult a bookkeeper or accountant for the latest developments in tax laws and other expertise.
1. Product Pricing
When setting prices for your products, it is advisable to think in terms of no tax at first. You are obligated to collect tax, so it is a portion of the final price that simply passes through your firm, whilst on its way to the government.
What will your price before tax consist of in order to cover all expenses involved in its creation as well as include your compensation for the work done?
Only then can you add tax as below.
1.1 Adding Tax
Shortcut
Once you have worked out a suitable number for the product, we will use Finnish 24 % VAT as example.
An offering worth 100 € would be multiplied by 1,24 to give 124 € like so: 100 € x 1,24 = 124 €. This is a shortcut calculation.
Remember percentage calculations from school in which 100 % means 1, and 90 % is 0,90.
The product price without VAT is 100 % (1), and the tax to add is 24 % (0,24), which is why VAT is handled as 1 + 0,24 = 1,24.
Longer Version
The longer calculation looks like this: 100 € x 1 (price without VAT) + 100 € x 0,24 (24 % VAT) = 100 € + 24 € = 124 €.
If your local tax is 19 %, the product price without tax is 1, or 100 %. Tax is 0,19. Price with tax then becomes: 100 € x 1,19 = 119 €.
1.2 Working Out VAT-Free Price
Shortcut
How do we figure out what a product costs without tax, if the number we begin with includes VAT?
If a product costs 150 € and it includes tax 24 %, some business owners make this mistake: 150 x 0,24 = 36 € and 150 € – 36 € = 114 €.
To get the correct price, calculate like this: 150 € / 1,24 = 120,97 €. This is the shortcut calculation.
Longer Version
The longer version of this equation is: (150 / 124) x 100 = 120,97 €.
- When dividing the product price by 124 (100 % + 24 %) you calculate what 1 % of the product costs.
- In the next step when multiplying that number by 100, you calculate how much 100 % of the product is. This is the price without VAT.
- The shortened calculation earlier is created because 124 / 100 = 1,24.
If you want to avoid memorising the formula and risking calculation errors, you can arrive at the VAT-free price by taking the longer route, which requires you to understand what you want to calculate.
If your local tax is 19 %, you divide the VAT-including price by (100+19=) 119 first, and then multiply by 100 just as above. Shortened it would be 150 € / 1,19 = 126,05 €.
1.3 Putting Products On Sale
When you want your 124 € costing product on 20 % sale, the new price will be 80 % of the original: 100 % – 20 % = 80 %, or 1,00 – 0,20 = 0,80.
Calculating the new reduced price looks like this: 124 € x 0,80 = 99,20 €.
This price includes product and tax, so you should proceed without the earlier, more complicated calculations.
Rephrased, due to the sale you get 80 % of the original product price, and therefore should also collect less tax, 80 % of the full amount.
Since VAT is left out of this consideration, it works the same regardless of local tax percentages.
1.4 Removing Sale
Shortcut
Once your sale is over and you want to increase the price to its original, there are a couple of mistakes that could happen.
Mistake 1: If you were to think that the discounted price is now considered 100 %, you would multiply 99,20 € from above by 1,20 (100 % + 20 %). You would end up on 119,04 €, not 124 € as you should.
Mistake 2: You could get confused and add VAT-related thinking to fixing the sale. For instance 99,20 € could become 123,01 € if you multiply by 1,24. It looks close enough, but is incorrect.
When you put the product on sale by reducing it to 80 % of its original price, you have to add back 20 % so it reaches 100 %.
You do it like this: 99,20 € / 0,80 = 124 €. This is the shortcut calculation.
Longer Version
The longer calculation looks like: (99,20 € / 80) x 100 = 124 €.
2. VAT In Online Sales To EU Customers
2.1 Digital Products
VAT is rarely a super fun discussion topic, but in order to sell digital products legally to customers in the European Union (billing address), you need to know quite a bit. The EU law has been in effect since 1 January 2015.
The nutshell version is:
- VAT is calculated based on the customer’s country VAT for the digital products in question, regardless of your own location.
- The easiest is to register to sell in the EU such that while you report taxes collected for each individual EU country, the total sum is transferred to one bank account only (and they distribute it from there to individual countries where you’ve had customers). UK called this system VAT MOSS (mini one-stop shop) before Brexit.
- Reports happen each quarter and are due on the last day of a new month once a quarter has closed (eg 30 April for Q1), whether it’s weekend or not, and fines are considerable for overdue payments.
Do you need to get your papers in order? Have you planned on selling digital products?
The above applies to B2C customers only by the way, so it is worth installing a plugin for B2B customers to add their VAT number at checkout!
2.2 Online Sales Within The EU
The EU decided to expand the above system to all online sales per 1 July 2021. If you sell on a small scale, you might still be able to collect local tax only and report locally, which is yet another reason why having a seasoned bookkeeper is crucial.
We at Wemla found it easier to implement this system and stick with it regardless of sales numbers. The backend of our website shop needs a long list of taxes added for every single EU country, but once it has been set up, maintenance is rather straight forward.
Services are still paid for by EU customers with our local tax 24 %, and people outside of the EU still pay no tax at all. Were we ever to sell physical goods locally, those would have the same tax added.
In other words, the new regulations concern physical goods and digital products (such as courses without a live element, audio or PDF files) sold on the internet.
It is worth noting that if a course includes a live element such as a workshop delivered via Zoom, these are considered demanding your presence and as such are categorised a service, not digital product. And since your person is located for example in your home country, that is also the tax, which is applied.
3. Wrapping Up
It is a lot to take in as a beginner, but as concluded earlier once this tax system is set up properly, you don’t have to touch it again apart from updating tax percentages when they change, and add or remove countries from the list of EU members. Typically a percentage changes around New Year, so it isn’t often.
And now, tell us in the comments what you think of the VAT calculations themselves as well as these regulations!
Disclaimer: We are no tax experts, so read the contents of this post as commentary only. Always consult a bookkeeper or accountant for the latest developments in tax laws and other expertise.
This is a blog post in our beginner-level series First Steps Into Accounting on accounting and bookkeeping.
Photo credit: David Kristianto.
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