“VAT will continue to gain importance, and when we look at its political popularity, and the complexities thrown up by VAT disputes, we can be sure that it will also evolve considerably over the years to come.”
In March, Baker & McKenzie once again played host to its annual Indirect Tax Experts Meeting (ITEM). This was the eleventh event of its kind and took place in Milan, Italy, with an audience of more than 100 delegates attending a series of seminars designed to address significant indirect tax issues and developments affecting businesses worldwide.
The 2014 ITEM focused on global VAT and tax policy trends, doing business in Italy, insights into changes on the agenda for 2015, VAT in payment transactions, VAT around the world, and compliance and risk management. The event brought together VAT and customs specialists from Baker & McKenzie’s offices around the globe as well as leading experts from the world of industry.
When compared to the environment facing delegates a year ago, the 2014 conference could be said to take place against a backdrop of growing certainty. Twelve months ago, populist and political issues around tax were dominating newspaper headlines internationally, as many of the world’s largest economies struggled and governments sought to pursue tax revenues by any means possible. Clients were forced to grapple not only with rapidly changing regulation, but also with a great deal of uncertainty around just what kind of behaviour may fall foul of not only lawmakers, but the court of public opinion.
Today the world has moved forward, perhaps not dramatically, but tentatively. Tax is no longer the stuff of daily newspaper reports, though it does remain a hot topic for policymakers at the European level and within the Organisation for Economic Cooperation and Development (OECD). A cumbersome review of the European VAT system by the Commission has resulted in some action points that businesses can make use of, and indirect taxation continues to win favour around the world.
A year ago, the ITEM conference concluded that VAT was the tax of the future, as more and more countries turn to indirect taxation for revenues, such that VAT now contributes one in five global tax dollars. The United States is today the only OECD country that has not introduced VAT in some form or another.
This year, our analysis concludes that VAT will continue to gain importance, and when we look at its political popularity, and the complexities thrown up by VAT disputes, we can be sure that it will also evolve considerably
over the years to come. While we wait and observe that evolution, driven by governments looking to simplify its workings and make systems more efficient and robust, we must also keep abreast of everyday compliance challenges and the complexities of cross-border and online cooperation with fiscal authorities.
VAT is a tax that does not stand still. We hope that you find the analysis and discussion in this white paper
to be of interest, and should you have any questions or wish to discuss any of the issues raised, please do not hesitate to get in touch with your usual Baker & McKenzie contact.
VAT in OECD countries accounts for
20% of total tax revenue
personal income tax 25% excise duties 11% corporate income tax 8%
VAT is used by approximately
and affects around
4 billion people
Global VAT and Indirect Tax Policy Trends 5
At our Indirect Tax Experts Meeting in Milan, Italy, in March 2014, Baker & McKenzie hosted more than 100 delegates and chaired nine panel discussions on key issues facing those dealing with VAT and customs around the world.
The conversations that took place, and the topics raised, are outlined on the pages that follow, but a number of key themes and trends emerge from the analysis in this report:
The European Commission’s review of the VAT system in Europe, along with the OECD’s initiative on base erosion
and profit sharing, will have a significant impact in the coming years but remains at a formative stage.
The EU’s fraud proposal is typical of a wider international crackdown on wrongdoing to protect states’ financial interests, along with much tougher enforcement measures in the form of financial penalties and criminal prosecutions.
When it comes to case law developments, the principal of fiscal neutrality is by far the most active area of
legislative movement, being both dynamic and pervasive in scope.
There are three significant VAT changes in the offing for 2015 that will have far-reaching consequences: those involving e-commerce, telecommunications and broadcasting services; immovable property; and access to cultural, scientific and entertainment events.
VAT and GST continue to gain popularity around the world, with more jurisdictions adopting versions of the tax, and rates generally increasing as indirect taxation becomes the fiscal revenue generator of choice. Common global challenges revolve around correctly capturing trade on the internet, and focusing on compliance and anti fraud measures.
The fast-moving market for payment transactions, where traditional card systems are being encroached on by online payment providers, e-wallets, cryptocurrencies and telecoms payments offerings, presents challenges for regulators around VAT exemptions.
VAT is a tax typified by documentation formalities and requirements, which gives rise to common mistakes. In
most jurisdictions, criminal liabilities and even penalties can be avoided by timely voluntary disclosure.
Global VAT and tax policy trends
The best thing to come out of the Commission’s review of the European VAT system so far is probably the proposals on a standard form. Guidelines and explanatory notes being published is progress, as is the Fraud Directive and enhanced cooperation between member states. But there is still a huge amount of complexity in the European VAT system that is not being addressed.
Mark Delaney Baker & McKenzie, London
Three significant policy changes are currently impacting global VAT legislation, and those are the European Commission’s review of the VAT system in Europe, the OECD’s initiative on base erosion and profit shifting, and the Commission’s new directive that has been proposed to combat fraud. In each of these cases the focus is on protecting government revenues, with the loss to budgets from tax inefficiencies a great concern to public officials around the world.
The future of VAT
The aim of the EC’s review of the VAT system has focused on three driving motivations: delivering a simpler system, a more efficient system, and a more robust one. The review was launched two and a half years ago and has since made some, but not a great deal of, progress.
With a view to delivering a simpler VAT system, the first step has been the standardisation of VAT obligations through a single EU VAT return. A proposal for this was put forward in October 2013 and supported by the European Parliament in February 2014, and will replace national VAT returns with a standard form of five compulsory boxes, though member states may request up to 26 further boxes, leaving plenty of room for potential variation. The harmonised system will introduce monthly electronic filing and no annual return, and is a legislative proposal currently going through an impact assessment process.
To the same end the Commission remains committed to the idea of a Mini One Stop Shop, which comes into effect in January 2015 and is available for registration from October 2014. Guidance has been published, and mirrors the existing scheme for non-established suppliers of e-commerce, with broadening of the one-stop-shop model envisaged if the mini version proves successful.
Another proposal, for an EU web proposal that would have provided businesses with centralised access to more accurate and reliable information on member state rules and obligations, has been rejected by member states. But the improvement of governance of VAT at the EU level is taking shape through the establishment of the EU VAT forum and the VAT Expert Group, both of which are now up and running.
When it comes to improving efficiency, the Commission has looked at broadening the tax base with more neutral and simpler rules for passenger transport in particular, and is also conducting a review of reduced rates based on three
Global VAT and Indirect Tax Policy Trends 7
criteria: compatibility with the single market; coherence with other EU policies; and that similar goods and services should be subject to the same rates. The aim is to abolish reduced rates that have a distortive effect or where consumption is discouraged by other EU policies, but this is still a work in progress.
The quick reaction mechanism, which allows member states to take immediate action in cases of sudden and massive VAT fraud, has been approved by the Council via two Directives in July last year. It also allows member states to apply, temporarily, a reverse charge mechanism for particular supplies.
A number of other measures to help member states tackle fraud through greater cooperation and better access to information are the subject of ongoing work.
OECD – Base Erosion and Profit Shifting (BEPS)
The OECD’s BEPS initiative is focused on tackling aggressive tax planning schemes, and yet whilst its greatest concern is with direct taxes and transfer pricing, it will undoubtedly impact indirect taxation in the longer term.
BEPS was initiated in the wake of the financial crisis when tax revenues moved higher up both the political and the populist agenda. Recent statistics show that the world’s third largest jurisdiction outside the US for multinationals to invest in is Bermuda, and the view is that some of the profit being channelled through there and other similar offshore financial centres should be brought back onshore.
With that in mind, BEPS has at its core five main action points: addressing challenges of the digital economy; establishing international coherence; restoring international standards; ensuring transparency and certainty; and developing ways to swiftly implement new measures.
In July last year these five principals were developed into a set of 15 action points to be dealt with in the next 18 months, during which time a series of recommendations will be issued.
In Europe, a number of countries have already issued new laws and guidelines and there has been a general shift away from aggressive tax planning and towards more cooperative compliance practice. Tax authorities are taking a more proactive approach during audits, and the biggest concerns from a VAT perspective come around permanent establishment issues and the needs to have substance, which will have implications for indirect taxes as well as direct. The increased exchange of information between not only European member states but also OECD countries could also impact the VAT environment for multinationals.
“The biggest concerns from a VAT perspective come around permanent establishment issues and the needs to have substance, which will have implications for indirect taxes as well as direct.”
8 A Baker & McKenzie Report – March 2014
An EU fraud proposal
December 2013 saw the latest steps being taken toward a European fraud directive, first proposed by the Commission in July 2012. The European Union’s motivation is to protect its financial interests, with suspected fraud amounting to around €600m annually. Whilst member states have adopted their own rules and levels of protection to combat fraud, corruption and money laundering, to date no equivalent protection exists for the EU’s financial interests.
As such, the aims of the proposed directive are to ensure effective, proportionate and dissuasive protection for the EU’s finances, to provide a framework within which a future European Public Prosecutor’s Office would operate, and to provide a more precise and comprehensive definition of fraud detrimental to the EU’s budget, which would include corruption and money laundering, and of course VAT fraud.
Those affected include both legal persons and natural persons, so companies are potentially on the hook. Legal persons are liable for offences committed for their benefit, either by people in senior positions, or if those people showed a lack of supervision or control that made the criminal offences possible. Here the sanctions include not just fines but also temporary or permanent disqualification from practice of commercial activities, and exclusion from entitlement to public benefits or aid.
Natural persons can be sanctioned as well, with a threshold of €50,000 beyond which penalties for VAT fraud can include a minimum of three months’ imprisonment, with a maximum of five years’ imprisonment rising to a maximum of ten years’ where the offence was committed within a criminal organisation.
Global VAT and Indirect Tax Policy Trends 9
Doing business in Italy
There is awareness in the Italian government of the need to identify a number of weak points in the Italian economy, including the tax system, and to improve those in order to make Italy a great place to invest.
Giuliana Polacco Baker & McKenzie, Milan
“Today’s system is run by judges not necessarily familiar with complex tax issues.”
In 2014, the Italian government approved a new investment decree known as Destinazione Italia (DI), which is a list of 50 actions covering things like tax, energy, labour and justice, introduced to facilitate and attract investments to the country, to encourage investment in people, and to promote Italy around the world.
Recognising that public debt and budgetary commitments have limited the country’s spending capacity, foreign investment is seen as a way of supporting the economic recovery as well as bringing advantages in terms of knowhow and research.
When it comes to taxation, the main measures that have come in under DI aim to encourage closer collaboration between the Revenue Agency and investors, and to introduce tax agreements for investments exceeding certain thresholds. A Foreign Investors’ Desk will be set up to facilitate and speed up communication, and resolve potential interpretative issues, while there will also be a reduction of excessive restrictions on business internationalisation, in keeping with EU law.
With respect to VAT, the measures that will have the most impact will be the review of the definition of the abuse of right, which will see an alignment with what has developed under EU Court of Justice case law, in place of the current high levels of uncertainty for taxpayers in Italy. Another key point will be the review of tax penalties, both criminal and administrative, as at the moment these are often disproportionate to the seriousness of the behaviour being punished. And finally, there is the review of the tax litigation system, to strengthen the jurisdictional protection of taxpayers, increasing the competence of judges on international and complex tax issues.
When carrying out transactions in Italy, there are four main issues that need to be taken into account from a VAT planning perspective. The first is the mandatory application of the reverse charge system, which has significant implications for non-resident companies. Since 2010, all supplies of goods and services performed by non-resident entities in Italy for VAT registered business customers have to be reverse charged by the latter, with very few exceptions.
The second issue is whether or not VAT registration is mandatory or simply recommended. The introduction of the reverse charge system meant a reduction in the number of companies that need to be VAT registered, and now
non-resident companies are not required to register unless they are selling to consumers, or to other non-resident companies that are not VAT registered.
Global VAT and Indirect Tax Policy Trends 11
VAT registration is not mandatory but is recommended where the company performs purchases in Italy that trigger Italian VAT and cannot apply for a direct refund. Then the VAT registration is the only way to obtain the refund.
The third challenge is how to register, and here there is a choice to be made between direct registration and the appointment of a VAT representative on the ground. Under direct registration, the company involved will manage the procedural formalities itself from its home country, and that is not always straightforward. With the appointment of a representative, there may be more costs involved but the individual concerned will likely have better relationships with the local tax authorities, and will offer a quick insight into the VAT formalities in Italy.
Finally, one of the particular idiosyncrasies of the Italian tax system is the VAT refund process, which can be both cumbersome and complex to navigate. The process at the beginning is quite easy, where a request is filed at a local tax office, who then evaluates it. But the timing has been reduced from anything up to four years to now taking around 12 months to finalise, and the challenges arise as the tax offices often request huge quantities of documentation for review as they go through the evaluation process.
One thing of note about the Italian tax system is the fact that the tax inspectors and local tax offices take a very formal approach to tax audits. This applies not only to the documentation kept by the taxpayer, for example proof
of exports, but also increasingly on the interpretation of contracts. Where there are issues of interpretation, rulings may tend to go in favour of the Italian tax administration, with limited regard to the application of the EU principals. Then there are high penalties to contend with, typically a minimum of 125% of value.
Other key challenges include abuse of law, where a very broad interpretation is used to reassess transactions, and the reverse charge mechanism, where an omitted reverse charge is sanctioned with a penalty ranging from 100% to 200% of VAT.
Denial of a VAT deduction in the case of reverse charge is a hot topic for costs considered not connected to the business for CIT purposes, and permanent establishment (PE) for VAT purposes becomes an issue if Italian companies are seen as PEs of the foreign entity and are then at risk of being treated as distributors, such that VAT is applied on all sales made in Italy.
There is no doubt that Italy is a difficult market to operate in from an indirect taxation perspective, but the government is now making moves to address many of these issues.
“There is no doubt that Italy is a difficult market to operate in from an indirect taxation perspective, but the government is now making moves to address many of these issues.”
12 A Baker & McKenzie Report – March 2014
Global VAT and Indirect Tax Policy Trends 13
Key EU VAT legislation and case law developments
Fiscal neutrality is by far the most pervasive, the most interesting and the most dynamic concept in VAT at the European level at the moment.
Frank Mitchell Barrister, Monckton Chambers
The EU’s fiscal neutrality principle, which holds that supplies of goods and services that are the same or similar must be treated the same for tax purposes so as to avoid any distortion of competition, has been around ever since the conception of VAT. Nevertheless, challenges to the tax authorities based on the fiscal neutrality concept have become a big theme in European Court of Justice (ECJ) activity, and a number of significant rulings in recent months are worthy of note.
The significant decision on fiscal neutrality, which brought the issue to the attention of taxpayers, was that involving Rank Group in 2011. There the ECJ found that the UK had breached the law by treating certain bingo games differently than others for VAT purposes. Rank had paid more than £250 million in VAT on mechanised cash bingo games between 2002 and 2005, while other gaming companies operating with similar bingo game machines had applied the VAT exemption on gaming and thus had not paid VAT on similar activities. Since the Rank case there have been more than 50 judgments from the ECJ that have related to fiscal neutrality, such that we have started to shape a sense of the extent and the strength of the concept.
In Deutsche Bank, the question was whether discretionary fund management services are exempt from VAT, based on whether they are a single or a multiple supply. The Advocate General concluded that there was a single supply and that such services are taxable. The ECJ made clear that the principle of fiscal neutrality cannot extend the scope of an exemption, since fiscal neutrality .principle must be applied concurrently with the principle of strict interpretation of exemptions.
In a case concerning GfBk, a German third party providing pure investment advice to special investment funds, the ECJ found in favour of GfBk and ruled that pure investment advice could be management for the purposes of exemption. It went on to make an important statement on fiscal neutrality, saying:
“If investment advice services provided by a third party were subject to VAT, that would have the effect of giving IMCs with their own investment advisers an advantage over IMCs which decide to have recourse to their parties. It follows from the principle of fiscal neutrality that operators must be able to choose the form of organisation which, from
the strictly commercial point of view, best suits them, without running the risk of having their transactions excluded from the exemption.”
That ruling appears to suggest that if, for commercial reasons, a business decides to outsource an activity, it should not be punished through the VAT system. The judgment may allow wider range of services to be provided on an exempt basis.
14 A Baker & McKenzie Report – March 2014
Next came the case of Dutch company PPG Holdings, relating to whether VAT borne on the management and operation cost incurred by a company where such costs have not been passed to its separate pension fund could be reclaimed. Here the Advocate General issued an opinion referring to Deutsche Bank, and saying that fiscal neutrality is not a rule of primary law and that partly competing activities may sometimes receive different VAT treatment. He went on to say that taxable persons may choose to structure their business so as to limit their VAT liability. However, the court took a different approach and said that VAT incurred on the management and operation of the fund can be claimed on the basis that there is a direct and immediate link between these costs and the taxable business activities of the employer. In essence, the court reasoned that if there were no right to deduct the input tax paid, not only
would the taxable person be deprived, by reason of the legislative choice to protect pensions by a legal separation of the employer from the pension fund, but the neutrality of VAT would also no longer be guaranteed.
Four significant judgments on fiscal neutrality were handed down by the ECJ in March 2014, just showing the volume of issues arising. In one of these, the German courts had referred a question to the ECJ on the deductibility of VAT
on the costs of transferring a partial share of a client base to a new partnership. Malburg was a member of a tax consultancy and bought from the partnership a portion of its client base for use, free of charge, by a new partnership in which he was a founding partner.
The court ruled that he could not deduct the input tax arising from the acquisition of the client base, even though it would have been deductible had he structured the transaction differently, because the principle of fiscal neutrality is not a rule of primary law. This judgment was difficult to reconcile with the principles set out in the PPG judgment.
Then came Jetair, which concerned the VAT distinction between travel agents and intermediaries, and which it was claimed was in breach of fiscal neutrality. The ECJ’s ruling said that it is apparent from the provisions of the directive that the EU legislature considered the two activities to be different, and not in a comparable situation, and as such
it does not breach the principle of neutrality. This decision seems to suggest that EU legislation distinctions on activities would take precedence over the fiscal neutrality principle.
Finally, the other recent judgment to contribute to the case law on this issue is ATP, a case to decide whether a defined contribution pension scheme can be a special investment fund (SIF), and therefore apply VAT exemption to its management costs. The scheme was held to be subject to the same treatment as SIFs, and as such, management fees were held to be exempt. The ruling mirrors what we saw in PPG, where it was held that starting to discriminate against those companies that chose to outsource would result in a breach of fiscal neutrality.
Global VAT and Indirect Tax Policy Trends 15
What conclusions can we draw from this spate of recent judgments? The very fact that so many cases hinging on fiscal neutrality have made it to the ECJ highlights the significance of the issue and the enormous interest in it following the Rank Group ruling. The court is not making it easy to find clarity, but there are two important questions to think about.
First is the question of whether it matters how activities are structured. Some judgments appear to suggest that it does not matter, and that is of critical importance to the way in which everybody gives advice around VAT. There
nevertheless remains some ambiguity following rulings that have said taxpayers must accept the consequences of structuring decisions.
Second is the question of passing on the benefit of exemption via an outsourcing. Taxpayers who in the past have had difficulty retaining the benefits of exemption for outsourcing activities might decide to look at some of these recent judgments to analyse whether case law now provides any assistance on exemption.
16 A Baker & McKenzie Report – March 2014
Global VAT and Indirect Tax Policy Trends 17
Overview of 2015 changes
Significant changes in the VAT Directive, particularly regarding e-commerce, will have a big impact. The EU has also taken the opportunity to clarify the VAT location rules, on services related to real estate and events, so there is a lot on the horizon.
Ana Royuela Baker & McKenzie, Barcelona
There are three significant VAT changes in the offing for 2015, and though these may seem a long way away, they will need some preparation from businesses affected and perhaps even some immediate action. The three areas affected are digital sales (electronically supplied services), telecommunication and broadcasting services; services relating to immovable property (as of 2017); and access to cultural, scientific and entertainment events.
E-commerce, telecommunications and broadcasting services
The growth of e-commerce in recent years has been rapid, such that e-books now create annual sales of more than
£400m in the UK alone, and online gaming generates revenues of more than €4bn across just a small number of European member states. This is a big industry, but it creates a problem for the tax authorities because the current VAT rules are leading to a competitive advantage for jurisdictions with low VAT rates. EU suppliers apply VAT to digital sales in the country where the supplier is located, and this has led many of the largest digital providers to locate their EU headquarters in countries with a low VAT rate, most notably Luxembourg, where the rate is 15%.
From 1 January 2015, VAT will be due on supplies of digital sales, telecommunications and broadcasting in the country in which the consumer is resident, meaning suppliers will be required to account for VAT in up to 28 different member states.
This will have a significant impact on Luxembourg revenues, which are expected to fall significantly, and as a result the country is expected to raise its standard VAT rate to 17% when the legislation becomes effective, if not before.
The increase in revenues for other member states will likely exceed this shortfall due to higher VAT rates, with HMRC in the UK estimating it will receive an additional £300m a year, for example.
Note that the changes only apply to B2C supplies of services. They do not impact the sales of goods (even when they are ordered online) or B2B supplies.
As a simplification measure, taxpayers will have the option to use a single point of registration, the so-called Mini One Stop Shop Scheme, which allows them to use one single VAT registration (in a chosen EU country) to proceed with the VAT payments. The rest of requirements must still be met on a country basis (i.e. the local regulations applicable at the country of residence of the customer need to be followed).
Many challenges arise with such a significant change. The first challenge will inevitably be in the definition of electronically supplied services. The regulation states that these are those where “their supply is essentially automated, involving minimal human intervention, and impossible to ensure in the absence of information
“VAT will be due on supplies of
e-commerce, telecommunications and broadcasting in the country in which the consumer is resident, meaning suppliers will be required to account for VAT in up to 28 different member states.”
18 A Baker & McKenzie Report – March 2014
technology.” There is a non-exhaustive list of excluded services, including services of professionals such as lawyers and consultants that are simply rendered using the internet. The key point is that the definition of a service is being changed, from one based on the material or subject being supplied, to one based on the means of delivery.
Services that might be impacted include not only e-books and e-learning, but also some payment services, financial intermediary services, membership fees or advertising services.
The next question arises around customer status, where the role of the VAT identification number will be crucial. Services will broadly be considered B2B if a VAT number is provided, and B2C if not, although other means of evidence may be allowed.
And then there will be the challenges around customer location, with a customer deemed to be located where they are established, have their permanent address, or usually reside. Sourcing this information, and working out how to charge accordingly, will bring extra work and burdens for suppliers, such as adapting their IT systems accordingly and keeping consumer data in a suitable way.
In addition, the changes may bring additional business and commercial decisions. In many cases, the arising question is how to deal with the VAT higher rate, whether by increasing the final price or reducing the margin.
The role of online marketplaces will also need to be checked, by determining, within complex supply chains, who is acting as the supplier and who is acting as a mere intermediary.
The new EU regulation adopted in September 2013 included a desire to harmonise at an EU level what would be considered to be land or immovable property related services across Europe, as supplies of these are subject to VAT where the land is located. With tax authorities adopting aggressive positions as to what is land-related, the regulation contains a definition that says “services connected with immovable property shall include only those services that have a sufficiently direct connection with that property”.
These include services that are derived from an immovable property and where that property makes up a constituent element of the service and is central to, and essential for, the services supplied. Also included are services where they are provided to, or directed towards, an immovable property, having as their object the legal or physical alteration of that property.
Global VAT and Indirect Tax Policy Trends 19
So, for example, legal services relating to the transfer of title to immovable property are land related, but those not specific to a transfer of title on immovable property are not. Similarly valuation and property management are land related, but advertising and exhibition stands with additional services are not.
The new provisions are legally effective as of 2017, but as they have been published in advance of coming into force it will be interesting to see whether tax authorities across the EU will adapt their approach on questions of services connected with immovable property to comply with the new definitions in the meantime.
Access to cultural, scientific and entertainment events
When hosting events, and taking fees for those events, organisations get into complex VAT issues, and particularly double-taxation risks where events take place in other countries and where ticket agents or other intermediaries are involved. Whether talking about exhibitions, trade fairs, public seminars, sporting events or art fairs, queries inevitably arise around the place where the tax should be paid, who owes the tax, and which tax rules apply.
Hence the new EU regulation, which seeks to simplify the issue by clarifying under which circumstances the tax place is at the event not only for the event-related activity itself, but also for granting of access to the event, and for related services.
The regulation sets out that the “organizer”, who may grant access to an event, is the taxpayer granting access in its own name but no matter on whose account. This wording clarifies that an agent acting in someone else’s name is not included so that its services would be taxed under the normal VAT rules rather than at the place where the event takes place. It is recommended to use clear contract language on this point.
Still, it remains unclear what actually constitutes “an event”, and what is a related services. There is also no harmonization around reverse charge rules so that different EU countries have different regulations as to who actually owes the VAT and as to who must register for VAT. The same applies for the concept of bundled supplies: individual countries may regard an otherwise event-related service as part of a bundled supply that follows other taxation rules than the pure event-related service.
So the impact of the new rules is essentially to clarify that the place of the event shall be relevant in all kinds of cases where the supplier is granting access in its own name. The result should be a reduced risk of double taxation.. But there remain a number of legal and practical uncertainties e.g. around when the reverse charge is applicable, around the scope of an “event” and its “related services”, and regarding the concept of bundled supplies definitions
As such this new rule marks a small step in the right direction, but is some way off harmonisation or the complete removal of double-taxation risk.
20 A Baker & McKenzie Report – March 2014
Global VAT and Indirect Tax Policy Trends 21
VAT around the world
VAT and GST are being applied in far more jurisdictions around the world – this is a tax that’s on the march.
Mark Delaney Baker & McKenzie, London
The rise and rise of VAT and GST continues around the world, with VAT in OECD countries now accounting for 20% of total tax revenues, as compared to 25% coming from personal income tax, 11% from excise duties, and 8% from
corporate income tax. VAT is today used by approximately 150 countries and affects around four billion people, and it continues to grow as the tax of choice in preference to corporate income taxes.
With this growth has come a general increase and convergence of rates, particularly in Europe, where VAT has been identified as a key tool for bolstering struggling government finances. Standard and reduced rates are increasing, such that the average EU VAT rate is now 21.5%, up from 19.5% in 2008.
At the same time we see a broadening of the tax base – the so-called “New Zealand” model, where countries are starting from a more restricted base, as is common in Africa. We see VAT trials in Asia also.
And a common challenge is the need to address the impact of the internet, which forces new VAT systems to be developed that can encompass digital sales and new technologies along with fast-evolving new business models.
Finally, we see a global trend towards a much greater focus on compliance and fraud, with increases in audits and penalties, specific measures being introduced to target carousel fraud, and simplification exercises being undertaken to tackle the VAT gap.
In this chapter we will drill down into some of the more country and region-specific trends affecting VAT around the world.
Malaysia first mooted the idea of the introduction of a GST back in 2005, but it has since been repeatedly deferred. The draft GST Bill got its first reading in Parliament in December 2009, but is yet to be passed into law. Last year, however, the Prime Minister announced that GST would be implemented on 1 April 2015, with Royal Customs of Malaysia as the administering authority. The proposed rate of 6% is up from earlier suggestions of 4%, and the tax will replace the current sales and service tax regime.
Malaysia’s proposed model will see a tax on local consumption and on the importation of goods and services, applying to all goods and services except exempt supplies. It will be a consumption tax with a credit-invoice mechanism, allowing for standard-rated, zero-rated and exempt supplies, similar to the systems in Australia and Singapore.
“VAT has been identified as a key tool for bolstering struggling government finances.”
22 A Baker & McKenzie Report – March 2014
GST registration will be required for businesses whose taxable turnover exceeds the threshold of RM500,000 ($150,000), and transfer of going concern relief will be available subject to satisfaction of certain conditions.
The current Brazilian tax environment is complex, with a lot of different levels of taxation, several ancillary obligations, and unclear legislation leading to frequent tax litigation. There are three different levels of taxation, at federal level, in each of the 27 states, and then in thousands of municipalities. There are four different indirect taxes:
IPI: excise tax on manufactured products, which is a federal tax rate according to tariff code
PIS/COFINS: Turnover taxes, also on importation, where there are three methods subject to different rules
ICMS: State tax on the circulation of goods and services, paid to the state of origin of the transaction, and paid by the importer or manufacturer
ISS: a municipal service tax, paid to the city of the service provider
The Brazilian VAT regime is not comparable to Europe, as there is no single VAT tax and different rules regarding credits. Given the complexities, there is a heavy reliance on compliance, with a very formalist system, quite literal interpretation of tax benefits, and withholding obligations. Certain regimes depend on information about the buyer while the liability is with the seller, and each branch of a company is deemed a separate VAT taxpayer.
Compliance is therefore the key issue with respect to Brazilian VAT, with PricewaterhouseCoopers estimating that complying with VAT reporting obligations requires 2,600 working hours per year for the average corporate. That requires a significant investment in headcount.
Australia has a sophisticated GST system, based on the European VAT model, with rates of 10% for standard-rated and 0% for GST-free or exempt. An overseas entity can register but has to account for all taxable supplies unless the reverse charge rules apply, or it appoints a resident agent through whom it makes the taxable supplies.
Latest developments include proposals to implement changes to the application of GST to cross-border transactions, and to narrow GST exemption for goods purchased overseas via the internet.
Global VAT and Indirect Tax Policy Trends 23
China has two systems: VAT and business tax (BT), where the characterisation of the supply is the important differentiator. VAT is imposed on the sale of goods, the importation of goods, and the provision of repair, replacement, processing and modern services in China, and BT applies to all other transactions.
VAT is at 17%, with reduced rates and exemptions available and the export of goods zero-rated. BT is generally between 3% and 5%, but can be as high as 20%, and an overseas entity cannot register for either.
Latest themes include the expansion of “modern services” under a pilot VAT programme, to include radio, film and TV services. Administrative measures on VAT exemption for cross-border services are also within the pilot.
In India, service tax is levied by the central government on the supply of services, VAT is levied under state laws in respect of intra-state sales of goods, and central sales tax is levied at 2% on inter-state sales of goods. So businesses must first look at the nature of the supply, and whether it crosses state borders, to determine the
relevant system. The prevailing rates are 12.36% for service tax, VAT ranging from 4% to 13%, and exports of goods and services are zero-rated. An overseas entity is not liable to register unless it has an office in India.
Current issues include a proposal to introduce a dual GST, comprising a central GST and a state one. It remains to be seen if and when that will be rolled out. Since July 2012 all services are taxable, unless falling within a “negative list”, and service tax is not chargeable on expenses charged as reimbursements. No service tax is payable on goods supplied free of cost by the recipient of construction services to the provider.
Indonesia has a VAT regime that covers the delivery, import and export of taxable goods, with a rate of 10% that the government can amend to a minimum of 5% and a maximum of 15%. Non-residents cannot register for VAT.
Recently the government has significantly increased the minimum threshold for being a taxable entrepreneur for VAT purposes from IDR600m ($55,000) to IDR4.8bn ($436,000). It has also given clear confirmation that input VAT incurred by taxable entrepreneurs who carry out integrated business operations can be proportionally credited.
24 A Baker & McKenzie Report – March 2014
Japan’s consumption tax system is broadly similar to VAT regimes elsewhere, with a prevailing rate of 5%. There is no invoice system, and a registration number is not required, but companies and individuals that are considered taxpayers have to notify the tax authority and file returns.
The rate of consumption tax will increase from 5% to 8% on 1 April 2014, with proposals for a further increase to 10% next year. There are proposals for a zero or reduced rate for certain food products and essentials, and for outbound payments from Japanese consumers to foreign service providers to be subject to the tax.
In Singapore, the GST is imposed on taxable supplies of goods and services made in Singapore by GST-registered persons, and imports of goods. The rate is 7%, with export supplies zero rated, and an overseas person can register but a local agent must be appointed to be accountable for their obligations.
Recent developments have seen an extension of the concession for qualifying funds to claim GST at recovery rate until 31 March 2019, and additional obligations imposed on new local agents appointed by overseas persons from January 2014. Also new this year is an ability for the tax authorities to disclose taxpayers’ information to other Singapore government bodies or statutory boards – though this is meant to be confined to research and statistical purposes.
South Korea completed a thorough overhaul of its VAT system last year to clarify key VAT concepts. VAT is levied on the supply of all goods and services and the importation of all goods into Korea, at a rate of 10%, with export supplies zero rated. A foreign corporation without a permanent establishment in Korea is not required to register for VAT.
The clarifications last year included refining the rules on reverse charges in a transfer of business as a going concern, and an exemption of VAT on alternative trading system services.
Global VAT and Indirect Tax Policy Trends 25
In Vietnam, VAT is imposed on goods and services used for production, trading and consumption in the country, with a prevailing rate of 10%. An overseas company can register for VAT or choose to pay it under the deemed VAT- withholding method.
There has recently been confirmation that loan financing by non-credit institutions remains VAT exempt, and that the sale of mortgaged assets will be exempt, along with an expansion of the list of goods eligible for 0% VAT to include goods sold to a local buyer but delivered and accepted outside Vietnam. Positive developments are a reduction in the time taken to issue decisions for tax refunds, and an introduction of a statute of limitation for tax assessments of 10 years from the date of finding violations.
26 A Baker & McKenzie Report – March 2014
Global VAT and Indirect Tax Policy Trends 27
VAT and the evolving market of payment transactions
Payment services are evolving as new technologies are adopted and new market players emerge. The VAT exemption for payment services continues to be examined at domestic and European level. Services
previously accepted to be exempt may become taxable.
Mark Agnew Baker & McKenzie, London
In recent years we have seen rapid change and expansion in the payments space, with numerous new entrants. Today we have not only the banks and traditional card schemes, but also online payment providers and e-wallets like PayPal and Google Wallet, mobile payment offerings from telcos, banks and other providers and new offerings such as Bitcoin, the virtual currency.
The EU rules state that there is a VAT exemption on transactions, including negotiation, concerning payments and transfers, which have the effect of transferring funds and entailing changes in the legal and financial situation. This exemption does not cover mere physical or technical supplies, and debt collection is specifically excluded.
The correct scope of the exemption has always created difficulties and is perhaps becoming even less clear. A leading case involved Axa at the ECJ in 2010. Axa administered a payment system for Denplan, a dental care programme where patients paid a fixed fee to their dentists for an agreed level of care. Axa collected the payments from customers and transferred the funds, less a service fee, to dentists. The UK authorities tried to claim that exemption did not apply to the services , and the ECJ agreedon the basis that the services Axa provided fell into the category of debt collection, which is excluded from the exemption.
It has always been held that the exemption applies according to the nature of the services provided, and regard should not be had to the person supplying or receiving those services. However, the reasoning in Axa suggests that the exclusion for debt collection can only apply, by definition, to services provided to a person to whom the payment or debt is owed. This test clearly must take into account the status of the recipient of the services. This, therefore, creates some difficulty in the approach that should be adopted in examining whether a payment service is in or out of the exemption. Merchant acquirers, card schemes and even card issuers can all potentially be argued to be “pulling” money from a cardholder to make a payment, and therefore acting as debt collectors, rather than a customer “pushing” pushing money for payment for goods and services, which should be VAT exempt
Another area of difficulty is payments concerning third party content billing on mobile phones. If, for example, a customer orders a game through his phone and pays €1 for it, including €0.17 VAT, he is charged that on his phone bill. Say the telco is then entitled to €0.20, excluding VAT, and the remaining €0.63 goes to the content provider. The question is, what is the telco actually doing – is it acting as a payment provider, making it possible for the content provider to receive €0.63, or is it providing content itself.
Then the question moves on to whether the telecoms company’s payment offering is taxable. In the situation set out above it is taxable, but if the €0.20 was charged directly to the customer instead of taken from the game company, then it would be exempt. The content provider here is making taxable content available to the phone company and the phone company is then making a taxable supply to the customer.
When it comes to near field communications, we are talking about devices that allow users to make payments when their phone comes within a few centimetres of a paypoint. In these circumstances the phone company is generally acting as a payments provider, although in some instances devices contain a secure element owned by a third party. So once again the question arises as to which party is carrying out the payment transaction and whether this is exempt or taxable. It hinges on whether the phone company is pulling money from the consumer on behalf of the vendor, in which case it is taxable, or whether the customer is pushing money for payment, in which case it is exempt.
Online ticket agencies
With regard to online ticket agencies, we have seen a couple of significant UK cases concerning exemption for booking fees charged by such agencies for payment processing on the behalf of promoters. Both cases have held that a booking fee is an exempt payment service, because it is charged to the end customer, but a question remains as to whether a booking fee charged to a promoter might be considered standard rated debt collection.
Meanwhile, transaction fees charged for the delivery of a ticket are standard rated, and facility fees for agency services are also standard rated.
VAT questions often arise in situations involving the outsourcing of the servicing of loans, whereby banks grant loans to consumers but then outsource part of the business process to a third party, the servicer. The servicer processes the loan agreement in the system, calculates the monthly amounts of principal and interest, pays out the principal loan amount and collects principal, interest and charges from the debtor.
So again the same question: is this taxable debt collection, or exempt payment services? This is an area of the law that remains blurred, although the recent ATP case lends support in favour of exemption. A different approach however has been followed by the Dutch Supreme Court which determined that such services were not payment services at all, rather that it is a taxable credit management service.
New payment methods
Finally, we come to the area of so-called cryptocurrencies, such as Bitcoin, the peer-to-peer payment system and digital currency introduced as open source software in 2009. Bitcoin’s value goes up and down every day, and it remains very tricky to establish how to trade bitcoins for VAT purposes, with almost every member state treating the currency differently.
For now, the UK government says that if you generate bitcoins or pay with bitcoins, it is out of scope and so no VAT is payable. But this is an industry that is fast-evolving and VAT law is failing to keep up.
Global VAT and Indirect Tax Policy Trends 29
Compliance and risk management
Even in those sectors where VAT is supposed to be an administrative burden rather than a tax, because it is not a cost for the business, it can still result in a huge cost because of the risk of compliance mistakes.
Maria Antonia Azpeitia Baker & McKenzie, Madrid
VAT by its very nature is a tax linked to a lot of formalities. Within the EU, VAT compliance requirements include the issuance of invoices and reverse charges, formalities relating to the VAT deduction, periodical payments of VAT, a regular VAT return, plus the holding of supporting documents for import and export controls, and reporting responsibilities to Intrastat.
Given all of these requirements, it is little wonder that mistakes are made, and here we have highlighted some of those that we come across the most frequently.
Common mistakes on VAT compliance
Transfer of a going concern (TOGC)
One of the most common issues that arises on VAT compliance is in the event of asset sales, deals and restructurings in M&A, where the most important thing to get right is the TOGC exemption, which states that there is no VAT payable if the business is continued and is in effect the “transfer of a business as a going concern”.
To avoid wrongfully charging VAT, it can be simplest to question a tax authority in advance on whether they consider the deal to be a TOGC deal, or another approach is to amend contracts to say that the deal is being approached as a TOGC transaction and VAT can then be charged at a later date if that turns out not to be the case.
In some countries there are additional taxes that can be triggered by application of TOGC, so it is not always the best option from all perspectives.
Place of supply
Determining the place of supply is often a big issue with certain services, and especially internet and combined services. It is necessary to determine what kind of service is being supplied first, and in most cases normal B2B services are taxed quite simply. With B2C services it becomes more complex, however, as then the tax may be due in the country of the service provider or the consumer. So especially with bundled or combined services it is vital to pay special attention to what interpretation a service is given, to avoid penalties or double taxation.
Global VAT and Indirect Tax Policy Trends 31
The VAT taxpayer
Another common mistake relates to the person liable for paying the tax, and whether that should be the supplier or the recipient. Often that is linked to the omitted or incorrect application of the reverse charge rule, with issues around the obligation to register for VAT purposes, VAT registration of non-resident taxpayers, and permanent establishment involvement or otherwise. Following the introduction of the VAT package by the EU, lots of the rules have been simplified, but this nevertheless remains an area to watch closely.
The amounts that need to be taken into account when calculating VAT often give rise to problems, particularly where indemnities, discounts and fair value are concerned. Indemnities must be taken outside the scope of VAT, while there are various systems on discounts. Consideration also needs to be given to intercompany charges, and whether they should be taken into account on a taxable basis or not.
There are still a lot of issues around chargeable events, for example relating to when a service is deemed to have been supplied. If dealing with advanced payments, payment by instalments or continuous supplies, it is always necessary to look closely at the rules on chargeable events.
When looking at questions of whether to apply general or reduced rates, for example with regard to ancillary services, the answer can often come down to invoicing. If, on an invoice, there are different services and different products identified separately, it is possible to charge different rates on each, but if they are bundled the top rate should be applied.
Pro rata calculation
Where there are taxable and exempt supplies, and costs need to be allocated between the two, this needs to be done according to a pro rata calculation. A lot of mistakes are made in making that pro rata calculation, even by seasoned accounting firms, but is important to remember almost every company or group entity has to have a pro rata.
32 A Baker & McKenzie Report – March 2014
The invoicing documents supporting exports or inter-community sales are always an issue, but in general if an exemption or lower VAT rate is being applied, every country will ask for evidence supporting its use. It is therefore essential to check systems are capable of proving, for every transaction, that it was done at the correct rate, and it is often necessary to make a member of staff responsible for the documentation, even if a third party logistics company is involved.
The Neutrality Principle
“In most jurisdictions criminal liability or even penalties can be avoided by voluntary disclosure.”
Breaches of the Neutrality Principle can be a risk in the case of incorrect invoicing, late invoicing, controversial interpretation of territoriality rules, or wrongful application of the reverse charge system. It is also essential to pay close attention to supporting documents in cases of exportation or intercommunity sales, to limitation to the VAT deduction right, to the request of refunds and to the issue of self disclosure versus audit charges.
To disclose or not to disclose
The problem with all of the mistakes set out above is that they normally have a simple solution, but it is important to have some kind of control, and in order to decide whether or not to self disclose there are several issues to take into consideration. In most jurisdictions criminal liability or even penalties can be avoided by voluntary disclosure.
When considering self disclosure, time restrictions are an important factor, as it is no longer available if an audit is announced or started, and often only for a limited period. Consideration needs to be given to penalties versus late payment interest, and to the ability of the business to propose a practical solution. Thoroughly prepared case documentation will be a mitigating factor, as will secure authorised economic operator status, which can lead to more lenience in respect of criminal procedures and personal exposure.
Global VAT and Indirect Tax Policy Trends 33
34 A Baker & McKenzie Report – March 2014
Abuse and VAT savings: A legitimate choice?
EU law cannot ever be relied on for abusive or fraudulent ends.
Redmar Wolf Baker & McKenzie, Amsterdam
In a string of recent decisions from the European Court of Justice, the judges have made clear that while taxpayers may choose to structure their businesses so as to limit their tax liabilities, EU law cannot ever be relied on for abusive or fraudulent ends.
There are two principles of EU law at stake here. The first concerns that of prohibiting abusive practices, and the first case where it was applied to VAT was one concerning Halifax. In that case, the ECJ held that, for VAT, an abusive practice existed if the transaction concerned resulted in the accrual of a tax advantage, the granting of which would be contrary to the purposes of the provisions.
For a transaction to be abusive it must also be apparent from a number of objective factors that the essential aim of the transactions was to obtain a tax advantage. This may involve deduction input VAT, an exemption or specific rate, or a lower taxable amount.
The second principle is the prohibition of relying on EU law for fraudulent ends. With respect to VAT fraud the ECJ elaborated on this in a case called Kittel, where the judge held that the right to deduct VAT should be refused if a taxable person knew, or should have known, that by his purchase he was participating in a transaction connected with fraudulent evasion of VAT.
Abuse in The Netherlands
The Dutch legal system recognises the principle of fraus legis, which is comparable to the concept of abuse as developed by the ECJ. Only after the ECJ’s decision in Halifax did the Dutch Supreme Court acknowledge fraus legis in VAT cases, and as a result, VAT saving structures involving costly medical equipment and school buildings were successfully challenged by the Dutch tax authorities.
With regard to fraud, Dutch VAT law does not recognise a principle under which the right to deduct VAT or to apply the zero rate is withheld from taxpayers who knowingly participate in fraudulent trade chains.
Abuse in the UK
The abuse of rights principle has been used frequently by the UK tax authority the HMRC in disputes with taxpayers. After several early successes with the principle following Halifax, however, more recently HMRC has failed in its arguments on abuse in several cases, which may represent a shift to a situation where abuse is argued in only a limited number of cases.
Global VAT and Indirect Tax Policy Trends 35
In a UK case known as Pendragon, a complex VAT avoidance scheme was not held to be abusive because there was a commercial justification for entering into the transactions as a whole – beyond VAT avoidance. This judgment surprised many in the UK, but shows the importance of establishing the full facts before the tribunal. The “essential aim” of a transaction is a question of fact: if taxpayer-friendly facts are found by the tribunal, it is difficult for HMRC to overturn a finding in the higher courts.
Indeed, an alternative argument that HMRC may focus on is the principle of economic reality as considered in the Paul Newey case. In many ways the principle of economic reality is more flexible than abuse, and is likely to be an increasingly important principle on which VAT cases will turn in the future.
Abuse in France
The abuse of law concept is a traditional one in France, and has been implemented to protect citizens from non- legitimate consequences of the rights granted by regulators. It is used to create an informal limit to the free use of legal rights, and the state, like other citizens, can benefit from its protection.
Abuse of law under French tax legislation covers two scenarios: either the transaction is fiction; or the operator has implemented the law in a literal manner against the objective of that law, without being inspired by any other goal than avoiding or mitigating the tax he has to pay.
The concept is difficult to use, however. The existence of a fiction is difficult to demonstrate, as is the fact that the structure is only tax driven. The French parliament attempted to change the definition from ‘only tax driven’ to ‘mainly tax driven,’ but that attempt to expand the scope of the abuse law was stopped by the Constitutional Court, who felt it would introduce too much uncertainty. It was also seen as contrary to the business practice and freedom of trading that implies a right to be able to select the best options for doing business from a tax perspective.
The procedures for enforcement are therefore complex, with a general principle that transactions are valid until the clear demonstration that they are fictitious. But the French tax authorities have to identify quite subjectively whether a structure is purely tax driven, and so to avoid unjustified actions, French law has implemented a specific procedure where the tax audit is supervised differently from the standard one.
36 A Baker & McKenzie Report – March 2014
The penalties involved are significant, and if the authorities succeed fines range from 40-80% and criminal offences can also apply. But there remain few practical examples, as there is no tax evasion when VAT is recoverable. Examples mainly concern situations where, for example, the parties have split one single supply subject to the standard VAT rate into multiple supplies, in order to be able to exempt some of them or apply reduced rates, using different legal entities managed by the same person.
Instead, very often the French tax authorities will use an alternative approach instead of relying on the abuse of law concept. According to the French courts, when the authorities give the right characterisation to a factual situation that was not properly characterised by the parties, they are not using the abuse of law concept, but merely correcting a mistake.
For example, a real lease that is only tax driven is abusive and has to be challenged as an abuse of law. But a sale that has been treated as a lease can be challenged without using abuse of law concepts. Also when a single transaction is split into multiple supplies, the authorities can just argue that the said supplies are ancillary and they get the same result with just a recharacterisation.
The problem is that the difference between the two situations is not always clear, and there is a big risk for the authorities if they opt for the wrong approach, as the entire tax procedure can be cancelled.
Global VAT and Indirect Tax Policy Trends 37
Amsterdam Koert Bruins Associate
+31 20 551 7534
Amsterdam Folkert Idsinga Principal
+31 20 551 7599
Amsterdam Mirko Marinc Legal Director
+31 20 551 7825
Amsterdam Mei Chel Tan Associate
+31 20 551 7133
Amsterdam Johan Visser Senior associate
+31 20 551 7501
Amsterdam Redmar Wolf Senior Counsel
+31 20 551 7113
Barcelona Ana Royuela Partner
+34 93 2060851
Brussels Sophie Clocheret Counsel
Frankfurt Nicole Looks Principal
+49 (0) 69 29 908 282
+49 (0) 69 29 908 504
Hong Kong Eugene Lim Associate Principal
+65 6434 2633
Senior VAT Adviser
+44 (0)20 7919 1620
London Mark Delaney Principal
+44 (0)20 7919 1802
+44 (0)20 7919 1289
Luxembourg Ludovic Deflandre Specialist
+352 261844 228
38 A Baker & McKenzie Report – March 2014
Maria Antonia Azpeitia
+34 91 230 45 30
+ 39 (02) 76 231 465
+39 (02) 76 231 368
+39 (02) 76 231 442
+33 1 44 17 53 21
Sau Paulo Adriana Stamato Partner
+55 (11) 3048 6956
Monckton Chambers, London firstname.lastname@example.org
Global VAT and Indirect Tax Policy Trends 39
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