When we make a supply that is subject to VAT, we add VAT to the price agreed with our clients. Therefore, when we receive payment from our clients, we receive our fees and the VAT. This VAT belongs to the tax office and should therefore be passed on at the end of the current reporting period. An example would be as follows:

When the sale has been completed, our profit is €3,000:

However, we have collected from our client our money and the VAT that becomes a creditor to be paid at a later date:

When we make a purchase that is subject to VAT, we add VAT to the price agreed with our supplier. Therefore, when we make the payment to our supplier, they receive our fees and the VAT. This VAT suffered should be refunded by the tax office; therefore we can deduct it from any VAT collected through our sales before VAT is passed on at the end of the current reporting period. An example would be as follows:

By making the purchase our profit is reduced by the amount of our cost:

However, we can deduct the VAT paid from our VAT creditor:

When we make a purchase that is subject to withholding tax (IRPF), we deduct withholding tax from the price agreed with our supplier. This tax is an income tax payment on account for the profits of our supplier. By making this deduction we are merely acting as tax collectors on behalf of the tax office, hence we pay that money at the end of the quarter. An example would look as follows:

Our profit is only affected by the actual cost of the rent:

However, the income tax withheld from our supplier becomes a creditor:

There are many transactions where withholding tax should be applied. Two of the most common forms of IRPF deductions are those relating to rental of property as seen in the previous section, and those relating to services provided by certain professional sole traders. Let’s consider a further example for this type of expense:

Again, for the purposes of our profit calculation VAT and IRPF can be ignored:

Having considered a few examples that illustrate ordinary business transactions, this example would lead to the following:

• Quarterly tax returns with payment of taxes amounting to €438.
• Reported profit amounting to €300.

Thus the commonly mistaken conclusion of taxes being high in Spain, as many puzzled entrepreneurs wonder how it is possible to pay €438 euros worth of tax when the profit was only €300.

The answer to that question can be seen below:

• The profit was €300 but the actual net cash inflow from operations was €738.
• The excess €438 was collected on behalf of the tax office which of course has to be paid when the period comes to an end.

Of course, in practice, it is never this simple. Businesses can face cash flow shortages for a number of reasons and when the taxes collected are not ring-fenced making the appropriate payments can be very difficult indeed.