Advances are one of the main tools businesses in Germany use to prefinance projects, deliveries, or services, while minimizing their own risk. At the same time, advances present challenges with accounting. For example, it is important that the value-added tax (VAT) on advances is handled correctly to avoid errors, back taxes, or issues with the tax office.

In this article, we explain advances, including when VAT is due in Germany and how advances differ from progress payments. We also detail how to avoid common errors when processing VAT on advances.

What’s in this article?

• What are advances?
  
• When is VAT due on advances in Germany?
  
• What are the differences between advances and progress payments?
  
• Revenue recognition and VAT on advances
  
• Common use cases for advances
  
• Causes of accounting and VAT errors on advances
  
• How Stripe can help you manage VAT on advances
  

What are advances?

Under German commercial and tax law, advances are up-front payments for future supplies or performances. Advances are paid before the supplies or performances are provided in full and are paid against concrete transactions that have been agreed upon. Legally, advances are considered pending transactions because there is a delay between the compensation for a supply or performance and the supply or performance itself.

Advances are standard practice on larger projects, personalized commissions, and long-term supply contracts, in particular. They protect the contractor financially and reduce debt risk

When is VAT due on advances in Germany?

When a business in Germany receives an advance, VAT is due as soon as payment is received. Payment is considered received when some or all of the fee is collected, regardless of when the agreed-upon supply or performance is actually rendered.

The legal basis is Section 13, Paragraph 1, No. 1, Lit. a, Sentence 4 of the German VAT Act (UStG). According to this regulation, businesses must indicate VAT on their preliminary VAT returns and remit VAT to the tax office during the preliminary reporting period in which the payment is collected. This is provided that the payment clearly relates to a concrete, agreed upon supply or performance.

When the contract is subsequently executed in full, the supplier issues a final invoice. The advance is deducted from the total on this invoice so only the outstanding amount is left to pay.

What are the differences between advances and progress payments?

Advances and progress payments both constitute partial payments for supplies and performances. However, the main difference between them is when each payment is made.

Advances are up-front payments made against future supplies or performances. Therefore, an advance invoice is usually issued prior to the start of a project or during an early stage.

On the other hand, progress invoices indicate partial performances or supplies that have already been rendered. This means that a progress payment is not an up-front payment; instead, it is a payment made in consideration for the ongoing scope of the supply or performance. According to Section 632a of the German Civil Code (BGB), parties to a contract can agree to this type of partial payment in their contract.

Progress payments are commonly used for complex or project-based performances, as well as for construction and work contracts. Similar to advances, they are subsequently deducted from the final invoice total.

Revenue recognition and VAT on advances

With advances, it is important to draw a distinction between when the revenue is recognized on the accounts and when VAT is incurred.

Revenue recognition involves a business recording revenue on its profit and loss (P&L) statement. According to Section 252, Paragraph 1 of the German Commercial Code (HGB), businesses in Germany must account for their income and expenditure for the financial year in their annual financial statements, regardless of when the corresponding payments are made. For advances, the business recognizes the financial gain at the time of performance or supply, even if it has already received the money.

On the other hand, VAT is due on advances as soon as payment is received. It must be remitted to the tax office, even if the corresponding performance or supply has not yet been rendered.

The supplier reports advances on its balance sheet as liabilities until the performance or supply has been rendered in full. Once it is rendered and the final invoice is issued, advances are offset, and the final revenue total is recorded on the P&L statement.

Common use cases for advances

In practice, advances are used in many industries to ensure that contracts are financed and to reduce the risk for contractors. They are primarily used for customized, long-term, or project-related performances. Here are some common use cases for advances:

• Construction projects: On larger construction projects, advances ensure the financing of materials and labor costs.
  
• Customized orders: Custom-made products or one-off productions are often prefinanced through advances before delivery of the final goods.
  
• Subscriptions: Advances are often used for long-term service or supply contracts as a way of hedging the contractual obligation.
  
• Events and bookings: Hotels, event organizers, and tour operators frequently require advances to confirm reservations and aid plannability.
  
• Project-related services: Consulting, software, and creative projects use advances to enable timely resource preparation.
  

Causes of accounting and VAT errors on advances

Advances can create accounting and administration challenges for many businesses. Errors often arise due to ambiguities about when VAT is due, how to post advances to balance sheets, and how to offset advances against final invoices.

Invoicing issues

Advance invoices must contain all the mandatory information required for a correct invoice, according to Section 14 of the UStG. However, there are two key differences: An invoice for an advance must be clearly marked as an “Advance invoice,” and it must indicate the anticipated performance period.

Invoices that do not have the mandatory information or that are otherwise incomplete can have tax and accounting implications. The tax office might not accept incorrect advance invoices with respect to input VAT deductions, and incorrect invoices also make it impossible to record the correct VAT on advances.

In addition, accounts might be unable to clearly identify what the payment is for, which can make it harder to offset the advance against the final invoice later. This results in inaccuracies on the balance sheet and P&L statement. Therefore, while the business is still legally entitled to the payment, it faces tax and accounting risks until it corrects the invoice.

VAT application

Suppliers often don’t record VAT on advances until they have rendered the corresponding performance or supply in full. However, VAT has to be collected as soon as the advance is received. If the tax is only posted later, then the amounts stated on preliminary VAT returns are incorrect. This can result in interest payments or penalties. Late reporting of VAT on advances can quickly lead to issues, especially on complex projects or long-term supply contracts.

Unclear accounting

Another common source of errors is how advances are presented on balance sheets. The supplier must first report the advance as a liability because the performance is still outstanding. However, if advances are incorrectly posted as revenue or income, this distorts the balance sheet and results in inaccurate profit figures.

Double posting

Businesses in Germany must also be careful they don’t record advances twice (e.g., once as a liability and once as income). This distorts the balance sheet and can result in VAT on advances being calculated incorrectly.

Therefore, businesses must ensure that every advance is posted correctly and only once—first as a liability and then as revenue, once the performance or supply is rendered. Errors here result in incorrect annual financial statements and can also be flagged during tax audits.

Failure to offset advances against final invoices

Suppliers might forget to deduct advances from the final invoice total. When this happens, the final invoice the customer receives is incorrect. When they settle this invoice, they end up paying too much for the supply or performance.

If they spot the error, they can demand that the final invoice be corrected. This results in delays, more administrative work on both sides, and loss of trust, in some cases.

How Stripe can help you manage VAT on advances

For businesses, managing VAT on advances can be a time-consuming process prone to errors. Stripe Tax can help you automatically calculate the correct VAT on advances—for physical and digital goods and services in more than 100 countries. Tax factors in the supply or performance invoiced and the place of sale. It also consistently implements the latest changes in tax law, so you don’t have to stay up-to-date with new regulations.

Tax also records and reports VAT collected from advances to the relevant financial authorities, helping you avoid errors and oversights. This helps minimize compliance risks.

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