How will the increase in the VAT rate affect previously concluded contracts?
The country is planning to increase the standard VAT rate from the current 20% to 22%, starting January 1, 2024. In the following, we will provide an overview of the impact of the VAT increase on previously concluded contracts and whether and how these contracts need to be changed. If the increase in the VAT rate comes into effect, entrepreneurs will have to review their concluded long-term contracts that include VAT. The Value Added Tax Act does not precisely regulate how the price is formed in contracts concluded between sellers and buyers of goods or services. This means that the contract price can be stated with or without VAT. Upon the VAT rate increasing by 2%, it should be checked that the contracts are in accordance with the new rate and, if necessary, the contracts must be brought into line with the law amendment.
Situation 1: Price plus VAT
If the contract stipulates the price and states that VAT is added to it or that VAT according to the rate provided by law is added to it then the contract will not need to be changed and in such a case the higher tax rate will automatically apply.
Situation 2: Price plus 20% VAT
If the contract stipulates the price and states that 20% VAT is added to it then the contract provision must be interpreted based on the principle of good faith. The VAT rate comes from the law and the parties cannot agree on a VAT rate between themselves, so the parties should interpret the VAT rate as a variable amount based on the principle of good faith. Additionally, it is possible to amend the contract by agreement of the parties, changing the VAT rate.
Situation 3: Price includes VAT
It is also possible that only the price is stated in the contract and there is no reference to VAT or that the contract states that the price includes VAT. This is a situation where the parties have agreed on a specific fixed price and it is not possible to change it unilaterally. If the VAT rate increases, the seller or service provider will run the risk of having to bear the difference in the VAT rate increase themselves.
In the latter case, it is also possible to change the contract in order to bring the price of the contract into line with the increase in the VAT rate. The seller or service provider may have the unilateral right to change the contract, but in this case the contract must contain a specific provision that allows the price to be increased if the law is amended. Another option is to change the contract by agreement of the parties, and in this case, the consent of the other party is also required to adjust the price. There is also a third option: an ordinary cancellation of the contract. An ordinary cancellation of a long-term contract with an indefinite duration is possible if the parties have not agreed otherwise in the contract. A long-term contract is aimed at fulfilling a permanent obligation or recurring obligations, such as a rental agreement, commercial lease agreement, lease agreement. Ordinary cancellation of such a contract releases both parties from their contractual obligations. The principle of ordinary cancellation is that the parties to the contract bind themselves to an open-ended contract as long as both parties to the contract are interested in continuing the contract. If one party loses interest, they can terminate the contract unilaterally. If, for example, the counterparty does not agree to change the stated price due to an increase in the VAT rate, the seller or service provider may have no interest in continuing the contract.
Conclude contracts that do not need to be changed in the event of an increase in the VAT rate
We recommend that all contracts be executed and worded in such a way that the contract clearly states the price of the goods and services and also states that VAT is added to the price or that VAT at the rate provided by law is added to the price. In this case, if the VAT rate should change, the contract will always include the new VAT rate and the entrepreneur will not have to worry about changing the contract or about having to bear the price difference due to VAT increase. For example, the price can be added to the contract as follows: “The price is 10 euros plus VAT at the rate provided by law” or “The price is 10 euros plus VAT”.
Transition period set out in the draft Value Added Tax Act
According to the draft Value Added Tax Act, Section 46(25) is planned to be added to the Act, according to which a person subject to VAT will have the right to apply the tax rate of 20% to turnover carried out on the basis of contracts concluded before May 1, 2023, on the condition that according to the contract, the price of the specific good or service will be calculated at 20% VAT rate, without the possibility to revise this condition due to changes in the tax rate. This option will be valid until December 31, 2025.
If you have any questions or would like advice regarding the change in the VAT rate, please contact the Chamber’s lawyers at the e-mail address of juristid@koda.ee.