What is a small business in Germany? VAT regulation explained

What is a small business in Germany?

A small business in Germany is a business that stays below the revenue limits defined by the small business regulation 💬 Kleinunternehmerregelung. These businesses do not charge VAT and follow simplified tax rules as long as their annual revenue remains under the legal thresholds.

What is the small business regulation?

For small businesses that do not exceed a certain turnover limit, the government created the small business regulation. This can make the day-to-day business of sole proprietorships (freelancers, Freiberufler, merchants), GbRs or small UGs much easier, by being exempt from VAT.

As an entrepreneur, you are free to choose whether or not to make use of this regulation. However, if you reject this, you are bound to the standard VAT obligations for five years. Needless to say, it’s important to consider carefully what makes sense for your business.

How can I apply for the small business regulation?

A business can apply the small business regulation, if its annual turnover is up to €22,000 (§ 19 UStG). To use this rule, you must provide a turnover forecast to the tax office.

Overestimating your expected revenue leads to paying too much tax upfront, while underestimating it can result in retroactive VAT payments. Incorrect forecasts are one of the most common mistakes small businesses make. There are no special prerequisites beyond staying under the turnover limits, which most new businesses meet anyway. To register, simply tick the option in the ELSTER tax registration you submit to the tax office.

What are the profit & revenue limits?

For new businesses:

• In the year of application, the expected total turnover may not exceed €22,000.
• In the following year, the cap is €50,000.

For already established businesses:

• In the previous year of application, the total turnover may not exceed €22,000 (actual turnover).
• In the current year, the turnover may not exceed €50,000 (planned turnover).

Please note: If you did not start your business in January, the projected turnover must be extrapolated to the full year (12 months). And if you exceed your permitted turnover as a small business in the current year (€22,000 or €50,000), standard taxation applies from 1 January of the following year.

What happens if I exceed the turnover limit?

As soon as you exceed the turnover and profit in the previous year (see table), you can no longer use the small business regulation in the following year. From then on, you will be treated like an entrepreneur for tax purposes and must report VAT on your products or services.

Is there any way I can deduct VAT?

If you no longer use the small business regulation for yourself and therefore have to charge your customers VAT, you can also deduct input VAT. As long as you make use of the regulation, you’re exempt from paying VAT and therefore not entitled to deduct input tax.

What are the advantages of being a small business?

For the most part, small businesses can skip most of the VAT-related administrative work. Plus, if your business isn’t entered in the commercial register, it can also use the simplified accounting method known as EÜR. Also, you don’t have to worry about distinguishing between gross and net amounts.

The following work is not required:

• Determining the appropriate VAT rate for the delivery (0%, 7% or 19% depending on the product/service).
• Invoicing customers incl. the appropriate tax rate and VAT amount
• Receipt of the invoiced VAT
• Calculation of the input tax portion with cash receipts, incoming invoices and purchase receipts
• Compliance with the UStG’s invoicing regulations on the possible endangerment of customers’ input tax deduction
• Monthly sending of an electronic advance VAT return to the tax office (determination of the payment burden: VAT receipts minus input tax already paid)
• Transfer of the payment burden calculated from the advance VAT return to the tax office.
• Transfer of the remaining payment burden, if any, after the annual VAT return.

What is required:

• Annual VAT return – in which it’s enough to declare the taxable turnover of the last two years.

Example: You became self-employed at the beginning of the year. Your investments in the first year amount to €15,000 gross. The invoice with and without the use of the small business regulation would therefore look as follows:

What are the disadvantages?

The small business regulation comes with several disadvantages that can affect your business operations and long-term growth. Because no VAT is charged, you cannot deduct input tax from your purchases. This makes buying goods and services from other businesses more expensive, which is a major drawback for companies in the B2B sector. Your customers also cannot reclaim input tax from your invoices, which may make your offers less attractive compared to competitors who charge VAT.

If your input tax refund would be higher than the VAT you would charge, you should avoid the small business regulation altogether. This situation is common for founders who make large initial investments. For example, if Business ABC buys a shelf for €100 plus 19% VAT, it pays €119 but cannot reclaim the €19 VAT because it does not submit advance VAT returns.

There is also the risk of retroactive VAT liability. If your annual turnover exceeds the legal limit, the small business regulation becomes invalid, and you must pay VAT at the regular rate in subsequent years. Additionally, every invoice must clearly state that no VAT is charged according to § 19 UStG, which can make your business appear less established and deter potential customers or partners.

For businesses that buy a high volume of goods, such as retailers, the inability to reclaim VAT is particularly costly. While the small business regulation can reduce your tax burden in the early stages, it may hold your business back as it grows. Considering these long-term effects is essential before applying.

How much tax do I have to pay?

Since the small business regulation doesn’t affect the determination of profits or other types of tax, you fundamentally pay the same taxes as all other businesses. The tax rate differs only in terms of trade tax:

• Income tax: small businesses must also pay tax on their profits. Income tax is assessed on the profit (income – expenditure). Furthermore, the basic tax-free amount of €9,408 for single persons and €18,816 for married persons and persons in a registered civil partnership applies (as of 2020).
• Trade tax: Partnerships and sole proprietors are entitled to a tax allowance of €24,500. Since the small business regulation applies up to a maximum turnover of €22,000, you don’t need to worry about this tax.
• VAT: As you do not have any VAT revenue as a Kleinunternehmen, you can skip the monthly or quarterly advance VAT returns. Nevertheless, many tax offices still require an annual VAT return. However, you only have to declare that you have not collected any VAT.

What should my invoice include?

First and foremost, although you can’t include VAT on your invoice, there are still VAT regulations that apply. That is, you may only list the gross price of the product or service in your outgoing invoices without VAT rates or VAT. This price listing prevents a recipient of the invoice who is entitled to deduct input tax from making deductions with your invoice.

Mandatory information in your invoice

• Your name and address
• Tax number
• Name and address of the customer
• Date of invoice or issue
• Invoice number
• Date of service or delivery (this can be replaced by stating that the invoice date and the date of service/delivery are identical).
• Type and quantity of the product or service (usual trade description)
• Price (without VAT)
• Note that no VAT was charged

Here you can find more information on how to write an invoice in Germany.

Other features

Low-value assets (GWG)

When determining profit, always take into account your business expenses at their gross prices (including VAT). And, observe the net value limit of €800 (as of 2018). This means you can claim purchases worth up to €952 (€800 + 19% VAT) for tax purposes in the first year. These acquisitions are considered low-value assets.

Using part of the revenue for private use

As a rule, private use of your business’s revenue (e.g. using the business telephone or company car for personal reasons) isn’t taken into account when determining the amount of annual turnover.

But If you were subject to standard taxation in the previous year and claimed input tax on the acquisition of the respective asset you’re using for additional non-business-related reasons, you must take the percentage of the personal use into account. This can get tricky, so be sure to discuss the ins and outs of it with your tax adviser.

Inventory

If you switch to standard taxation and still have inventory left over from your time as a small business, you must in principle claim input tax retrospectively (§ 15a para. 2 UStG). However, this only applies if the input tax portion of an individual asset exceeds €1,000 (§ 44 para. 1 UStDV). As always, it’s best to clarify things with your tax adviser.

How can I stop using the small business regulation?

Both voluntary and involuntary use of the small business regulation is possible. Involuntary revocation occurs when the actual turnover is exceeded. However, the voluntary switch to standard taxation is possible at the turn of each year.

But, there’s a catch: You’re bound by this decision for the next five years. This is what you have to do to make the change successfully:

• The tax office must be informed of the change
• You may have to apply for a VAT-ID number in time for the change. You will need this if you receive or deliver goods from other EU countries or generally do business with companies abroad.
• The most important customers should be informed about the change.

If orders and invoices occur close to the date of the bill of exchange, please note that the decisive date is the date on which the service was rendered or the goods were delivered. If this date is later than the bill date, VAT must be added to the invoice item, otherwise not.