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The VAT system is notoriously complex and very different to the sales taxes that operate in the US. It is essential to ensure that VAT is dealt with correctly from the time trading commences in the EU, in order to avoid the non-compliance penalties that may otherwise be incurred – not to mention gaining a bad reputation with the tax authorities.

VAT planning is not just about ensuring compliance and avoiding penalties, however. Professional VAT consultants can advise on optimizing your overall position, and will often identify steps that, if implemented correctly, can result in real and cash flow savings. Ignoring the effects of the VAT system can cause a business to find itself in a significantly worse-off position.

Needless to say, the earlier that VAT is considered the better, as some VAT planning measures must be implemented prior to making sales in order to be effective. It does not pay to place VAT at the bottom of the “to do” list.

What Is VAT?

VAT is one of the main sources of tax revenue for EU governments. It is a transactions-based tax that is self-assessed by individual businesses, meaning it is the responsibility of each business to find out about and take steps to ensure compliance with the rules. The fundamental principle of VAT is that it should not be borne as a cost to most businesses. VAT is passed on and recovered by businesses along the length of their supply chains, with the tax usually only being suffered by the final consumer at the end of the chain.

When VAT was first introduced in the UK in 1973 it was known as the “simple” tax. Subsequently it has become very complex and, although being part of a system that is theoretically harmonised across the EU, each member state has its anomalies as well as its own rates of VAT (17.5% being the standard rate in the UK, compared with 19.6% in France and 16% in Spain for example).

Many member states also have a reduced rate of VAT that applies to certain types of supplies, as well as a zero-rate liability. To add further complexity, some supplies are treated as VAT exempt, meaning that VAT is not chargeable, but that there is a restriction on the recovery of VAT incurred on purchases and expenses. Clearly, advice should be sought on the rate at which VAT is chargeable on your sales. The rules concerning whether VAT is chargeable can vary significantly between member states, as can the rules concerning whether VAT can be recovered. In the UK for example, VAT is not recoverable on things like business entertaining and also most cars.

VAT is usually paid over to (or potentially recovered from) the tax authorities by means of a VAT registration. In the UK, this requires either monthly or quarterly VAT returns to be filed either on paper or electronically. Payment of any VAT due to the authorities can be made electronically or by cheque. Repayments due from the authorities should generally be received within 30 days of filing the VAT return.

Matters Particularly Affecting US Businesses

There are some aspects of the VAT system that specifically affect businesses whose main or only establishment is located outside the EU. Since these issues are clearly likely to affect US businesses, we summarise some of the main points to be considered below.

Businesses Supplying “Electronic Services”

In 2003, new rules were introduced throughout the EU to catch within the VAT net businesses established outside the EU and selling “electronic services” to non-business customers in the EU. The objective of the new rules was to put EU and non-EU suppliers of such services on a level playing field regarding VAT. Previously, it was perceived that there was a distortion of competition between the non-EU suppliers, who were generally not required to charge their customers VAT, and the EU suppliers who were.

There are various types of business activities to which these rules apply. However, all involve selling services that are delivered over the internet and which are heavily dependent on information technology, requiring minimal human interaction. Examples of services covered by these rules are:

• Web-hosting;
• On-line information and databases;
• Internet search engines and directories;
• Distance teaching via the internet;
• The accessing or downloading of music and films;
• The accessing or downloading of software.

Where US businesses sell such services, the effect of the 2003 rules is to make VAT chargeable in each EU member state where the business has non-business customers.

The business may meet its VAT requirements by obtaining a separate VAT registration in each EU member state where it has non-business customers, and filing separate VAT returns for each country. Alternatively, it may opt to use the Special Scheme available for suppliers of “electronic services”. The Scheme is essentially a simplification mechanism that allows businesses to register in one member state and account for VAT on all sales to non-business customers in the EU on a single VAT return. Under both the VAT registration and Special Scheme methods of VAT accounting, the business must charge its customers VAT at the rate applicable in the member state where the customer belongs. In some cases, it may be possible to argue that the business has a fixed establishment in the EU, thereby allowing it to register for VAT in just one member state and to charge VAT at the same rate on all its supplies within the EU.

Mike Adams, Partner, Tax Consultancy Services

Sharon Jessop, VAT Manager

VAT Recovery

US businesses that incur VAT in the EU, but which do not have an establishment there or a requirement to VAT register there may be able to recover the VAT incurred via the “13th Directive” reclaim mechanism. Under this mechanism, claims are generally made covering the period July 1 to June 30, with a filing deadline of the following December 31. Claims must be supported by original VAT invoices clearly addressed to the business and certification from the US tax authorities that the business is registered for taxes in the US.

Expenses that may typically be recovered via this mechanism are things such as hotel expenses relating to marketing trips or attending conferences in the EU. It should be noted, however, that the rules concerning the types of expenses on which VAT may be recovered do vary between EU member states. In the UK for example, VAT recovery is specifically blocked on business entertaining. Professional advice should be sought on whether the eligibility criteria for making a claim are met and on whether the expenses incurred are recoverable in the member state concerned.

Voluntary VAT Registration

In some cases, US businesses that do not have a requirement to register for VAT may still be entitled to register in the UK or other EU member state on a voluntary basis. The main advantage of obtaining a voluntary registration is that it provides a timely method for recovering VAT incurred on expenses. In some cases, obtaining a VAT registration may be the only means available for recovering VAT if the eligibility criteria for claiming under the 13th Directive mechanism are not met. An example of this would be where the business has an establishment in the member state where the VAT was incurred.

Imports/Exports

Where goods are shipped into the EU from outside the member states, “import VAT” will generally be incurred upon importation, and is payable by the “importer of record”. This can be either the business that is shipping the goods or its EU customer. This import VAT may often be recovered via a VAT registration, and advice should be sought on whether VAT registration is possible or required.

Goods that are shipped from within to outside the EU are known as “exports” and are zero-rated, provided shipping documentation is retained as evidence that the goods have left the EU within a certain time period. To conclude, VAT is a major source of revenue for governments in the EU and its effect should be considered from the outset by any business that may be caught within its net. Each business has a requirement to ensure its own compliance with the VAT system, but savings may also be available. It pays to take professional advice.

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