Sole trader status: with VAT or without VAT?

Sole trader (micro-entrepreneur) status is praised for its simplicity. Your accounting obligations are limited, which frees up time to focus on growing your business. However, it would be wrong to say you don’t need to worry about VAT as a sole trader. The status is indeed exempt from it, but only up to a certain threshold. Here are all the conditions you need to know to understand the VAT / no-VAT rules that apply to your micro-business.

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What is VAT?

VAT, a French invention

Our leaders have always been inventive when it comes to creating new taxes, and France can boast having invented VAT, now applied worldwide. Credit (or not) goes to a young 37-year-old finance inspector, Maurice Lauré, a graduate of the École polytechnique, who invented Value Added Tax on 29 March 1954. This famous VAT replaced the production tax that was in effect at the time.

Rather than requiring the final seller to pay the entire amount of this consumption tax to the state, Maurice Lauré designed a system where each business involved in the production and distribution chain (manufacturer, wholesaler and retailer) would pay tax on the value it added to the product.

In the process, the polytechnicien relieved the state of a burden by requiring businesses to collect VAT on its behalf.

How VAT works in France

The principle behind VAT is that it is paid by the consumer, after being collected by businesses. It is therefore an indirect tax. When you buy a good or service, you pay the amount including tax (TTC). Businesses operate on prices excluding tax (HT). The difference between the amount including tax and the amount excluding tax equals the VAT.

Each business is responsible for collecting VAT on the goods and services it sells, then remitting it to the SIE, the Business Tax Department.

As we’ll detail below, VAT collection for sole traders only applies beyond a certain threshold that exceeds the authorized exemption.

The different VAT rates

It’s important to know the VAT rate that applies to your sole trader activity if you exceed the exemption threshold.

• In France, the standard VAT rate is 20%. It applies to most sales of goods and services. There are also lower rates.
• The intermediate rate of 10% applies to unprocessed agricultural products, passenger transport, firewood, certain home improvement works that don’t qualify for the 5.5% rate, trade fairs, funfair rides and games, some accommodation or camping services, tickets for museums, zoos and monuments, waste treatment, and certain catering services.
• The unchanged reduced rate of 5.5% covers most food products, feminine hygiene products, equipment and services for disabled people, books in any format, works improving the energy efficiency of housing, certain catering services, gas and electricity subscriptions, renewable energy, school canteen meals, tickets for live performances and cinema, certain imports and deliveries of artworks, social or emergency housing, and homeownership schemes.
• The unchanged special rate of 2.1% applies to medicines reimbursed by social security, the TV licence fee, certain performances, as well as press publications registered with the Joint Committee for Press Publications and Agencies.

How does VAT work for sole traders?

The sole trader status was created to make it easier to start a business and help people become self-employed, without a major investment or excessive risk. Accessible to everyone, the status allows unemployed people to create their own job, as well as employees to test an idea while keeping their job, until they can live fully off their activity.

It was therefore crucial that the accounting side be simple and not require the help of a professional accountant. The sole trader had to manage their own bookkeeping, with basic tools at first, then potentially with professional accounting software as their business grew.

To respect this basic rule, a revenue threshold was set. Crossing it required the business owner to leave sole trader status and adopt another status subject to VAT.

As long as you stayed below this threshold, you paid for your micro-business purchases including tax, like any consumer (without being able to reclaim it), and you sold your products or services excluding tax. You then had to state on your invoices: “VAT not applicable, art. 293 B of the French Tax Code.”

With/without VAT: the exemption tied to sole trader status

As always, policymakers have complicated a system that was very simple until 1 January 2018. Before that date, the exemption was tied to sole trader status and was never subject to invoicing.

Since then, the revenue caps have been revised upward, but a VAT exemption threshold was introduced, which means you can become liable for VAT while keeping your micro-business status. These thresholds and caps depend on the nature of your activity.

1 — Craftspeople and liberal professions

If you work as a craftsperson or in a liberal profession:

• your revenue cap is €72,600;
• the VAT exemption threshold is €34,400;
• the increased VAT threshold is €36,500.

2 — Retailers

If you are a retailer:

• your revenue cap is €176,200;
• the VAT exemption threshold is €85,800;
• the increased VAT threshold is €94,300.

Sole trader VAT: the difference between the threshold and the increased threshold

When you declare revenue between the VAT exemption threshold and the increased threshold, you can still claim VAT exemption for the following year. However, if this happens two years in a row, you become liable for VAT invoicing and declaration from 1 January of the third year.

If you exceed the increased VAT threshold during the year

If you exceed the increased VAT threshold during a calendar year, you instantly lose the benefit of the sole trader VAT exemption, effective from the first day of the month in which the threshold was exceeded.

Businesses excluded from the VAT exemption

Certain activities are excluded from the VAT exemption, which means they cannot be carried out under the micro-business regime. If you fall into one of the categories below, you must switch to another status, such as an EURL, EIRL, SAS or SASU.

• Businesses excluded from the VAT exemption are the following:
• sale of new vehicles outside European Union countries;
• rental of durable consumer goods;
• rental of unfurnished properties for professional use;
• equipment rental;
• activities subject to real estate VAT;
• activities subject to agricultural VAT;
• civil service or ministerial functions;
• transactions on options and futures markets, as well as transactions on options warrants.

Invoicing with/without VAT

As long as you remain below the thresholds detailed above, your invoicing stays exclusive of tax. Never forget to include the wording “VAT not applicable — article 293 B of the French Tax Code” on each of your invoices.

Once you no longer benefit from the VAT exemption threshold, you must remove this wording and invoice like any standard business, showing the breakdown with:

• price excluding tax;
• applicable VAT rate and amount;
• price including tax.

Filing your VAT return with the tax authorities

To file your VAT return with the tax authorities, you need to create an online account on their website. You must also request an intra-community VAT number from the tax authorities. You should normally receive it quickly, within 48 hours. This number must appear on every one of your invoices, along with your SIRET number and your APE code.

Paying VAT to the tax authorities

You have a choice between two options for paying your VAT to the tax authorities.

1 — The standard actual tax regime

If you adopt the standard actual tax regime, you must declare your VAT monthly and pay it as you go.

2 — The simplified tax regime

If you prefer the simplified tax regime, your VAT return becomes annual. You must submit it before the second business day following 1 May, declaring VAT for the previous year.

This figure is used as the basis for calculating the tax authorities’ estimate of your first instalment, due in July, and the second, due in December.

Any adjustment to this estimate — in your favour or against you — takes place after the final return for the following year.

Using professional software as a sole trader to simplify VAT

As soon as you exceed the exemption threshold that requires you to charge VAT, your accounting instantly becomes more complicated. The transition between these two states is also very tricky. Remember that you’re allowed two consecutive years if your revenue fluctuates between the threshold and the increased threshold, but you must immediately start charging VAT if you exceed the increased threshold along the way.

VAT returns are subject to strict controls, as the tax represents a significant source of revenue for the state. Indeed, VAT collection accounts for nearly half of its tax revenue (44.9%, or €186 billion in 2019). By comparison, income tax lags far behind, at 21% of revenue (€87 billion in 2019). Next comes corporate tax (16.1%), the domestic tax on the consumption of energy products or TICPE (4.1%), and other direct and indirect taxes (13.9%).

To make sure you don’t make any mistakes, it’s in your best interest to use professional accounting software designed for sole traders, unless you exceed your threshold with just a handful of high-value invoices. If you issue many invoices, a mistake can easily happen, and the consequences can be unpleasant. You would then have to pay back-owed VAT, as well as possible penalties, which could seriously strain your cash flow or even put your business at risk.

With good software, you’re alerted as soon as you reach the thresholds, and the VAT invoicing mechanism becomes automatic.

What are the advantages and disadvantages of the sole trader VAT exemption

The advantages of invoicing with VAT

Exceeding the sole trader VAT exemption threshold affects your micro-business’s accounting, which leads some people to carefully avoid ever crossing that line. However, charging VAT can be seen as an advantage, depending on your activity.

First and importantly, if you exceed the threshold, it means your micro-business is growing very well. Also, not collecting VAT means you cannot reclaim it on your purchases of goods and services. This can be a disadvantage:

• when you start an activity that requires a significant investment in equipment: IT tools, company vehicle, etc.;
• when your activity requires purchasing raw materials: you pay VAT on these purchases but cannot pass it on to your customers, unless you significantly raise your prices and lose competitiveness;
• when you work mainly with businesses, as you find yourself in direct competition with other companies that also invoice excluding tax.

If you find yourself in one of these situations, filing VAT returns becomes an advantage and an asset. This is why some sole traders prefer the standard tax regime.

The advantages of the VAT exemption

The first advantage of the VAT exemption is that it greatly simplifies your accounting and the management of your micro-business. You don’t need to distinguish between individual and business customers, and you’re exempt from filing VAT returns, whether monthly or annual.

Additionally, in certain activities, not charging VAT becomes a competitive advantage. An individual customer has no VAT to pay on your invoice, giving you an edge over a standard business whose price is increased by the tax.

It’s up to you to weigh the advantages of invoicing with or without VAT based on your activity and the nature of your customers. It can sometimes be advantageous to stay below the VAT threshold to keep your competitive edge (and avoid complicating your life), or conversely to exceed it in order to reap benefits worthwhile for your business.