Small and medium-sized enterprises (SMEs) make up an impressive 99% of all businesses in the European Union (EU), playing a vital role in fostering economic growth and job creation. However, despite their significance, SMEs grapple with disproportionately higher tax compliance costs compared to larger enterprises. While compliance costs across the EU typically range between 1% and 2% of turnover, research conducted by the European Commission reveals that SMEs bear a heavier burden in relative terms, although larger enterprises face greater absolute costs in meeting compliance obligations. This discrepancy suggests that compliance costs may include fixed expenses, and larger enterprises leverage economies of scale to manage tax compliance more efficiently. Interestingly, the decision to outsource tax compliance activities versus handling them internally appears to influence companies’ tax compliance costs. Approximately 74% of microenterprises opt to outsource tax compliance activities, indicating a significant reliance on external assistance to navigate tax obligations.

In an effort to ease the VAT compliance burden for SMEs, many EU member states have implemented special rules known as the ‘SME scheme’. This scheme exempts businesses established within the member state with an annual turnover below a certain threshold from VAT registration and collection obligations. However, these exemption thresholds vary significantly among member states, ranging from as low as €10,000 in Greece to €85,000 in Italy. Participation in the SME scheme is voluntary, and if a business chooses to utilize it, it must refrain from charging VAT on any sale as the scheme cannot be applied selectively to specific transactions.

Effective January 1, 2025, the SME scheme will undergo significant amendments. EU member states will retain the ability to set exemption thresholds for small businesses, but a maximum threshold will be set at €85,000. Additionally, small businesses established in EU member states other than the one where VAT is due will be eligible for the exemption, provided that their revenue in the non-establishment member state falls below the national threshold and their annual revenue across the EU does not exceed €100,000.

New SME scheme

The most significant change lies in extending the SME scheme to businesses established in member states other than where VAT is due. This cross-border exemption will have two cumulative conditions: first, the EU annual turnover must not exceed €100,000, and second, the value of supplies made in a specific member state must not exceed that state’s threshold. If the annual turnover is below the state’s threshold but exceeds the EU annual turnover, businesses won’t qualify for the exemption. The cross-border exemption can be used independently of the domestic exemption, and businesses are not required to use this exemption in all member states where they make supplies. Thus, it is possible that a small business will not charge VAT in its home country but will collect VAT when selling to consumers in other member states.

To access the cross-border exemption, the business must first inform their member state of establishment and obtain an individual number with the suffix ‘EX’ in that member state. This notification requirement aims to ensure effective control of the cross-border exemption’s application. This is different from the current rules that do not require member states to register persons covered by the SME scheme. Once identified, the business must report the total value of supplies made in every member state to the member state of establishment.

Regarding the domestic exemption, future rules won’t bring significant changes. Member States may continue applying this exemption, though it remains optional. The annual turnover threshold will be set at €85,000, with each state able to establish lower national thresholds tailored to its economic and political conditions. It’s crucial to note that member states can’t differentiate between established and non-established businesses when setting thresholds. If only the domestic exemption is used, the member state may exempt businesses from registration requirements. Additionally, countries that require exempt businesses to submit a VAT return must allow for a simplified return covering a calendar year.

How the new SME scheme will impact other businesses

The proposed changes to the SME scheme are expected to bring about some alterations for businesses interacting with small enterprises. With the introduction of a higher maximum exemption threshold, it’s anticipated that national thresholds will gradually rise, prompting more businesses to opt for VAT-exempt sales under the SME scheme. As a consequence, businesses purchasing goods and services from small enterprises transitioning to the SME scheme will no longer incur VAT charges. This could lead to complications with systems flagging purchase invoices as incorrect.

EU-established businesses choosing to apply the SME regime may lack a valid VAT identification number, despite still qualifying as businesses under EU VAT rules. As a result, tax authorities in some member states may deem such small businesses as consumers, potentially requiring foreign service providers to charge VAT on cross-border sales of digital services and goods to such businesses. While this position is subject to debate, tax professionals are already observing instances where this approach is being adopted. Consequently, businesses currently engaged in business-to-business (B2B) cross-border sales of digital services and goods to EU customers may need to reassess whether their customer base still includes only businesses and whether they are exposed to new VAT compliance obligations due to the SME scheme changes.

Interaction between the new SME scheme and the One Stop Shop

In addition to the SME scheme, the EU offers another simplification mechanism called the One Stop Shop (OSS), which streamlines the declaration and payment of VAT for certain cross-border transactions. It functions similarly to the SME scheme in that it allows EU businesses to interact solely with their member state of establishment. However, while both schemes aim to reduce VAT compliance obligations, they have fundamentally different scopes.

The SME scheme currently applies to domestic B2B and B2C transactions, aiming to ease the tax compliance burden for small enterprises. Effective January 1, 2025, it will also encompass cross-border sales. On the other hand, the OSS simplifies VAT compliance exclusively for cross-border B2C sales within the EU. It enables businesses to declare and pay VAT for these transactions in a single member state, rather than registering for VAT in each country where they sell.

An intriguing aspect arises when a small business is eligible for both the SME scheme and the OSS. In such cases, simultaneous application of both schemes is possible. A small business can utilize the OSS to collect VAT on cross-border B2C sales while still benefiting from the VAT exemption on sales within their domestic market.

A special type of the OSS is the Import One Stop Shop (IOSS), which allows businesses selling low-value imported goods to charge VAT of the customer’s country at the time of sale, with no VAT levied at the border upon goods arrival in the EU. The commercial benefit of using the IOSS is transparency: the customer pays a VAT-inclusive price at the time of the sale and will not face any additional charges upon the goods’ entry into the EU. To use the IOSS, EU businesses must have separate registration in their country of establishment. According to guidance from the European Commission, the IOSS and the SME scheme are mutually exclusive. This means that if a business opts to use IOSS for importing goods, they must first opt out of the SME scheme. While the guidance is unambiguous on this matter, the VAT law lacks a clear provision that would prevent businesses from using both schemes, leading to uncertainty for small businesses importing goods into the EU.

Concluding remarks

The new SME scheme will extend the VAT exemption to small businesses established in other EU countries, with an estimated reduction of up to 18% in overall VAT compliance costs annually. While these changes primarily target EU-established small businesses, they may also have implications for other businesses involved in transactions with such small enterprises.

Non-EU businesses without a physical presence in the EU will not benefit from the SME scheme and will therefore remain liable for VAT from the first sale. However, there is debate regarding whether a non-EU business with a fixed establishment in an EU member state can be considered ‘established’ and thus allowed to apply the SME scheme. It is essential to clarify the scheme’s eligibility before its implementation in January 2025 to ensure legal certainty.

The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which the author is affiliated.

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