The following post shares my opinion on this subject and must not be deemed as professional financial advice. My opinion is based on information that is freely available online at the time of writing, however that information is always subject to change!
You have maybe heard on the grapevine about new VAT laws that are being enforced in a couple of weeks time, maybe you have thought that it doesn’t affect you but the truth is if you sell your crafts to customers in Europe whether they are digital or physical products, the changes are likely to affect you at some point over the next few years.
So I am writing this post in hope that it will make the whole complicated discussion about the new laws a little easier to understand for makers who are new to business. They say that Tax doesn’t have to be taxing which is true, but easier said than done for many designers & makers who have never had to consider VAT. If you are new to VAT and find the whole tax/vat thing a little confusing hopefully this post will help you out.
Are you a tax expert?
No I’m certainly not a tax expert! I’m that person that teaches Photography & Styling to anyone who will listen, sharing 12 years of photography & business experience to help people sell more online.
I have been self-employed pretty much all of my career and have owned various businesses alongside being a photographer. If you are serious about your business you can’t hide from tax rules, you need to stop what you are doing for a moment and get your professional hat on. Read, learn, ask questions, discover how the changes will affect you and try to plan ahead.
I also know that it can be so confusing for small businesses. No one helped me when I started out all those years ago and I remember that fear of the unknown well. I meet a lot of fellow creative business owners in my line of work, people just like you who simply want to get on with being creative!
It would be so easy to ignore this stuff but trust me, just being aware of the changes and what it could mean for your business in the future is really going to help you out. So I thought why not write a post to share my opinion on this, hey if it helps just one person sleep easy this Christmas it’s worth it right?
Rule changes can be so frustrating!
Just when you have got your business selling something someone comes along and changes the rules. I know, it’s frustrating right? But change is not always a bad thing, for starters it’s the perfect excuse for a pretty new notebook, an escape to somewhere quiet, and an opportunity to really think about where you want your business to go.
Ultimately these changes, despite being a complete headache for micro businesses and from what I gather highly underestimated by the government in terms of how many people it will affect, they are there to stop tax avoidance by the big corporations who often set up offices in lower rate tax havens as an opportunity to pay less tax and undercut their competitors. So while it’s not helpful right now due to the seemingly overlooked side affects on micro businesses, eventually those large corporations won’t so easily get away with dominating the market and independents should once again get a look in on international trade, which can’t be a bad thing.
How is VAT Calculated?
Some makers I have spoken with think that Value Added Tax doesn’t apply to them because they don’t earn enough money from their sales to pay income tax, let alone VAT, but VAT is paid on your sales and is very different to income tax which is calculated from your profit. Because the new laws would mean that some makers need to calculate VAT here is an example of how it affects your pricing.
Let’s say you sell an item for £10 and it costs you £4 to make.
When you are VAT registered you sell the item for £10 + VAT (which in the UK is currently 20%).
£10 x 1.2 = £12 this becomes the VAT inclusive price your customer pays, you receive £10 (making £6 gross profit), HMRC receive £2.
Some businesses choose to absorb VAT if they don’t want to put up their prices and so they might charge £10 inclusive of VAT.
£10 / 1.2 = £8.34 so the customer pays £10, you receive £8.34 (making £4.34 gross profit) and HMRC receive £1.66
You only pay income tax on any net profit that your make over and above the tax free allowance. So once you have deducted the running costs of your business you will end up with a net profit figure and it is this figure that is used to calculate your income tax. So you see VAT is very different to income tax.
On submitting your VAT return you are able to claim any VAT back that you have spent on business purchases/materials which will reduce your VAT bill.
So what exactly are the changes in the law?
In a rather large nutshell what it all boils down to is the place of supply for digital products. Until now the place of supply ruling for B2C (business to customer) services meant that if you sold a service from the UK, the UK was considered to be the place of supply and therefore you would simply add up all of your sales/turnover until you reached the current VAT threshold of £81k in any rolling 12 month period and only then would you need to become VAT registered and start charging your customers VAT on future sales. The threshold hasn’t changed and still applies to UK sales.
However, now the law states that the place of supply from Jan 1st 2015 will be at the consumer end for digital products.
HMRC states on it’s website:
Section 3: Registration for MOSS by businesses currently below the UK VAT Registration threshold (£81,000)
If you supply digital services to a customer in another EU member state, you must account for VAT to the tax authorities in that member state and at that member state’s VAT rate.
Although it is a condition of registering for the MOSS that you must have a UK VAT registration number to identify the business, you will not lose your UK VAT registration threshold.
So in future anyone selling even just a single digital product or service to a country in the EU will be required to register for VAT and pay applicable VAT on their EU sales to all of the relevant member states where the digital product is purchased. For example you sell digital downloads online from Nottingham, UK and sell one to a customer in Paris, France – immediately you would be required to account for VAT in France.
A new scheme called the MOSS (Mini One Stop Shop) makes it easier for micro businesses by allowing you to register for VAT once, and then HMRC will dish out the relevant share of VAT owing to each of the EU countries for you (saving you the task of registering and submitting separate returns for each country you sell to, can you imagine what a nightmare that would be?). However even using the MOSS will involve record keeping like you have never known record keeping before, to prove to MOSS where all of your customers live and to differentiate your sales between each country.
This kind of record keeping is required for 10 years so also involves data storage, and with that comes registering as a data controller to abide by data protection laws. So while you will still be allowed your £81k threshold in the UK before you have to charge VAT on your UK sales, the admin involved in submitting VAT returns to the MOSS for your EU sales alone is a huge burden for designers & makers.
I am nowhere near the VAT threshold so the new law doesn’t affect me, right?
Most crafters haven’t had to worry about VAT it’s true because let’s face it £81,000 worth of sales is a lot of designing, stitching and sewing for one person in a 12 month period. But the new laws apply to all digital sales to the EU regardless of how many sales you have. Also, the EU commission are working towards destination-based taxation on all goods sold to the EU so although the new laws are only relevant to digital products at the moment, it probably won’t be long until all sales to the EU are affected regardless of thresholds.
Will the changes affect my craft business?
The changes only affect digital products sold to the EU from Jan 1st so that might not be relevant to you unless you sell printables, screensavers, graphics, patterns, etc., but remember digital products are just the beginning.
My advice…
Read the new VAT rules and establish whether your products are classed as e-services.
If they are, and you only sell a few here and there to the EU, consider if it is worth continuing to do so. Weigh up the admin costs of submitting quarterly VAT returns and record keeping compared to the return you will make on your EU sales.
See if there are alternative ways to deliver your digital products that could allow you to offer a similar product, but be exempt from the new laws such as creating physical knitting patterns that you post by mail instead of offering downloads. I agree that is not exactly embracing the future of download technology, but hey it’s better than no sale!
Do the new laws apply if I sell via a marketplace?
Some makers I have spoken to think they will not be affected by the change because they sell on a marketplace and have read that selling on marketplaces means that you are exempt, but you would be wrong to assume that this means the likes of Folksy or Etsy will pay your VAT for you.
I read their current terms of use, and in my opinion, both suggest that they are simply venues for you to do business in (much like a craft fair is), and so as a business it looks like you are liable for all taxes involved in the transactions between you and your customer.
HMRC also clearly states on its website that when it comes to 3rd party platforms it is your job to determine whether you are supplying to the platform operator (meaning the platform are responsible for charging the VAT) or supply to the customer directly (meaning that you are responsible for the VAT).
Marketplaces such as Etsy or Folksy, suggest in their terms of use that you are supplying your customers directly. If this is the case, then the VAT on sales would be your responsibility. More importantly, HMRC states that it is your job to determine this in the first place. This means that they won’t accept any excuses such as ‘Etsy didn’t notify me of the new VAT law’ if they start questioning why you are avoiding paying VAT. It is your responsibility to find out, don’t wait to be told.
Some platforms however, act more like retailers and treat you like a wholesaler. HMRC add that…
…if the platform doesn’t clearly state the name of the supplier on the receipt or invoice issued to the consumer, then they’ll be seen as making the B2C supply even if they’re contractually only an agent…’
So in those cases it would be the responsibility of the platform you use to charge the VAT to your customers. But again it’s your responsibility to check.
There is still a lack of clarity in this area, as can be seen in the update from the HMRC on 19 December 2014:
Digital portals, platforms, gateways and marketplaces
If you supply e-services to consumers through an internet portal, gateway or marketplace, you need to determine whether you are making the supply to the consumer or to the platform operator. If the platform operator identifies you as the seller but sets the general terms and conditions, or authorises payment, or handles delivery/download of the digital service, the platform is considered to be supplying the consumer. They are therefore responsible for accounting for the VAT payment that is charged to the consumer.
and the work Enterprise Nation has done to clarify the situation for marketplaces such as Folksy, as seen on the Folksy blog:
1. Is Folksy a marketplace as defined by the legislation?
There is still some debate about this (we find the legislation quite confusing!) so we are engaging in talks with HMRC to try and get confirmation on this. For the moment we are presuming we are liable.
My advice…
Check the terms of use on all of the 3rd party marketplaces and platforms that you sell on, and establish which of those specify that you are responsible for taxes on sales.
Once you have all the facts in front of you, it will be much easier for you to make an informed decision on which market places are working for you, and which could cause you a headache in the future.
It might be possible to switch off sales to the EU on some marketplaces if you feel that the number of sales you have in the EU are not worth registering for the MOSS scheme.
How can I prepare for the future?
The overall future plan for the reformed EU VAT system looks like it will eventually affect all products. The EU commission have abandoned the idea of taxation in the country of origin and have for some time been working on the future of a destination-based VAT system.
Therefore the new law in 2015 is perhaps just the first step. I think it’s highly likely that if the MOSS scheme is successful the EU Commission will roll out a similar system to cover the distance selling of all goods, possibly as early as 2016.
My advice…
If you are planning on selling your crafts a year from now, why not prepare yourself for a potential change in law that could apply to all sales to the EU? There is no harm in keeping an eye on news from HMRC, and making some plans so that you are ready should it happen. Also, it is a good business discipline to plan for the future regardless of law changes.
Here are some reasons why it is a good idea to plan for the future of your craft business NOW…
If you have to register for VAT in the EU, sudden increases in your sales prices will have a huge impact on your business, especially on low ticket items where profit margins are already tight for makers. The additional admin costs will only squeeze them further, so at least with a little advance warning you could increase your prices slowly over time without shocking your regular customers. It will also give you time to look into more efficient ways of purchasing materials.
Suddenly having to register for VAT with just weeks notice is a burden for any sized business. If you are aware now and keep an eye on any changes in legislation, you will be prepared and can set aside time to plan for the next step.
If it looks likely that the VAT laws will soon apply to ALL EU sales, you can plan where you are going to target your marketing. You might decide that it won’t work for your business to sell in the EU and instead decide to concentrate your efforts on craft fairs in the UK, just in case. Or, you might think bring it on! and start pricing for VAT now so that you are ready for the change. You could even increase prices a little now, and squirrel away the extra funds ready to pay an accountant for assistance if needed. You see there are so many advantages to being aware of what could happen next!
Even if the EU VAT reform takes a huge unlikely u-turn, and the ‘place of supply laws’ are not extended to all products, it is still a good idea to think about the eventuality of becoming VAT registered. At some point your sales could get close to the UK VAT threshold. The affect on your sales and costs mean that you will want to be ready to leap over that VAT threshold in terms of sales, and not be loitering around the £80k level, otherwise you will be working harder for the same amount of money. So it’s a great idea to plan for what you would do should you get close. Would you boost your marketing efforts to ensure you increase turnover quick enough? Or, should you stay under the threshold even if it means doing less work? There is no harm in planning now for what you would do in that eventuality.
I hope this post has helped you to understand what is going on with the new law, why it is important to keep your ear to the ground, and has given you the confidence to face these challenges head on.
With the reaction to the law changes, plus the endless petitions on the affect it will have on small businesses, we could see a complete change before it is enforced, who knows!
LJ x
Read further guidance on MOSS at the HMRC website
UPDATED (19 December 2014) – HMRC Guidance
Read about registering as Self-Employed and what counts as income vs hobby
Complete the survey by EU Vat Action on how the changes will affect your business
Follow Enterprise Nation as they build a case for a change in how the new laws affects micro businesses.
This post shares my opinion on this subject and must not be deemed as professional financial advice. My opinion is based on information that is freely available online at the time of writing, however that information is always subject to change!
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