How does Value Added Tax work?
In contrast to Sales Tax, where an end customer pays a tax during purchase of a product, Value Added Tax is collected at every stage of production. 166 countries around the world use a Value-Added taxation system, as it is easy to track the exact tax imposed during each stage. There is no risk of a double-taxation if VAT is followed.
Take the example of an Oak company that sells raw Oak to a furniture maker for €100 + a VAT rate of 5%. It will charge the maker €105 and pay the tax amount of €5 to the government. The furniture maker will sell the furniture to a store for €300 + a VAT rate of 5%. It will charge the store €315 and pay €15 - €5 = €10 to the government. Finally the store will sell the finished furniture to its customer for €500 + a VAT rate of 5%. It will charge the customer €525 and pay €25 - €15 = €10 to the government.
Does VAT affect your SaaS business?
Businesses that want to sell their SaaS products in a region where VAT is employed, must first register for VAT and obtain a VAT number. The VAT number is an identifier that is used to verify if you are a business or an end customer. Filing VAT invoices and returns is also mandatory for your business. They report the amount you are due to pay, and also the amount you can reclaim.
All SaaS businesses selling in a region where VAT system is followed must comply with the VAT rules. Choosing not to comply could result in paying back-taxes and penalties. To see if your SaaS product is qualified as VATable, you can address the following criteria:
It is not a physical, tangible good.
It’s essentially based on IT. The offering could not exist without technology.
It’s provided via the Internet or an electronic network.
It’s fully automated or involves minimal human intervention.