In principle, businesses in Germany must collect value-added tax (VAT) on sales and pay it to the tax office. However, under certain conditions, a business can qualify for a VAT exemption. This article explains what VAT is, in which cases businesses can earn an exemption from it, and how to apply for a VAT exemption. We also explain the advantages and disadvantages of a VAT exemption.

What’s in this article?

• What is VAT?
  
• When is an exemption from VAT possible?
  
• How do you apply for a VAT exemption?
  
• What is the difference between tax-obligatory, tax-free, taxable, and nontaxable sales?
  
• What are the advantages and disadvantages of a VAT exemption?
  

What is VAT?

VAT is a consumption tax in Germany regulated by the VAT Act (UStG). The tax applies to nearly all products and services bought and sold in Germany (see Section 1 of the VAT Act). Because VAT is an indirect tax, the business selling taxable goods pays VAT to the tax office; customers do not. Businesses include this tax in the price of their goods and services. Though doing business in Germany entitles businesses to the net price of their sales, these businesses pay the added VAT directly to the tax office as part of their preliminary VAT return. This makes VAT a pass-through tax for businesses.

The standard tax rate is 19%. A reduced tax rate of 7% applies to those daily-use goods and services the government classifies as essential (see Section 12 of the VAT Act). These include, for example, basic foodstuffs, medical supplies, and public transport expenses. When invoicing, a business must carefully check which tax rate is the right one.

In everyday language, the term “Mehrwertsteuer,” or sales tax, is used interchangeably with VAT. The wording also frequently appears on invoices, usually as the abbreviation “MwSt”. However, the term “Mehrwertsteuer” no longer appears in tax law because VAT and sales tax are not the same thing: sales tax is an umbrella term that includes input tax and VAT. Input tax and VAT are essentially the same tax but from different perspectives: the input tax paid by users of services or customers of goods becomes the sales tax of the businesses, which pass it on to the tax office.

Businesses that purchase products or use services from other businesses subject to VAT can reclaim the input tax paid from the tax office. This way, they end up paying only the net price. Private individuals cannot reclaim the input tax they have paid.

You can find more information in our articles on VAT or VAT rates for businesses.

When is an exemption from VAT possible?

The general obligation to pay VAT is not universal. In some cases, an exemption is possible. The deciding factors include the types of products and services and where they are delivered or provided. In addition, an exemption from VAT is possible if the annual revenues of a business are below legally defined limits.

Zero tax rate

Instead of 7% or 19%, some goods and services in Germany are subject to a VAT rate of 0%. The purpose for a zero tax rate is to promote social and charitable activities, relieve the burden on education and health sectors, and avoid double taxation in international transactions, among other things. Section 4 of the VAT Act includes a comprehensive list of products and services that are eligible for a VAT exemption. Here are some key points:

• Medical services: Outpatient and inpatient medical services and nursing services are tax-free. This includes, but is not limited to, the services of physicians, dentists, physiotherapists, midwives, and obstetric nurses as well as alternative health practitioners.
  
• Educational services: School education, higher education, and certain continuing education and training measures also benefit from a VAT exemption. In addition to public institutions, this also applies to private educational providers.
  
• Cultural services: The zero tax rate also applies to concerts, theater performances, museum visits, and many other cultural services.
  
• Renting and leasing of real estate: In principle, the long-term rental of residential property is tax-free, as is the leasing of land. However, there are exceptions in which landlords can waive the tax exemption to claim input tax.
  
• Financial and insurance services: Special regulations also apply in the financial and insurance sectors. The granting of loans, payment processing, or insurance policies are exempt from VAT.
  
• Air and sea transport: Revenues from air and sea transport are also taxed at the zero rate.
  
• Solar modules and photovoltaic systems: To reduce the bureaucratic hurdles involved in the installation and operation of photovoltaic systems, the VAT Act was amended in 2023. Since then, a third paragraph in Section 12 of the VAT Act exempts the delivery of solar modules from VAT. The new regulation also covers all components essential for the operation of a photovoltaic system as well as the storage units. The prerequisite is that you install the photovoltaic system on or near private homes or public buildings.
  

Intracommunity supply

The decisive factors for exemption from VAT are which products a business sells and to whom and where. If a business delivers goods and products across borders to businesses in other European Union (EU) countries, this is intracommunity supplies (see Section 4, Number 1, Letter b of the VAT Act). In these cases, the business providing the product or service issues an invoice without VAT. For example, if a German business sells goods to France, only the net amount will appear on the invoice. The receiving business calculates the sales tax itself according to the rate in its home country and then pays it to the local tax office.

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The Germany tax authority introduced the VAT exemption for cross-border business-to-business (B2B) commerce to promote the European movement of goods. For the supplying or invoicing businesses, the regulation represents a bureaucratic relief: instead of having to pay VAT in other EU countries with different tax rates, the intracommunity supply of goods is tax-free.

Intracommunity services

Other intracommunity services function the same as intracommunity supplies. These are services one business provides to another in a different EU country. In this case, a business can reverse its VAT liability. In the case of other intracommunity services, VAT is typically levied at the location of the receiving business. For example, if a German business provides a service in Poland, the Polish business pays the VAT. The tax rate in the recipient’s country applies.

Small scale entrepreneurs

Regardless of their products or services, or target groups and markets, businesses in Germany can apply for a VAT exemption if they have the status of a small business. The prerequisite for this is an annual turnover of a maximum of €22,000 in the previous year and €50,000 in the current year. Businesses and freelance professionals whose turnover falls below these limits can apply for an exemption from sales tax under the small-business regulation (see Section 19 of the VAT Act). In return, they cannot claim input tax and therefore do not receive any VAT refund on their business expenses.

How do you apply for a VAT exemption?

You can submit an application for a VAT exemption under the small-business regulation when you found your business. The application system sends the relevant information to the tax office as part of the tax registration questionnaire. Applicants must select the small-business regulation; it does not come into effect automatically—even if the applying business’s annual turnover is below the legal limits.

However, even if a business meets the requirements for small-business status, there is no obligation to be exempt from sales tax. Alternatively, businesses and freelancers can opt for standard taxation. In this case, they show the VAT on their invoices. However, according to Section 19, Paragraph 2 of the VAT Act, standard taxation applies for at least five calendar years. Only then is it possible to switch back to the small-business regulation and be exempt from VAT. All they need to do is write an informal letter to the tax office.

Businesses interested in a VAT exemption must also apply for that exemption according to Section 4 of the VAT Act using forms at the appropriate tax office or other relevant institutions, such as school authorities in the case of a VAT exemption for lessons or concerts.

What is the difference between tax-obligatory, tax-free, taxable, and nontaxable sales?

Basically, the tax authority distinguishes between taxable and nontaxable sales. The latter are transactions that do not fall under the VAT Act (i.e., they do not correspond to any of the transactions listed in the law). For example, if a private individual sells their mobile phone to a friend, this is not a taxable transaction. We can also refer to nontaxable sales as tax-exempt sales.

Then there are taxable sales that fall under the VAT Act. The tax authority further divides taxable sales into tax-obligatory and tax-free sales. Taxable sales are always subject to tax if no exemption in the VAT Act applies to them. Tax-free sales are those that have an exemption. It is important to not confuse tax-free sales with tax-exempt sales.

Definitions at a glance

Although tax-free sales are typically subject to tax, you are unable to pay sales tax on them because of special legal provisions. The VAT Act distinguishes between genuine and nongenuine tax exemptions. The tax authority permits sales that are subject to genuine tax exemption in accordance with Section 4 of the VAT Act for input tax deduction, but the tax authority does not permit nongenuine exemptions. In this way, genuine tax exemptions allow the businesses concerned not to have to declare VAT themselves and yet enables them to reclaim the input tax paid on input services from the tax office. For example, genuine tax exemptions exist for export deliveries and transport services to countries outside the EU, intracommunity supplies within the EU, or certain financial services. Nongenuine tax exemptions that do not entitle a business to input tax deduction include, among others, sales generated from medical services, school and educational services, or artistic services.

What are the advantages and disadvantages of a VAT exemption?

Exemption from VAT offers businesses advantages and disadvantages. We summarize the most important points below.

Advantages of a VAT exemption

• Price advantage for customers: Businesses exempt from VAT can offer their goods and services at net prices. Private customers save money because, unlike businesses, they cannot claim input tax. Lower prices can mean higher sales and therefore a competitive advantage for the selling businesses.
  
• Simplified accounting: Anyone who does not pay VAT does not have to submit preliminary VAT returns to the tax office. There is also no need to prepare a full VAT return. This saves time, simplifies bookkeeping, and reduces administrative effort.
  

Disadvantages of a VAT exemption

• No input tax deduction possible: Depending on the type of VAT exemption or the VAT-exempt service, this might mean businesses are not able to deduct input tax from their business expenses. For example, small-business owners are not entitled to deduct input tax and cannot claim back the VAT they have paid on business expenses from the tax office. This can increase costs considerably, particularly if the business purchases a lot of inputs subject to VAT. On the other hand, entrepreneurs who offer services in accordance with Section 4 of the VAT Act (UStG), for example, are entitled to deduct input tax, provided they do not exclusively offer VAT-free services. You can find further exceptions in the respective legal text on the relevant VAT exemption.
  
• Reputational disadvantages: Invoices from small businesses without VAT can give customers the impression the business has only low sales. In the worst case, customers might interpret this as a result of a lack of business experience or lack of success.