Private individuals with low volumes of sales can take advantage of simplified tax and administrative arrangements by registering for the small scale entrepreneur rule. Discover what the small scale entrepreneur rule is, what requirements you need to meet, and what your obligations are as a small scale entrepreneur.

What’s in this article?

• What is the small scale entrepreneur rule?
  
• How is a small scale entrepreneur different from a small business?
  
• What are the eligibility requirements for the small scale entrepreneur rule?
  
• Who benefits from the small scale entrepreneur rule?
  
• How do you register as a small scale entrepreneur?
  
• What other tax obligations apply with the small scale entrepreneur rule?
  
• What other obligations apply for small scale entrepreneurs?
  
• What do you need to do if you exceed the sales thresholds?
  

What is the small scale entrepreneur rule?

Companies in Germany are subject to value-added tax (VAT) and therefore are obliged to charge VAT on their goods and services. However, companies with low volumes of sales may be exempt from this obligation. The small scale entrepreneur rule is regulated in Section 19 of the VAT Act (UStG). The aim of this simplification rule is to reduce administrative tasks for both businesses and tax offices, which would otherwise be disproportionately high given the low level of tax revenue. In 2022 alone, around 550,000 people set up small businesses in Germany. Those anticipating low sales volumes found themselves facing the decision of whether to register for the small scale entrepreneur rule.

How is a small scale entrepreneur different from a small business?

The terms “small scale entrepreneur” and “small business” signal different circumstances. A small business is a commercial enterprise that is not subject to the provisions of the German Commercial Code (“Handelsgesetzbuch” or “HGB”), provided its profits are lower than 60,000 euros, or its sales are lower than 600,000 euros, for the year. Small businesses are not entered in the German commercial register and they have simplified accounting obligations. Small businesses can also opt for the small scale entrepreneur rule and a distinction is made in this regard between noncommercial enterprises, such as freelancers, and limited liability companies (“Gesellschaft mit beschränkter Haftung” or “GmbH”).

What are the eligibility requirements for the small scale entrepreneur rule?

The most important prerequisite for small scale entrepreneur status is that the freelancer or company’s entire annual sales volume for the previous year must not exceed 22,000 euros, and it must not be expected to exceed 50,000 euros for the current year. The month in which the company was founded is relevant when calculating the sales threshold for the year of establishment. This is because the sales threshold applies on a pro rata basis when a company is not founded at the start of the year.

For example: if a company is founded in June, the sales threshold is recalculated for the remaining seven months of the year. This means that the company can only record total sales of 12,833 euros in order to achieve small scale entrepreneur status: (7 ÷ 12) × 22,000 euros.

Who benefits from the small scale entrepreneur rule?

The small scale entrepreneur rule has advantages and disadvantages, which need to be carefully weighed based on your situation. Managing a business subject to standard taxation rules involves considerable obligations. These include charging VAT on all invoices, submitting regular preliminary VAT returns, and preparing a comprehensive VAT return. However, these three obligations do not apply to businesses exempt from VAT. This results in the following benefits:

• Reduced accounting administration, and therefore more time for conducting business and acquiring customers
  
• A competitive advantage over companies subject to VAT, since VAT-free prices are clearly lower
  

However, VAT exemption does come with its disadvantages:

• Small scale entrepreneurs are not entitled to deduct input tax and therefore do not receive a VAT refund on their operating expenses.
  
• If there is no VAT indicated on the invoice, it can give customers the impression that the business has low levels of sales and, by extension, limited business experience.
  
• The small scale entrepreneur rule only applies to goods and services sold in Germany. Standard tax rules apply to cross-border sales.
  

The small scale entrepreneur rule is a secure option for anyone starting out on their own, or using their business to generate additional income. In the long term, however, it does prevent your business from growing.

How do you register as a small scale entrepreneur?

The decision to register for the small scale entrepreneur rule must be made at the time the business is established, and notified to the competent tax office when registering for tax purposes. The rule is not automatically applied as soon as the relevant requirements are met, however; it needs to be selected proactively. It is important to make sure that the sales forecast indicated is below the relevant sales threshold for the small scale entrepreneur rule. Alternatively, businesses can opt not to be subject to the rule. If the company opts against registering for the rule, it cannot then change its mind again for five years. It is only after this five-year period has passed that businesses can apply for the small scale entrepreneur rule by writing to the tax office.

The tax registration form needs to be sent electronically to the competent tax office within one month of registering as a business. This can be done using the tax administration platform ELSTER.

What other tax obligations apply with the small scale entrepreneur rule?

Small scale entrepreneurs are subject to the same general tax provisions as other taxed entities since the small scale entrepreneur rule only applies to VAT.

The following types of tax apply to small scale entrepreneur:

(Note: The submission deadline for all of the tax returns stated below is July 31 of the following year. For example, a tax return for 2022 must be submitted by July 31, 2023.)

Income tax

In accordance with Section 2 of the EStG, income tax includes, among other things, all income from freelance work and from a trade. This means that all small scale entrepreneurs need to declare their income within the context of income tax. To this end, once a year, businesses must submit their accounts—prepared using the cash accounting method, (“Einnahmenüberschussrechnung” or “EÜR”)—to the tax office.

The cash method of accounting is a simplified accounting method for freelancers and small scale entrepreneurs. All of the income and expenditures for the relevant tax year is included in the relevant “EÜR appendix” form and is used to calculate the relevant profit. This profit forms the basis for the income tax liability. A personal allowance of 10,908 euros applies (as of 2023). If the calculated income is below this limit, then no income tax is due.

Trade tax

Trade tax is only imposed on trade businesses. Small scale entrepreneurs operating on a freelance basis are, therefore, not subject to trade tax and do not need to submit a trade tax return. The personal allowance for trade tax is 24,500 euros per year. Given that this amount is over the VAT threshold for the small scale entrepreneur rule (maximum 22,000 euros for the previous year), small trade businesses are usually not liable for trade tax. However, a trade tax return still needs to be submitted by the relevant deadline.

VAT

Small scale entrepreneurs must still submit an annual VAT return despite being exempt from VAT. Since it can be assumed that no VAT will be indicated on the return, it merely serves to confirm that no VAT is due.

What other obligations apply for small scale entrepreneurs?

Aside from their tax obligations, small scale entrepreneurs are also subject to other requirements relating to accounting and the retention of documents. There are also specific regulations applicable to invoicing.

Retention periods

A retention period of up to 10 years applies to business documents such as invoices, receipts, and contracts. During this period, the tax office is entitled to request access to these documents within the context of a tax audit. The precise deadlines and relevant documents are listed in Section 147 of the Tax Code (“Abgabenordnung” or “AO”) and Section 257 of the Commercial Code (HGB).

Accounting obligation

Small scale entrepreneurs are obliged to keep simple accounts. This means maintaining chronological and separate documentation of all operating income and expenditures, which is then used to prepare the cash-based accounting statement.

Mandatory identification on invoices

Invoices issued by small scale entrepreneurs must be labeled as such given they do not include any VAT. Reference to section 19 of the UStG is sufficient in this respect. All mandatory information required on invoices is set out in the article “Creating invoices as a small business in Germany.”

What do you need to do if you exceed the sales thresholds?

If a small scale entrepreneur exceeds the sales limits set out in Section 19 of the UStG, then it will need to switch to standard tax rules from January of the following year. This means that the small scale entrepreneur rule no longer applies and the company will become liable for VAT. When a business becomes subject to standard taxation, the following steps need to be undertaken:

Write notification to the tax office

If the threshold of 22,000 euros in the current year is exceeded, the competent tax office needs to be informed. Otherwise, the tax office will only learn of this circumstance by the middle of the following year when it receives the relevant tax return. If the business continues to not charge VAT from the start of the following year until the date of the tax return, then the tax amounts legally due for the entire period will have to be paid retroactively to the tax office. To avoid considerable financial losses, it is therefore essential for small scale entrepreneurs to keep an eye on the VAT thresholds.

Charge VAT

Businesses subject to VAT must charge the corresponding rate of VAT on their goods and services. Depending on the VAT rate, this amounts to 19% of the net value, or 7% for discounted goods and services.

For example: A small scale entrepreneur sells a service for 100 euros. After switching to standard taxation, it will need to charge 119 euros for this service (net value of 100 euros + 19% VAT = gross value of 119 euros).

Submit preliminary VAT returns

Businesses subject to VAT must pass on the VAT they collect to the tax office. To avoid the resulting tax liability becoming due in its entirety at the end of the year, businesses are obliged to submit preliminary VAT returns—and make the corresponding payments. Collecting tax on a monthly or quarterly basis protects the tax office against payment defaults, and it helps businesses with their financial planning.

Preliminary VAT returns need to be submitted on a monthly basis during the first two years after switching to standard taxation; after that, the tax period will depend on the VAT liability for the previous year.

This brings us to a benefit of standard taxation: by reporting and paying VAT in advance, businesses can offset their own input VAT—in other words, VAT that businesses themselves have paid. If the total VAT on expenditure is higher than that for income within a given period, this leads to a VAT credit and the business will receive a rebate.