Value Added Tax (VAT) Act – What You Need to Know?
Lepmets & Nõges Law Firm was asked about the Estonian VAT Act and our lawyer will explain some of the basics below. Simply put, the Value Added Tax Act regulates the national tax that (legal) persons are obligated to pay on the object of VAT (primarily from selling goods or providing services in the course of business, self-supply, goods transferred for free to another EU member state for business purposes, expropriation of goods for a charge, importing goods, purchasing goods within the EU, etc.). The obligation to register as a taxable person arises primarily for persons whose taxable turnover exceeds €40,000 from the beginning of the calendar year. The obligation to register as a taxable person with limited liability arises when the taxable value of goods acquired within the EU exceeds €10,000 from the beginning of the year.
The VAT system is harmonized at the EU level, meaning that VAT regulations in EU member states (such as the Estonian VAT Act) must comply with the standards set out in EU regulations (primarily directives and regulations from the European Parliament and Council). If, for example, the Estonian VAT Act and an EU-level regulation conflict with each other, the EU regulation will apply (not the VAT Act). In practice, potential conflicts between the VAT Act and EU law are rare in the experience of our lawyers. In real life, the provisions of the VAT Act are of central importance to all taxpayers registered in Estonia. Based on our daily experience, clients are more likely to need legal assistance with questions related to the VAT Act. Namely, there are numerous misconceptions and misunderstandings related to the VAT Act that, in the worst case, may lead to the taxpayer being held liable for violating the rules set out in the VAT Act. In this article, we will take a closer look at the 0% VAT rate, turnover exempt from tax, and the right to deduct input VAT. For a brief overview of other common questions related to the VAT Act, you can visit the website of the Estonian Tax and Customs Board.
0% Value Added Tax rate and tax-exempt turnover
As lawyers providing legal aid services, we often encounter misunderstandings that 0% VAT rate is the same as tax-exempt turnover. It should be kept in mind that in terms of the VAT Act, the 0% VAT rate is not a tax exemption nor tax-exempt turnover. The VAT Act clearly distinguishes between the 0% VAT rate and tax-exempt turnover - these are regulated by different provisions of the VAT Act.
0% Value Added Tax rate
In practice, the 0% VAT rate most commonly occurs in cases of reverse charging, i.e in cross-border transactions, especially when purchasing goods and services from other EU countries in the meaning of the VAT Act. Let's take an example where a taxable person registered in Estonia purchases a car from another EU country. Without reverse charging, the seller of the car (i.e., a taxable person in another EU country) could be obligated to pay VAT in Estonia. This would be unreasonably burdensome for a seller from abroad.
The reverse charging regulation in the VAT Act allows the situation to be resolved as follows:
- The taxable person from Estonia purchases a car from another EU country;
- The seller in the other EU country marks the car invoice with a 0% VAT rate;
- The taxable person from Estonia pays the seller for the car and pays the VAT due on the car to the Estonian state in accordance with the VAT Act.
Clearly, the 0% VAT rate in the example described above is in no way considered a tax exemption under the VAT Act. The VAT must still be paid on the car. The difference is that if, as a rule, the seller pays VAT to the state, in a reverse charging situation, the buyer is the one who fulfils the tax obligation.
In the context of the VAT Act, examples of tax-exempt turnover include social goods and services such as universal postal services, certain healthcare services, services relating to shelters for the protection of children and young people, or paid pre-school, basic, vocational, secondary, and higher education that is not provided for commercial purposes. Insurance services, leasing or renting of immovable property or parts thereof, and most securities are also not subject to VAT. According to the VAT Act, VAT is not levied on loan transactions, leasing transactions, collateral and guarantee transactions, and other transactions that create obligations binding on the person in the future.
Input Value Added Tax deduction rights
Definition of input Value Added Tax:
Input VAT and its deduction are part of the daily business activities of many taxpayers. According to the VAT Act, input VAT is:
- VAT payable on goods or services acquired or received from another taxable person;
- VAT paid or payable on imported goods;
- VAT calculated on the taxable value of a service he place of supply of which is Estonia and which are received from a foreign person engaged in business who is not registered as a taxable person in Estonia;
- VAT calculated on the taxable value of goods acquired by way of intra-Community acquisition, goods installed or assembled which are acquired, goods acquired by way of a triangular transaction or other goods which are acquired and on which the taxable person is required to calculate VAT pursuant to the VAT Act.
Law firms in Estonia: How does the right to deduct input VAT work in practice?
The entire logic of the VAT Act is based on the understanding that VAT is generally paid by the final consumer. The essential purpose of input VAT is to avoid an astronomical VAT liability for the final consumer. For example, when a person buys a new car for personal use, the situation is simple - the person pays the seller for the car's price and VAT. The seller pays the VAT to the state. However, a problem arises when it is necessary to assemble the car by purchasing various materials. If the car manufacturer had to pay VAT on each material necessary for production, it would inevitably result in a disproportionate increase in VAT liability for the final consumer. The right to deduct input VAT (i.e. the VAT paid on the materials needed to purchase the car) allows the VAT liability generated under the VAT Act to be kept within reasonable limits (because the car manufacturer does not have to add the VAT paid on each material to the final price for the consumer).
However, it should be noted that the VAT Act sets certain limitations on the right to deduct input VAT (e.g. if the turnover generated is tax-exempt in the sense of the VAT Act). For legal advice on more precise questions regarding the VAT Act, please contact our law firm. Our attorneys at Lepmets & Nõges Law Office will help you find a solution to your tax situation, so contact us here.