In Germany, whether companies have to pay value-added tax (VAT) to the tax office depends on the type of taxation. In this article, we’ll explain the two possible types of taxation: accrual-based and cash-based. We’ll also explain the advantages and disadvantages of each taxation type for a business and the conditions under which the business can change taxation type.
What’s in this article?
- What are accrual-based and cash-based taxation?
- Advantages of accrual-based and cash-based taxation
- Which taxation applies to the different types of business?
- What special cases apply?
- How do I apply for each taxation type?
- How can I switch from accrual-based taxation to cash-based taxation?
What are accrual-based and cash-based taxation?
In Germany, businesses must pay their value-added tax (VAT) to the tax office according to either accrual-based taxation (Section §16 of the UStG) or cash-based taxation (Section 20 of the UStG). Both types are taxed according to the agreed rates.
In the case of accrual-based taxation, businesses have to pay VAT as soon as they have issued the invoice, even if the customer has not yet paid. However, with cash-based taxation, businesses only have to pay VAT to the tax office after customers have paid their invoices. Cash-based taxation thus has a clear advantage here since companies do not have to pay VAT in advance.
Here are two examples to show how the different types of taxation work in practice.
Example of accrual-based taxation:
- On May 15, you issue an invoice for 1,000 euros plus 190 euros in VAT to your customer.
- You pay 190 euros in VAT for the month of May in line with the invoice date.
- If you have not applied for a permanent deadline extension for the preliminary VAT return, you must report and pay the VAT to the tax office by June 10 in accordance with the accrual-based taxation—even if the customer has not yet paid.
Example of cash-based taxation:
- On May 15, you issue an invoice for 1,000 euros plus 190 euros in VAT to your customer.
- You pay the VAT after receiving the customer’s payment.
- If your customer pays in May, you will have to pay the VAT on June 10 (as with accrual-based taxation). However, if the customer does not pay until the following month, the VAT will not be due until one month later. So, unlike with accrual-based taxation, you are not paying the VAT in advance.
Advantages of accrual-based and cash-based taxation
Whether your business pays VAT according to accrual-based taxation or cash-based taxation affects your liquidity. With cash-based taxation, you have more wiggle room since you do not have to pay the VAT weeks in advance, which is especially useful if you are dealing with a large number of orders or large sums of money. However, if your customer is late with a payment, this can quickly lead to liquidity problems, especially if several customers are late in the same month.
The advantage of accrual-based taxation is that VAT is paid when the invoice is issued, which means that if the customer has not paid the invoice (and therefore has not paid the VAT), you will not be in tax arrears.
For those who generally have a smaller capital buffer—for example, startups, small scale entrepreneur, and freelancers in particular—cash-based taxation is much less of a burden. It can make a significant difference if smaller companies do not still have to pay VAT to the tax office in the event of late payments. Cash-based taxation is therefore especially beneficial for small- and medium-sized enterprises (SMEs) looking to avoid liquidity bottlenecks and that meet the basic criteria for this type of taxation. These criteria are explained below.
Which taxation applies to the different types of business?
Businesses in Germany are generally subject to accrual-based taxation if they submit preliminary VAT returns. However, there are three types of business that can apply for cash-based taxation:
- Freelancers (profit determined by excess income statement, or EÜR in German)
- Sole proprietors and civil law companies (GbRs) that generate a revenue or profit below the mandatory accounting threshold of 600,000 euros in revenue or 60,000 euros in profit per year and are exempt from accounting in accordance with Section 148 of the German Fiscal Code (AO)
- Companies with an annual revenue of less than 500,000 euros (GmbH, OHG, UG business structures) that are required to keep accounts
Companies with a revenue of over 600,000 euros or a profit of 60,000 euros per year are automatically subject to accrual-based taxation. Unlike the companies mentioned above, they do not have the option of choosing cash-based taxation.
Unlike tradespeople, freelancers do not have to declare their activities, so they can apply cash-based taxation with their first preliminary VAT return without having to apply for approval of cash-based taxation.
What special cases apply?
In certain cases, special rules apply to businesses for the assessment of accrual-based taxation or cash-based taxation. These are the most common cases:
A business consisting of several companies
If there are several companies belonging to one business, the revenue of all companies must be added together to determine the total revenue. Only if the total revenue does not exceed the threshold of 600,000 euros can cash-based taxation be applied—regardless of whether the individual companies are engaged in different business activities. Unlike when calculating income tax, all companies belonging to a business must be included when calculating VAT.
Freelancers with additional income
If a person engaged in business has both self-employed income and income from a trade, both accrual-based taxation and cash-based taxation can be applied at the same time. Revenue is then estimated separately and VAT is paid separately: freelance activities are subject to cash-based taxation, while trade activities are subject to accrual-based taxation (provided that revenue exceeds 600,000 euros or profits exceed 60,000 euros per year).
If the other earnings do not exceed the threshold of 600,000 euros, a freelancer should seek approval for cash-based taxation of all income. They should indicate when submitting the application that they receive other income in addition to the freelance income. In this case, the tax office will not include the freelance income in the calculation.
How do I apply for each taxation type?
If you are a founder of the business, you can choose and apply for the type of taxation when you set up the business by completing the tax registration questionnaire. You can also change the type of taxation at a later date if the criteria for the initially selected type of taxation change in the course of your business activity. For example, if you have been assessed for accrual-based taxation and your annual profit is still below the 60,000 euros revenue threshold, you can apply to change to cash-based taxation. You can switch at any time without notice. All you have to do is write a simple letter to the tax office containing the following information:
- Your tax number
- Date from which cash-based taxation will apply
- Last tax assessment notice as proof of your total annual revenue or annual profit
The tax office cannot reject your application if the criteria are met and your total revenue or profit is below the specified threshold. As soon as you have received approval from the tax office, you can switch to cash-based taxation.
In which cases can the tax office revoke cash-based taxation?
If the tax office has approved cash-based taxation, this approval is valid until it is revoked. Revocation is only possible if the criteria that were met at the time of assessment for cash-based taxation are no longer met. If the tax office discovers while processing a tax return or during a tax audit that the previous year’s revenue was more than 600,000 euros, it can revoke the previously granted approval—but only for the future (i.e., only from the beginning of the next calendar year).
A retroactive revocation is only possible if a business has deliberately made false declarations to the tax office. In this case, the business concerned will be taxed immediately according to the agreed rates for accrual-based taxation. The business must include the VAT from any unpaid invoices (which may be the case with cash-based taxation) in the next preliminary VAT return.
How can I switch from accrual-based taxation to cash-based taxation?
If your business is subject to accrual-based taxation after being assessed by the tax office or by your own choosing when you set up your business, this does not mean that you cannot change the type of taxation in the future. It is also possible to switch from accrual-based taxation to cash-based taxation at a later date if your revenue falls below the threshold set by the tax office. You can easily apply to change at your local tax office. If you switch to cash-based taxation after approval by the tax office, you can submit your next preliminary VAT return under the new taxation type.
However, because the VAT owed accrues at different times for accrual-based and cash-based taxation, you should make sure that your revenue is not recorded twice or even not recorded at all. If you do not have a clear idea of when the change from accrual-based to cash-based taxation will take place when submitting your preliminary VAT return, you could end up declaring VAT twice if, say, you accidentally enter the VAT on an invoice according to both taxation types. Ultimately, all revenue may only be taxed once.
When switching from accrual-based to cash-based taxation—or vice versa—the figures cannot be corrected at a later date. For example, if you have paid too much VAT to the tax office due to double payment, this can no longer be reversed. When changing the type of taxation, it is therefore advisable to create a separate list of invoices for which the VAT has already been reported in the preliminary VAT return at the time of the change. This way, you can smoothly transition from one type of taxation to another.
You can also use an accounting program that makes it easier to switch between the two types of taxation. Accounting programs can give you a clear overview of your accounts receivable and receivables management and makes it easier to allocate all invoices with the respective payment history and VAT owed.