The Value Added Tax (VAT) is an indirect tax used within all European Union (EU) countries. Although the basic principles are the same within all EU countries, every individual country has its own rules, legislation, and rates. The European Commission has issued two directives to harmonize those rules to minimize the administrative burden for companies engaged in cross-border operations. It also wants to prevent distortions of competition between member states operating with different VAT rates and to diminish fraud.

At the Economic and Financial Affairs Council (ECOFIN) in 2007, a measure called the VAT package was approved. The package has two directives on VAT: one concerns the place of supply of services and one concerns VAT refunds. In February 2008, the directives were accepted by the EU Council of Ministers. They will become effective on January 1, 2010.

I’ll describe the new rules on a high level and show the consequences of the new rules for your SAP system. My intention is not to explain the new rules in all their detail because many local exceptions may remain. I also do not cover changes for specific services that become effective on January 1, 2011; January 1, 2013; and January 1, 2015. They apply mainly to large sports and cultural events, service for these events, rental of transportation, telecommunication services, and radio and television stations.

Overview

There are three principal changes.

1. New place of supply rules for services. The place of supply rules for cross-border services is the major change regarding VAT. Cross-border in this context means that the services are provided in a different EU country than the country of the service provider. A distinction is made between business-to-business (B2B) services and business-to-consumer (B2C) services. B2B services are applicable if the receiver has its own VAT registration number in the country the service is delivered. B2C services are applicable if the receiver doesn’t have a VAT registration number. The B2C services are not only provided to individual consumers, but they can be provided to large organizations (e.g., hospitals) as well.
   
   B2B services will be taxed in the country of the customer receiving the services. For example, if a Dutch company provides services to a German customer, the services will be taxed according to the German law. However the VAT will be charged under the reversed charge mechanism. That means that the sales VAT will not be charged by the Dutch company, but the German company has to register the sales VAT as well as the purchase VAT.
   
   
2. Alignment of VAT rates. Currently, the VAT rates for services and materials may differ per EU country. This is not only because individual EU countries have their own rate, but also because a service or material may have a high VAT rate in one country and a low rate in another country. This latter difference should be eliminated by January 1, 2010, so that a service or material has either a low rate in all EU countries or a high rate in all EU countries.
   
   
3. New VAT refund procedure. Currently, companies can only reclaim their foreign VAT in the country the VAT was incurred. For example, working for a Dutch company, I am legally allowed to reclaim the VAT paid in Germany. However, because I don’t have a German VAT registration number, this is a cumbersome process and therefore only worthwhile if it is a considerable amount. Companies often hire specialized service bureaus to help them to reclaim VAT. On January 1, 2010, it will be possible to reclaim foreign VAT electronically in your own member state. Therefore, I can reclaim German VAT via the Dutch tax authorities.

Now I will provide more detail about the changes, followed by the consequences for your SAP system.

New Place of Supply Rules for Services 

The main VAT rules that are currently in place for services will be reversed. This means that businesses (i.e., companies that have a VAT registration number) will be charged with the VAT rate applicable in the country in which the service is provided. For example, a Dutch company providing a service in Germany to a German company must charge the German VAT percentage (16%) on its sales invoice. (As of this publishing, the Dutch company must charge the Dutch VAT rate of 19%.) The German company must also register this sales invoice as a purchase invoice with a purchase VAT rate of 16%.

For internationally operating companies, this change means an immense increase of VAT rates to maintain and charge. Because one of the purposes of the rule change is to decrease the administrative pressure for companies, companies will use a new reverse charge mechanism. This will also prevent fraud, such as the VAT carousel. For example, company A1 in country A sells a product to an accomplice company A2 also in country A, charging VAT. Company A2 sells the product to customer B1 in country B without VAT. Company A2 reclaims the VAT paid to company A1, but company A1 never pays the VAT because the company disappears (e.g., goes bankrupt or moves to another country). Company B1 sells the product to accomplice company B2 also in country B. Company B2 reclaims the VAT and company B1 disappears. This process keeps repeating itself. The reason company A2 has to sell the product is because tax authorities ask questions if a company doesn’t have turnover but reclaims VAT.

Using the reverse charge mechanism, no VAT is mentioned on the sales invoice, but only a remark that a reverse charge is applicable. When the German company registers the purchase invoice, it has to register both the sales VAT of 16% and the purchase VAT of 16%. This principle is the same as for materials, but in this case it is called the acquisition tax. Now that VAT is reclaimed and paid by the same company, the VAT carousel becomes impossible.

For B2C services, the rule remains as is, namely that you use the VAT applicable in the country in which the service provider is located. A Dutch company providing service to a French person in France must charge the Dutch VAT percentage (19%) on its sales invoice.

Because B2B customers must apply the reverse charge for more cross-border services from January 1, 2010, onward, suppliers will report an EC sales list for services. This report is similar to the already-existing EC sales lists for goods. EU member states themselves can decide whether companies must file these sales lists monthly or quarterly.

Consequences for Your SAP System

The changed rules for cross-border service deliveries will affect both the sales and the purchasing processes. On the sales side, the change will only affect the B2B sales invoice and its related VAT derivation. With a cross-border sale of service within the EU, you’ll have to print a statement on the sales invoice stating that a reverse sales tax is applicable. The exact wording of the statement is country dependent, the country being the country from where the sales invoice is sent. This should be added to the sales invoice as a conditional text, meaning if the tax code used is for a service delivered in another EU country, the text must be printed.

Because you’ll have to report cross-border service deliveries, you have to define a new sales tax code and create or change condition records that contain the derivation of the VAT code. For a correct derivation of the tax code, you may have to define an additional tax classification for the material master. You don’t need to define a new tax classification if you already have such a classification in place. This classification is then already used for the current situation. You define the new VAT code and tax classifications in customizing. The creation or changing of condition records is master data maintenance.

The situation is slightly different for purchasing. The change requires new tax codes, just as sales does, but it most likely will not have to create additional tax classifications and condition records. It is uncommon for EU companies to automatically derive the purchase VAT code. Entering the VAT as mentioned on the purchase invoice, whether it is correct or not, is legally required. However, if you need to set up new tax classifications, you use the same method as for sales. The way to set up condition records is basically the same as for sales, but you use transactions MEK1 and MEK2 instead.

To create new VAT codes, use transaction FTXP or follow IMG menu path Financial Accounting (New) > Financial Accounting Global Settings (New) > Tax on Sales/Purchases > Calculation > Define Tax Codes for Sales and Purchases. Start the transaction and enter the country code and the new VAT code when the system prompts you to do so. Figure 1 shows the settings for a Dutch VAT code for the sales of services. The tax code is A7 and the tax type is A, meaning it is output tax (sales tax). The tax is a reverse tax, meaning that the percentage is 0. Figure 1 also shows you the properties of this tax code. It is important to mark the tax code with EU code 2, which represents services within the EU. You must also assign a general ledger (GL) account to this tax code by clicking the Tax accounts button.

Figure 1

VAT code for sales of service

Figure 2 shows the settings for a Dutch VAT code for the purchases of services. The tax code is Y2 and the tax type is V, meaning it is input tax (purchase tax). In the case of reverse tax, the purchase tax must have two lines: one for the payable tax and one for the reclaimable tax. In Figure 2, you can see that two lines have a percentage. One line is the acquisition tax debit and the other is the acquisition line credit. Figure 2 also shows you the properties of this tax code. You must mark the tax code with EU code 2.

Figure 2

VAT code for the purchase of services

To set the new tax classification for the material master, follow IMG menu path Sales and Distribution > Basic Functions > Taxes > Define Tax Relevancy Of Master Records. On the resulting pop-up screen, choose Material Taxes. For the correct derivation of the tax code in the condition records at least one tax classification for service materials must exist. All service materials must have a tax classification that enables you to recognize them. In Figure 3, you can see two tax classifications for service materials: classifications 5 and 6. The tax category used for the tax classifications for VAT is MWST. It is not necessary to create additional tax classifications for vendors.

Figure 3

Material tax classification

After you customize the tax classification and tax codes, maintain the related condition records for sales with user transaction codes VK11 (creation) and VK12 (maintenance). Figures 4 and 5 show the condition records. Before January 1, 2010, you must apply the local VAT rate. Figure 4 shows that for 2009 you use VAT code A2 for sales from the Netherlands to Germany (country code DE). This code calculates 19%. For 2010, you can see that you’ll need to apply VAT code A7. The percentage is 0.

Figure 4

Sales VAT code for 2009

Figure 5

Sales VAT code for 2010

Alignment of VAT Rates

At the moment, EU countries apply different rates for the same products or services. For example, in some countries a low rate is applicable for books, while others use a high rate. This causes unfair competition, especially in the border areas. With the new VAT, the same tax regime will be applicable for the same products. In all EU countries, the VAT rates on books will be low. This change is applicable only for products sold locally, because for cross-border sales the VAT percentage is 0%. The consequence of the alignment is that for some products the VAT will change from low to high or vice versa.

Consequences for Your SAP System

For your SAP system, this means that you need to apply new rates for some products on January 1, 2010. Before explaining how this is to be solved, I’ll give you a short explanation about how SAP calculates VAT. You can find a more extensive explanation in Roy Brookes’ article, “How R/3 Accounts for the European Union’s Value Added Tax.” 

For local sales, the VAT is determined by the tax classification in the customer master and the material master. If the customer has a classification 1 (relevant for VAT) and the material has tax classification 1 (high rate), the SAP system derives a VAT code for the high VAT rate. If the customer has tax classification 1 and the material has tax classification 2 (low rate) the SAP system derives a VAT code for the low VAT rate.

To handle the change in VAT rates, you must define new tax classifications. In Figure 6, you can see that new tax classifications 7 and 8 for the material masters have been defined. The new tax classifications are to be used for materials or services for which the VAT rate will change. Suppose the VAT rate for a service will change from low to high. This means that currently in the master data of this service the tax classification is 6 (Figure 3). You would like to change this to classification 5, but this will lead to incorrect tax derivation during the year-end period. It is also not possible to make new tax condition records whereby for tax classification 5 the rate is changed to the low rate because the rates for some materials or services won’t change. The use of the newly created classification 7 solves the issue. It allows you to create new condition records that derive the correct VAT rate in 2009 and also new conditions records that derive the correct VAT rate in 2010.

Figure 6

New tax classifications defined in the material master

Figure 7 shows the changed tax classification in the material master. Based on this new classification for the material, you need to set up additional condition records for the VAT. Figure 8 shows a condition record for condition type MWST (VAT) that remains valid until the end of 2009, thus ensuring that the system calculates the low rate VAT until the end of the year. Figure 9 shows the same condition with the percentage valid from 2010 onward.

Figure 7

Tax classification in the material master with a classification of 7

Figure 8

VAT derivation until end of 2009

Figure 9

VAT derivation from 2010 onward

VAT Return Process

You currently have to perform tax return reporting in the country in which the tax occurs. For example, if I stay for my work in a hotel in France, I can reclaim the VAT amount of my hotel bill from the French tax authorities. Because this is a complex process, it is not worth the trouble. Even if the reclaimable amount is large enough, companies often hire special service bureaus that reclaim the tax for them. This saves them the trouble of becoming acquainted with local tax procedures and the administrative burden therein. Companies will now be able to reclaim foreign VAT with their local tax return reporting. How this procedure will work in real life is not clear yet.

Consequences for Your SAP System

Although the local procedures and the SAP changes aren’t clear yet, it is possible to prepare your system for the changes. You need to set up new tax codes for all countries for which you want to reclaim VAT. This is a bit easier for companies that have activated the Plants Abroad functionality.

When setting up new tax codes in transaction FTXP you can enter the reporting country using the Properties button in Figure 10. You can use the tax reporting country later as a selection criterion for tax reporting. Figure 11 shows the tax reporting country (Tax return country) as the selection criterion for tax reporting. If you leave the field blank, all tax codes will be reported. When you fill in a country code, only the tax codes for the selected country will be reported.

Figure 10

Transaction FTXP for tax code with reporting country

Figure 11

Tax reporting with reporting country

When Plants Abroad functionality is not activated, you don’t have these options available. A possible solution is to start the description of the tax code with the related country code. For example, for Dutch VAT codes the description should start with NL, as in NL Input VAT, high rate 19%. This allows you to select the VAT codes that you want to report to the tax authorities.

Posting the VAT

After you set up the foreign VAT codes, you can start using them when making postings. The consequence is that the VAT is posted in the GL. You should use at least one VAT account per VAT country. This allows you to analyze the VAT per country. You can allocate a GL account to the VAT code by clicking the Tax accounts button in transaction FTXP (Figure 10). It is not necessary to use VAT accounts per country, but it gives you more transparency. It also makes it easier to check what already has been refunded per country.

Periodically, you must send your tax declaration to the tax authorities. Your SAP system can automatically make a posting for the advance tax return, but you can only set up this automatic posting using one GL account. Figure 12 shows the tax customizing for the tax return. You can set up this automatic posting within customizing following menu path Financial Accounting (New) > General Ledger Accounting (New) > Periodic Processing > Report > Sales/purchases tax returns > Define Accounts for Automatic Tax Payable Transfer Posting.

Figure 12

Automatic tax return posting with transaction OB89

For a more transparent process, it is better to use one account per country. The standard tax return report RFUMVS00 (or transaction S_ALR_87012357) gives you this flexibility. In Figure 13, you can see that this report allows you to enter an alternative account for the tax return posting. By creating country-specific variants, you can use country-specific accounts.

Figure 13

Alternative account for advance tax return

Final Details Being Worked Out

Because of the late acceptance of the new legislation by the EU Council of Ministers, the local legislation is not yet in place. This means that the country-specific procedures haven’t been finalized yet. Make sure that you check with the local authorities about how the new rules will be applied and what the new procedures will look like. Also, SAP does not provide standard information about this subject. The current EC sales list only reports materials that have a VAT code with an EU code 1 or 3 (for physical materials). So currently no report exists for reporting cross-border service deliveries. Be aware that the deadline for tax refunds differs per country. This may affect your period-end closing procedures.

Kees van Westerop

Kees van Westerop has been working as an SAP consultant for more than 25 years. He has an MBA degree in mathematics and a degree in finance. Kees has been concentrating on the financial modules, especially in general ledger accounting, cost center accounting, and consolidation. He also has a great deal of experience with rollouts of kernel systems and integrating finance and logistics.

You may contact the author at keesvanwesterop@hotmail.com.

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