More and more businesses are operating globally and changing their structure to meet the challenges involved. Decisions about how the business is structured, how it buys, sells, or manages its supply chain or back office functions, need to take value-added taxes (VAT) into account. Ideally it should be considered in the planning stages – failing to do so could lead to severe delays when it is realized, all too late, that invoices will not be produced properly by the system, or that purchase invoices are in the name of the wrong legal entity. Either the project has to be delayed or the penalties and the cost of correcting the issues and dealing with the indirect tax authorities have to be paid.
The aim in a business change project is to keep VAT costs at zero, and where they are already zero, reduce any real VAT costs, VAT cash-flow effects and administration costs as far as possible and minimize customs duty.
PRODUCT SOURCING
When it comes to indirect taxes, there is a great difference between the economic effects of customs and excise duties and those of VAT. Whereas the principle of VAT is that it should not be a cost to businesses, customs and excise duties are intended to be a direct cost, as, except for some very specific situations, duty cannot be reclaimed.
Customs duties are widespread and the rates applied in the country of import vary considerably. Product sourcing decisions should always take account of the potential duty cost of change.
Every product has a customs commodity code, which determines the rate of duty and quota applicable to that product. Relatively minor modifications to the design or specification of a product can have a significant impact on its classification for customs purposes and on the rate of duty applicable.
Having established the classification of a product and the rate of duty applicable, the importer must then determine the value on which the duty should be calculated. The vast majority of imports are valued on the basis of the transaction value, ie, the invoice value, subject to various rules and conditions. The invoice value may be subject to the addition or exclusion of certain costs and care needs to be taken that duty is declared on the correct value. The potential impact of any changes in sourcing policy and/or the supply chain on the customs value of goods should be given careful, and early, consideration, particularly in related party situations.
The origin of a product will also influence the amount of duty paid as most importing countries offer preference regimes to developing countries, giving access to their markets at reduced or zero rates of duty. The EU has a particularly extensive network of preference arrangements and this can have a significant impact on the amount of duty paid on eligible products. For example, the full rate of duty for a woven jacket is 12.4% but, provided that the jacket satisfies strict conditions, the rate could drop to 9.9%, 6.1%, 2.7% or zero, depending on the country of origin.
Although many preferential arrangements stem from multilateral agreements, there is an increasing number of bilateral treaties, particularly in Eastern Europe, Asia Pacific and African countries, which can be taken advantage of to reduce duty costs. Knowing how these affect your company can directly reduce costs and improve profits.
CENTRALIZED PROCUREMENT
Centralized procurement can mean different things to different people. It may be that a central group of people make decisions about what to buy, at what price, from whom and on what terms. It is also more likely to be the case that not only are the decisions made centrally but also that the legal entity that houses those decision makers is the legal entity that is doing the buying; taking legal title to the goods and contracting for the services.
Great care needs to be taken that any central procurement organization (CPO) recognizes its obligations to account properly for indirect taxes. Although customs authorities are not too concerned about who pays customs duty, provided that someone does, VAT authorities are likely to be less forgiving. Paying import VAT in the wrong entity may well create problems recovering what should be a tax that has no impact on the business. Here, as elsewhere, careful planning pays.
From a VAT point of view, the problem with centrally procuring goods is that the indirect taxation of supplies and movements of goods follow the physical flows. Goods bought by a CPO for use in the country of origin may involve the CPO registering for VAT. Even if the goods are to be exported, registration may be necessary if the contracts do not deal carefully with the point at which title is transferred. In some countries, such as Belgium, the Netherlands and Spain, buying and selling goods locally will not require the CPO to be registered, but it will create a VAT cash-flow issue of between three and six months because the taxable customer, rather than a foreign procurement company, has to account for the VAT on the onward supply.
The obvious solution to these issues is to consider whether one legal entity is essential to central purchasing. Central procurement can be limited to contract negotiation and scoping, leaving legal ownership with a local company. The right answer commercially will depend on the company's objectives and structure, but both direct and indirect tax considerations need to be taken into account when the structures are set up.
There are other VAT issues when a CPO takes title to the goods. Centralized procurement does not end with buying. The procured goods or services are then supplied to the rest of the group and the CPO is likely to have a liability to account for VAT in other countries, for example, where the goods are moved to or services are performed. The problem of VAT recovery could then be amplified when passed on to another group company.
Finally, care needs to be taken to ensure that there is no VAT exposure if the costs of the central procurement team are charged out to the global subsidiaries. This could be seen as a supply of intermediary services, which is likely to take place where the underlying supply, the one that has been arranged, takes place? If so, the central procurer may have to charge local VAT on these services. If the subsidiaries cannot apply the reverse charge, it may have to register for VAT there. It should also be remembered that many service charges could be deemed to relate to the import of goods, so any service contracts agreed should be drafted and negotiated with this in mind.
PROCUREMENT OF SERVICES
Anyone used to importing goods may find the VAT rules governing the importation of services confusing in the extreme but they are outside the scope of this chapter.
INVENTORY MANAGEMENT
One ideal in managing inventory is that it should be held by one legal entity throughout the supply chain. In order to achieve this in a tax-efficient way, a number of changes need to be introduced.
TOLL MANUFACTURING
In toll manufacturing, the company buying raw materials (principal) retains title to those raw materials while a third party manufactures them. The toll manufacturer is the legal entity that provides the service of processing the raw materials into finished goods.
For toll manufacturers, solutions need to be found to the following questions:
if there are imports of raw materials, which legal entity can and should act as importer of records?
should the toll manufacturer charge VAT in the country of manufacture? and
what can be included in calculating the value of the toll manufacturing service?
Inward processing relief from customs duty is available in most countries for goods, which are imported, processed and re-exported, provided certain criteria are met. Many countries operate customs and VAT-free zones where processing can be done VAT and duty free, or, in some countries, manufacturers can apply for special export status. However, the commercial barriers to using these arrangements are often the record-keeping requirements that need to be complied with to qualify for the relief.
WAREHOUSING
If a principal owns inventory in a central/regional warehouse, it is possible for that legal entity to be registered for VAT only in the country of the warehouse, if the transfer of title to the goods being warehoused will change when they are dispatched from the warehouse. If, on the other hand, goods are shipped to a selling subsidiary in another country, and title only passes as the sale to the ultimate customer, the principal may have to register for VAT in that country. This is because it has now moved its own stock to the second country and is required to fulfil all the requirements regarding the movement of goods. This may be avoided if the country of import has a consignment stock concession.
SELLING STRUCTURES
There are a number of different ways in which a company might alter the way in which it sells goods or services:
Limited risk distributors – Unlike the traditional model of local distributors taking all the risk in relation to the sale of goods and services, a limited risk-distribution model may be more appropriate if a group has the majority of its functions and risks in one country and its remaining distribution functions minimized. Costs and risks that may traditionally be borne by the distributor would be borne centrally in this model;
Commissionaires/undisclosed agents – This is where an agent acts on behalf of an undisclosed principal. The customer is not aware that the principal exists and will contract with the commissionaire;
Commission agents – Here an agent sells to the consumer on behalf of a named principal. The consumer knows that the principal is the person who he is really contracting with but the commission agent explains the terms of sale and arranges the sale; and
Direct selling – A legal entity sells direct to the public without using local distributors, these days, often enabled by the internet.
With all of these sales structures one question likely to arise is whether the principal has to register for VAT in any one country. One additional twist to the question will be whether, by its actions, the distributor creates an establishment of its principal. In the EU this is a risk if the agent is acting as a dependent agent according to the tests set out by the European Court of Justice in DFDS (1997). In the majority of cases the arrangements between the principal and its agent will be such that the agent remains independent of the principal. This is usually important from a direct tax perspective as well but it is important to remember that the tests for the two taxes are not always the same.
LIMITED RISK DISTRIBUTION
The distributors' risk will typically be limited through the principal retaining title to goods until the distributor makes a sale to the customer. Another part of the contract may be that foreign exchange risk remains with the principal. This can be an issue when the cost of foreign exchange is recharged to a principal. What is the VAT liability of this supply? Is it a supply at all?
COMMISSIONAIRES/UNDISCLOSED AGENTS
A commissionaire or undisclosed agent is the only contact with the customer and will therefore be the person who accounts for VAT. However, title to goods passes directly from the principal to the customer. The majority of countries around the world see the logical result of this to be that the commissionaire is making a supply to the customer and that this is mirrored by a deemed supply by the principal to the commissionaire. Some countries do not see it like this and take, perhaps, a more literal approach, so that the commissionaire is issuing an invoice to the customer in its own name but the output VAT shown on that invoice is for the principal to declare on its VAT return.
The fact that the commissionaire will never take title to the goods it is selling can cause difficulties in many countries. In the majority of the EU the commissionaire could act as the consignee; import and pay the VAT and then reclaim it.
Commissionaire arrangements can lead to higher duty costs because, unless carefully structured, the value for duty purposes will be based on the final price to the customer, as this is the only transaction relating to the imported goods. It would be possible with careful duty planning to mitigate this and industries with high duty rates should ensure that they consider these options at a very early stage.
COMMISSION AGENTS
A commission agent is different from a commissionaire in one crucial respect: the customer knows that he is dealing with an agent and that the principal exists. The same issue regarding customs duty valuation arises with both commissionaires and commission agents. Due to the fact that the customer knows that he is contracting with the principal, the principal will issue the invoice to the customer, not the agent. This leaves the commission agent to calculate its commission and invoice the principal for its services.
With a commission agent structure, the principal will be unable to take advantage of the agent to act as importer/acquirer and reclaim import VAT so it is more likely that the principal will choose to, or have to, register for VAT. It may be that the principal will chose to register locally for VAT, if possible, to provide the service to the end customer of receiving customs cleared goods and an invoice with local VAT on it.
One remaining question to answer is what the VAT liability of the services arranging the supply is. This question assumes a prior assumption – that this service is more than just advertising or marketing, since it actually involves bringing the parties together. In the EU, a commission agent's services would be treated as being supplied in the same place as the underlying supply or, if the principal has a VAT registration elsewhere in the EU the place of supply can be shifted by quoting the VAT registration number on the invoice. The principal would account for VAT under the reverse-charge mechanism in the Member State of the VAT registration number used.
Outside the EU, the fact that the principal is a foreign company can sometimes be sufficient for the invoice to be zero rated.
CONCLUSION
Business transformation is not a one-stop-shop and the indirect tax pitfalls and opportunities should be examined as early as possible to ensure that the project meets its objectives and business can run smoothly through the transition. Early input into any ERP implementation, or change that is to support the restructuring, is vital to ensure all parties fully understand the requirements of a particular business model for a particular company. If this understanding is achieved the ERP implementation is likely to be much more successful in achieving its objectives than without indirect tax help.
The author would like to thank the following PricewaterhouseCoopers advisers for their contribution; Emma Ormond, UK; Thierry Vialaneix, France; Anna Mclaren and Jannie Van Dyk, Kenya; John Fay, Ireland; Daniel Keller, Germany; Fabio Oneglia, Italy; Frank Debets, Thailand/Singapore; Bart Vanham, Belgium
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