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is published by Ernst & Young.

Editor Mary O’Hare mohare@uk.ey.com +44 28 9044 5472

Editor Ros Barr ros.barr@uk.ey.com +44 20 7980 0259

Issue 7 | May 2013

“ Across the globe, the shift from direct to indirect taxation continues. The key global indirect tax trends are outlined in this publication, and a number of indirect trends are evidenced in the articles: increasing VAT and GST rates, reforms of indirect tax systems and the focus by tax administrations on enforcements and compliance.”

In this issue

Philip Robinson Global Director — Indirect Tax

Themes and trends

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New EU rules on invoicing mean that electronic invoicing should become the norm. Is this happening in the EU Member States? How are businesses dealing with the new legislation? Borealis, a plastic producer based in the EU, explains how it has successfully introduced electronic invoicing and archiving for accounts payable.

VAT is an increasing challenge when structuring international mergers and acquisitions transactions. How are the rules applied in different countries? What can businesses do to ensure that they comply with these complex rules and differences?

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Country updates

China’s VAT system is one of the most complex in the world and is undergoing major changes. How can businesses that trade in China keep up-to-date with this system and ensure that VAT is effectively managed?

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Colombia’s VAT system is undergoing major reform with a view to simplifying the tax. What are the changes and the potential impact of these changes for businesses?

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Taxpayers in Slovakia may be liable to pay their supplier’s unpaid VAT. Have you taken steps to protect your business against any potential VAT payment on behalf of your suppliers?

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The European Court of Justice (CJEU) has ruled against taxpayers in relation to fund management services provided to pension funds and in favor of taxpayers regarding advisory services provided to special investment funds. What is the impact of these rulings in the UK?

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The number of customs audits in Korea of multinational businesses is expected to increase by over 50% this year. What should companies do to mitigate potential risk from these audits?

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The Turkish VAT system does not currently have a process for collecting VAT on e-services to non-business

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Effective 1 July 2013, Croatia will become the 28th EU Member State. Harmonization with EU VAT rules will bring challenges for businesses, their customers and the tax authorities — as well as suppliers and customers in other parts of the EU who trade with Croatia.

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Share transactions in the EU involving immovable property are not treated the same in all the Member States. What are the potential VAT costs and VAT compliance obligations for sellers and recipients of such shares?

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Recent instructions issued by the German tax authority on customs valuations have a knock-on effect on transfer

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Tel: +41 58 289 3197 Email: philip.robinson@uk.ey.com

Welcome to the seventh edition of Ernst & Young’s .

WelAcross the world, we see governments continuing to shift their taxation focus from direct to indirect taxes. Reasons for this shift are numerous. Many governments consider that indirect taxes are seen as less harmful for growth, and rate increases are politically less sensitive than for income tax increases. Also as transaction taxes are collected in real time, increases provide an instant boost to government revenues. In our article “With

trends in indirect taxation in 2013:

• Increasing VAT/GST rates

• Rising excise duties

• Increasing free trade accompanied by protectionist challenges

•

• Focus on compliance and enforcement by tax administrations

explore in our other articles and features.

Our regular “snapshot” overview of recent and upcoming indirect tax changes around the world (page 28) illustrates the increases in VAT/GST rates, excise duties and free trade. While this is not an exhaustive list of global indirect changes, it clearly shows the challenges that international companies face in keeping up to date with this ever-changing area of taxation. Our annual overview of indirect tax changes around the world, Indirect tax in 2013,1 provides a more comprehensive overview of these changes.

The focus on compliance and enforcement by tax administrations is evidenced in articles on the anticipated increase in the number of customs audits in Korea and in the move by the Slovakian tax authority to hold taxpayers liable for a supplier’s unpaid VAT in certain circumstances. In Germany, revised guidance regarding

pricing. As these articles illustrate, the increased focus on compliance and enforcement means additional compliance and administrative burdens for businesses.

As with previous editions of , in

trends and developments in indirect taxes. Our global network of indirect tax professionals provides information and insights on developments and hot topics in a number of countries and regions including China, Colombia, Croatia, the European Union (EU), Germany, Korea, Slovakia, Turkey and the United Kingdom (UK).

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1. Indirect tax in 2013, Ernst & Young, 2013, www.ey.com/indirecttax2013.

comeA number of countries around the world are introducing major VAT/GST reforms. VAT reforms bring challenges for businesses in these countries, for their local customers and for the country tax authorities – as well as suppliers and customers in other countries. In this issue, we feature Colombia’s recently enacted VAT reform, which is aimed at making the

user-friendly. As part of the reform, Colombia has reduced the number of VAT rates, changed the tax rate for certain goods and services and improved processes regarding VAT recovery and

Croatia is due to join the EU on 1 July 2013; in preparation for accession, the Croatian VAT system has undergone a number of changes, and additional changes will come into force on 1 July 2013 and beyond as the country’s domestic legislation harmonizes with EU VAT law. China’s VAT system is one of the most complex in the world, but it is undergoing major change. A VAT pilot was launched in Shanghai in January 2012. This was later extended to cover a number of other locations and from August 2013 will be extended nationwide. We outline some of the key messages from our recent report A look inside China’s VAT system,2 which deals with the issues and challenges that companies operating in China face in meeting their VAT obligations.

Emerging technologies and the increased use of the internet also present opportunities and challenges for taxpayers and tax administrations. Turkey, like many other countries, has seen a

services to non-business customers in recent years, but its indirect tax system is struggling to keep up. We examine some of the VAT issues arising in Turkey from e-commerce and compare the approach of the Turkish VAT legislation and tax administration to the approaches taken to taxing electronic downloads in other countries. We also outline some of the possible options available to the Turkish authorities to tackle this issue.

We also take a look at the implementation of the Invoicing Directive in the EU that came into effect on 1 January 2013 and the opportunities for improving and simplifying VAT reporting obligations, arising from advances in technology. The European Commission’s aim is that e-invoicing will be the primary method of invoicing in the future, and the Invoicing Directive was introduced to overcome barriers to the uptake of this technology. However, not every EU Member State has implemented the rules in full yet. In our article (on page 12), we share the current implementation status of e-invoicing in the EU. We also talk to Eddie Van den Eede, European Head of the Accounts Payable department of Borealis, about how his company has introduced a successful process for accounts payable.

As well as staying up-to-date with indirect tax changes introduced by tax administrations, we follow court cases that have an impact on the interpretation of current legislation. In this issue, we look at a number of recent CJEU and UK court cases that may have an impact on

including the implications on sales of shares representing immovable property, VAT exemption for fund management services and the challenges posed by international mergers and acquisitions (M&A).

useful and informative. We want this publication to continue to be relevant to you and your business, and we welcome your feedback and suggestions for future topics.

Please let me know your thoughts either by email (philip.robinson@uk.ey.com) or by telephone (+41 58 289 3197).

Best regards,

2. A look inside China’s VAT system, Ernst & Young, 2013,

Despite continuing economic uncertainty in many developed markets, M&A activity is still high on the agenda of large businesses, whether corporate, private equity or investment funds. Of the tax directors surveyed for Ernst & Young’s Global

, 91% said that their companies were likely to consider a deal within the next three years, and more than one-third reported that their function had been involved in more deals over the past year.

01Themes and trends

Sunil Parmar Tel: +44 20 795 15469 Email: sparmar@uk.ey.com

Tony Bullock Tel: +44 20 7951 3408 Email: tbullock@uk.ey.com

Martin McQuillan Tel: +44 20 7951 2180 Email: mmcquillan@uk.ey.com

6

1. , Ernst & Young, www.ey.com/GL/en/Services/Tax/Global-M-A-tax-survey-and-trends--the-growing-role-of-the-tax-director, 2011.

Given this level of M&A activity, the VAT challenges and complex issues that arise in structuring international M&A transactions are highly topical. In this article we look at some of the common VAT challenges we have encountered in the UK in carrying out international share and asset transactions in recent years.

VAT has long been recognized as an important factor to consider when contemplating a domestic acquisition, whether a share acquisition or a trade and asset purchase. Increasingly, VAT is a challenge in structuring global M&A transactions. VAT rates have generally increased globally in recent years, particularly across the European Union (EU). Higher VAT rates necessarily increase the potential VAT cost and risk when executing a transaction. Figure 1 shows how the average standard VAT rate across the 27 EU Member States has increased steadily since 2008. By the start of 2012, the average EU VAT rate had passed 21%.

Furthermore, uncertainty around the recovery of VAT on deal costs with respect to a share acquisition continues to be prevalent across the EU. In the UK, the recent Court of Appeal ruling between the UK tax administration, HM Revenue

and Customs (HMRC) and British Airports Authority (BAA) Ltd., and, to an extent, the pending litigation between HMRC and Airtours Holiday Transport Limited (formerly My Travel) dominate the VAT landscape on deal cost recovery.

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Uncertainty around the recovery of VAT on deal costs with respect to a share acquisition

continues to be prevalent across the EU.

Increasingly, VAT is a challenge in structuring global M&A transactions.

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Many M&A transactions involve the transfer of shares. The VAT treatment of the sale of shares depends on a number of factors (including where the buyer is located), but, in many cases, the disposal

is exempt from VAT. In this type of transaction, the VAT taxpayer (i.e., the company itself) generally continues even though the shares have changed ownership.

In the UK, and largely across the EU, the main VAT buy-side issues faced in relation to a share acquisition include the following:

• Due diligence: as the VAT taxpayer continues, the buyer generally takes on the VAT compliance history of the target company or group when the transaction is completed. As a result, any potential historical liabilities are generally the ultimate responsibility of the buyer (in the absence of any contractual protection agreed to as part of the acquisition and subject to the statute of limitations in each jurisdiction). The trend toward increasing global VAT rates and the aggressive stance taken by many tax authorities in carrying out VAT audits and imposing penalties for past errors make VAT due diligence prior to any acquisition highly important to identifying and reducing, or at least mitigating, any potential risks.

• VAT recovery on transaction costs: the position of the buyer (the Bidco) in relation to VAT recovery on transaction costs incurred may be complicated. Although the VAT incurred may be recoverable given careful and timely structuring, the Bidco is likely to face a challenge from some tax authorities, such as in the UK. The decision in the UK VAT case BAA Ltd. (discussed further below) demonstrates that it is of the utmost importance to take the VAT recovery position with respect to acquisition costs into account at the earliest possible stage to increase the chances of VAT recovery by the Bidco.

• VAT structuring: consideration should also be given at an early stage to ensure

implemented. Issues such as VAT registration and ongoing business activities are likely to have an ongoing impact on issues such as compliance, reporting and VAT recovery of the acquired company following the deal. The structure should help provide a smooth transition of the day-to-day business separation through the deal period.

On 21 February 2013, the UK Court of Appeal delivered its judgment in the taxpayer’s appeal in the case of BAA Ltd.2

The disputed matter concerns the recovery of input tax on professional fees

2. BAA Ltd. v. HM Revenue and Customs judgment, UK Court of Appeal, http://www.bailii.org/cgi-bin/markup.cgi?doc=/ew/cases/EWCA/Civ/2013/112.html&query=baa+and+plc&method=boolean, 21 February 2013.

incurred by a newly incorporated bidding company in connection with the acquisition of the BAA Ltd. group (the Target) in 2006. The Court of Appeal has effectively followed the Upper Tribunal’s decision, which disallowed the recovery of VAT. However, the Court of Appeal’s

What are the implications?

Although BAA lost its case, we consider that VAT recovery on acquisition costs should still be possible to the extent that the taxpayer can evidence that:

• From the outset, the Bidco always intended to provide strategic and management services to the Target,

activity (and there is documentary evidence of this intention).

• There is a direct and immediate link between the acquisition costs incurred by the Bidco and the taxable supplies made by the Bidco.

This case also likely has historical implications for taxpayers that have:

• Undertaken any acquisitions in the last four years and— Have been assessed by HMRC for the

recovery of VAT on associated costs— Have recovered VAT on associated

costs and have not yet been assessed by HMRC

or

• Have had assessments raised by HMRC stood behind the BAA case

This case will also be of interest to any businesses planning acquisitions.

The starting point when considering trade and asset acquisition deals is that VAT is chargeable on the assets transferred, subject to any exemptions and reduced

In the UK, and in many other jurisdictions

allows the acquisition of trade and assets to qualify as a VAT-free transfer of a going concern (TOGC), provided that a number of conditions are met. The qualifying conditions for TOGC status can vary widely from country to country, particularly if the assets are moving from one country to another. As a consequence, it is not possible to take

structuring global transactions. Inconsistencies in the availability of relief and the conditions for the relief can lead to potential unexpected VAT costs or may require the transaction to be structured in a particular way to qualify for VAT-free treatment.

It is not possible to take a “one

structuring global transactions.

Ernst & Young has experienced these common VAT issues in the last 12 months working on international trade and asset transactions:

• VAT registration: generally, in order to qualify as a TOGC, the acquiring company must be registered for VAT in the country where the transfer is taking place. As acquisitions often involve the formation of a new company (Newco) to acquire the assets, the timing of this local VAT registration is particularly crucial. In many jurisdictions, the formation of a Newco and the subsequent VAT registration can take a

resources. As the VAT registration should be in place before the acquisition’s completion for any possible reliefs to apply, this issue could delay the transaction’s completion or result in unexpected VAT costs. Additionally, in some countries, new taxpayers may be required to register for all taxes at the same time, which can create even more costs and administrative burdens in those jurisdictions prior to completion. Global coordination is imperative for international transactions to monitor

jurisdiction VAT registration administrative requirements in each country involved in the deal.

• Local invoicing requirements: local VAT invoicing requirements must be followed to ensure that any available reliefs can apply and, if VAT is chargeable, to protect any input VAT credit that may be available for the VAT charged. This can be a time-consuming exercise prior to completion as it involves liaising with the vendor’s tax advisors and lawyers to collate the selling entity’s details, agreed asset values, description of the asset(s) transferred and tax points in accordance with the contract or agreement.

• The VAT recovery position of the company: in the UK, taxpayers who are in a VAT credit position generally receive a cash repayment from the tax administration. However, in some jurisdictions, the tax administration does not repay excess VAT credits to the acquirer; instead, the administration will hold the VAT repayment on account as a credit against future VAT payments. In contemplating an acquisition, therefore, it is important to accurately estimate the costs involved at an early stage. If the Newco is likely to never be in a VAT payment position, even though a VAT credit is on the account of the purchaser, it is possible that the VAT credit will be held

become a cost.

• Protective clauses in contracts: careful consideration must be given to the clauses in contracts. For example, is the consideration stated as being VAT inclusive or VAT exclusive? The buyer may seek to include relevant clauses in the contract to protect itself from any VAT caused by the seller’s actions, particularly with respect to TOGC transactions that may be subject to subsequent inquiries from the tax administration.

• Valuation of assets: the correct valuation of the assets being

invoice and be in line with the contracts

allocation values change at a later stage, “true-up” invoices or credit

the actual price paid for the assets transferred. It is important to understand the compliance requirements in each jurisdiction to account for any required VAT adjustments in the correct VAT return period.

increased in recent years due to higher global VAT rates, countries introducing VAT systems for the

rules more aggressively. Governments are generally being challenged to raise revenue, and preventing VAT refunds can be an effective way to do so.

Global M&A transactions need careful VAT

reliefs available for trade and asset transfer transactions. Furthermore, timely consideration to VAT matters is required to enable deals to progress according to the intended time frame. Issues such as the need for VAT registrations, correct invoicing and contractual reviews need to be considered early and dealt with on time.

In relation to share transactions, while some aspects of the VAT treatment are still uncertain, VAT incurred on transaction costs may still be able to be recovered, given careful structuring and timing. That said, the VAT treatment will ultimately

depend on the exact nature of the transaction, the circumstances of the buyer and the fees involved. Therefore, it has become increasingly important to give greater attention to VAT issues earlier in the transaction cycle to reduce the impact of transaction costs and expenses. In the UK, HMRC will likely use the Court of Appeal decision in the BAA Ltd. case to aggressively challenge the VAT recovery of costs in relation to a share acquisition by a UK acquisition vehicle.

Finally, given the uncertainty surrounding VAT and global transactions, specialist advice should be sought when structuring deals, especially given the current legal proceedings in this area and the specialist nature of work related to VAT and global M&A, which is not part of the day-to-day routine of the business.

Global M&A transactions need careful

any potential reliefs available for trade and asset transfer transactions.

In its strategy for 2020, the European Commission stated that electronic invoicing should become the primary method of invoicing in the future. The Commission believed that all Member States needed to revise existing burdens and barriers to uptake of the technology, since it can help businesses reduce costs and be more competitive.

02Themes and trends

Matthias Penninck Tel: +32 9 242 5257 Email: matthias.penninck@be.ey.com

Marc Joostens Tel: +32 2 774 6158

Gwenaelle Bernier Tel: +33 2 51 17 50 31 Email: gwenaelle.bernier@ey-avocats.com

As a consequence, on 1 January 2013, the legal framework governing e-invoicing

implementation of Directive 2010/45/EU

invoicing came into force in the EU.

However, not every Member State has implemented the rules in full yet. In this article, we share the current implementation status of e-invoicing in the EU and a client success story related to accounts payable.

Under the new rules, paper invoices and electronic invoices should be treated equally. In light of the Commission’s objectives, the Directive prohibits the EU Member States from requiring the use of a certain technology to send or receive invoices electronically. However, the client’s acknowledgement of the receipt of an electronic invoice remains a prerequisite.

As of 8 May 2013, as Figure 1 indicates, nearly every EU Member State had transposed the Directive into domestic legislation, but few of them had commented on the actual implications of the new legislation in their territory.

Although the format and the technology used to transmit the invoices can be chosen freely, businesses are required to demonstrate that the technical solution they have adopted ensures the following:

• The authenticity of the origin (the vendor is the one who sent the invoice)

• The integrity of content (no

the transmission of the invoice)

• The legibility of the invoice (human-readable invoice)

The focus for businesses to guarantee those three items has been shifted to internal business controls, technology or a combination thereof. Therefore, the ability for businesses to prove that they are in control of the entire invoicing and archiving process (for both paper and electronic invoices) will become even more important in the future.

Countries that have implemented Directive 2010/45/EU

Austria Greece Poland Cyprus

Belgium Hungary Portugal

Bulgaria Ireland Romania

Czech Republic Italy Slovakia

Denmark Latvia Slovenia

Estonia Lithuania Spain

Finland Luxembourg Sweden

France Malta United Kingdom

Germany Netherlands

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On 1 January 2013, the legal framework governing e-invoicing was

invoicing came into force in the EU.

Under the new rules, paper invoices and electronic invoices should be treated equally.

Taking this into account, businesses will need to ensure that their technology and processes are up to the challenge. They will need to assess, document and, where necessary, improve their internal processes and the technology used for issuing, receiving and storing electronic documents to ensure that they can meet this requirement. The tax authorities will have the power to audit the existence of adequate “business controls” during a tax audit.

Businesses that have accepted the possibility of sending and/or receiving electronic invoices should consider without delay how they are going to meet the conditions of authenticity, integrity and legibility and be able to demonstrate to the authorities that they have done so.

The concept of “business controls” is new for VAT. Numerous tax authorities are discussing with businesses what is at stake. However, even if they publish guidelines commenting on the practical impact of transposing the Directive into their domestic legislation, they will need to be careful not to reinstate the differences between countries’ systems that the new rules were meant to tackle.

A case study: Borealis, a leader in e-invoicingLet’s consider a real-life case. Borealis, a company based in the EU, explains how it has successfully introduced electronic invoicing and archiving for accounts payable.

Eddie Van den Eede: As in most companies of our size, the paper invoicing process is a well-oiled process. We receive a paper invoice by regular mail from our suppliers. The invoice is manually scanned. Software which makes use of optical character recognition reads the relevant information and stores it into our ERP system. The scanned data is subsequently processed by the accounting department. We archive our documents electronically.

Eddie Van den Eede: Cost savings. A paper invoice quickly costs the supplier €3 per invoice, and for us this amount can rise to €4 per invoice. I look at it this way: with paper invoices a lot of actions have to be carried out. At the premises of the supplier the invoice is printed, put in an

envelope, stamped and posted. The client sorts its mail, opens the envelope and scans the invoices manually. What is the result? An electronic image of the invoice which may not even be optimally readable. If you abolish that whole paper detour, an important cost reduction,

be realized.

Eddie Van den Eede: The technical implementation of the e-invoicing project was rather straightforward. It took an IT programmer just two days to enable our ERP system to accept invoices in a PDF format. Since then our suppliers can simply send PDF invoices to one of our dedicated servers.

The real challenges lay elsewhere. First of all, we had to make sure that what we were doing was in line with the expectations of the authorities. For this

project in Sweden, Finland, Belgium and Germany. In these countries, it was already acceptable to send PDF invoices by email. Moreover, Borealis disposes of sizable industrial sites in those countries with an important volume of invoices.

In other EU Member States, the legislation regarding e-invoicing imposed additional requirements at the time of the implementation of our e-invoicing solution, resulting in extra costs and complexity. Luckily, since 1 January 2013, all those requirements have been abolished.

Businesses that have accepted the possibility of sending and/or receiving electronic invoices should consider without delay how they are going to meet the conditions of authenticity, integrity and legibility and be able to demonstrate to the authorities that they have done so.

In the light of the (former) legal requirements and the new requirement to have (internal) business controls which

call upon the assistance of the E-Invoicing Center of Excellence of Ernst & Young to audit the compliance of our solutions with the applicable legislation.

Eddie Van den Eede Without any doubt: persuading our suppliers. In the four EU Member States in which we started our project, we approached around 1,400 suppliers who were invited to sign a simple contract. In the meantime, 720 of them have already accepted and have signed, 130 other suppliers are currently working on a solution, 350 suppliers have simply refused and 200 suppliers have not responded as yet. With these numbers, we currently achieve a volume of approximately 26% to 27% of all invoices. Our e-invoicing target is 50% to 60%.

Eddie Van den Eede: If you add up the

should in principle happen quite quickly.

not yet fully understood by the market. I always have to explain that e-invoicing is permitted by law. Many companies apparently are not aware of this important new trend in the invoicing landscape. I believe that this is a serious problem.

Although large suppliers usually are aware that e-invoicing is permitted and that it

reluctant to accept electronic invoicing. This is due to the fact that electronic invoices are an exception on their well-oiled paper invoicing process, which in many cases is outsourced. Apparently, their priorities are elsewhere, and the fact that e-invoicing would not cost a lot of time and money to implement cannot convince them.

In this respect, it is also remarkable that we are hardly being approached by our suppliers with the request to start invoicing electronically. Out of a total of 1,400 suppliers only 3 have asked for our agreement to start invoicing electronically. Needless to say, the penetration of electronic invoicing in the market is still very low. Consequently, I mainly consider myself as an accompanist to our suppliers in entering a new digital world.

The sheer number and variety of changes in indirect taxes in recent years and the challenge of implementing them into accounting and reporting systems can be overwhelming — making it hard to keep sight of the bigger, strategic picture. But what do all these changes add up to? Do common themes emerge? What changes can we expect in the future?

03Themes and trends

Claudio Fischer Tel: +41 58 286 3433

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mechanism, such as value-added tax (VAT), has spread around the world in less than a half century. Limited to fewer than 10 countries in the late 1960s, VAT — or, in several countries, goods and services tax (GST) — is today an essential source of revenue in more than 150. Despite its importance, VAT/GST is not the only

services — consisting primarily of excise taxes, customs duties and certain special taxes — form the other important leg of indirect taxes. The unweighted average of

taxes as a percentage of overall taxation in the Organisation for Economic Co-operation and Development (OECD) member countries indicates that the proportion of indirect taxes make up about one-third of the total (Figure 1).

We believe that the importance of indirect taxes will continue to grow. The economic crisis has caused many governments to

budgets and stimulate growth. This would

imply government will continue the shift from direct to indirect taxes, which are less harmful for growth, look to improve

action to combat tax fraud and avoidance.

The “tax mix” is shifting toward taxes on consumption

1. Percentage share of major tax categories in total tax revenue.

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indirect taxation that we believe will be

in 2013 and beyond:

1. VAT/GST rates are increasing.

2. Excise duties are on the rise again.

3. Free trade is increasing but is meeting protectionist challenges.

4. Indirect tax systems are

5. Tax administrations are focusing on compliance and enforcement.

Let’s consider each of these trends in detail and look at which regions of the world are most affected by each.

Around the world, many countries are relying more and more on indirect taxes

ongoing economic crisis, VAT/GST rates have increased impressively in recent years as a result; at the same time, the scope of VAT has broadened in many countries.

The trend in rising VAT rates has been particularly strong in Europe, especially in the European Union (EU), where, as a result of the consistent rises, between 2008 and 2012 the average EU standard VAT rate increased from around 19.5% to more than 21% (Figure 2, p10). The upward rate trend in Europe continues as Cyprus, the Czech Republic, France, Finland, Italy, Poland and Slovenia have already increased rates recently or have announced increases later in 2013 and 2014.

trend is less explicit, but still noticeable. Japan, for example, which is struggling

August 2012 to increase the current VAT rate from 5% to 8% effective 1 April 2014 and to 10% effective 1 October 2015. Thailand has also announced a rise in the VAT rate from 7% to 10%, to happen by October 2014.

By contrast, VAT/GST rates in the Americas remain relatively stable. In South America, where VAT systems are widespread and have been in use for some time, rates have not changed much in recent years. One exception is in the Dominican Republic, where the rate is set to increase from 16% to 18% this year and next year.

Broader baseThe scope of VAT/GST is also widening in many countries. This is being achieved

goods or services to apply a different rate and by removing exemptions. Examples of countries where the scope of the zero-rate (0% rate) was reduced in 2013 include Croatia, Norway and Kenya; while in the Dominican Republic, Jamaica, and Zambia, exemptions have been removed, and in Iceland, Italy and Poland, the application of the standard rate has been widened to goods that were previously taxed at reduced rates.

The impact on business

consumers is clear: retail prices rise. But its impact on businesses is equally important: higher VAT/GST rates increase the compliance risk. Companies must ensure that all the increases are properly dealt with in their accounting and reporting systems, which often results in a range of IT and administrative costs. Errors frequently arise when rates change, resulting, for example, from incorrect product or tax codings or confusion about the correct rate for supplies that span the change. More generally, rate increases mean the amount of VAT/GST “under management” also increases, as do penalties for errors that are based on the amount of tax payable.

Increasing VAT/GST rates

Higher VAT/GST rates increase compliance risk

The percentage of government revenues received from excise duties has seen a constant decline over recent years (Figure 1). However, this development has now slowed down and we might see a turn in the opposite direction as excise rates are rising and new duties are being introduced.

In Europe, in particular, all three important groups of “classic” excise duties (alcohol, tobacco and mineral oils)

only decrease in fuel excise duties implemented in Slovenia in 2012. This year, excise duties on tobacco and/or alcohol have increased or will soon increase in most EU countries, Guernsey, Moldova, Norway and Switzerland. This trend can also be seen in other parts of the world; in Africa higher excise duties are being imposed on these items, e.g., in Benin, Gambia and Zimbabwe. In the

Americas, Aruba, Canada, Costa Rica and Mexico have also raised taxes on alcohol or tobacco, as have Fiji, New Zealand and

While the main purpose for excise duty rate increases — and the original reason for the introduction of excise duties — is to raise revenue, these taxes are also increasingly being used to discourage consumption of certain products

consumer behavior in a number of areas.

A relatively new trend is the introduction of excise taxes on health-related products (other than alcoholic beverages and tobacco products) such as snack taxes on “unhealthy” food. For example, Benin, Costa Rica, Norway and the Philippines have all increased excise duties on soft drinks, Finland has introduced an excise

Rising excise duties

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Customs duties were once a primary source of revenue for most countries. But continuously growing global trade and the efforts of organizations such as the World Trade Organization (WTO) have led to a constant reduction in customs duties around the world. This trend continues around the world as countries continue to conclude a growing network of various kinds of trade agreements.

The WTO currently has 158 members (the most recent, Laos joined at the start of February 2013) and it reports 546 active and pending reciprocal regional trade agreements among its members. This number does not include unilateral preference programs, that is, trade preferences granted to products

Generalized System of Preferences (GSP) in the EU and the US, which provide duty-free treatment to many products from developing nations.

Free trade increases but is meeting protectionist challenges

Environmental issues have played an increasing role in determining the

nature and application of taxes

duty on sweets and ice cream, and in

introduced on suppliers of beverages (sodas) with added sugar or sweeteners.

Over the last decade, environmental issues have also played an increasing role in determining the nature and application of taxes, e.g., on road fuel, motor vehicles and CO2 emissions. This type of measure includes tackling issues such as waste disposal, water pollution and air emissions. With support from the OECD,

advantages of environmental taxes,2 many countries are introducing or increasing such taxes. For example, Germany has introduced a tax on nuclear fuel, Austria and Germany have introduced a duty on airline tickets for airplanes leaving from domestic airports, Ireland has introduced a tax on CO2 emissions and South Africa is currently working on a framework for a carbon tax for which legislation is expected in the latter half of 2013.

Finally, there is a noticeable trend toward

transactions. Although there seems to be a common and widespread belief among

contribute its fair share in remedying the

there is no common approach as to how this should be achieved. Some countries have increased supervision of the industry and tightened regulations. However, in Europe, in particular, the preferred approach has been to levy taxes on

2012, and on 1 January 2013, Hungary introduced a tax of 0.1% on the amount involved in any payment service. Italy will follow in March 2013 with a tax on the transfer of shares and derivatives and high-frequency trading. In addition, 11 EU member states have agreed to introduce a common transaction tax on the exchange of shares and bonds and on derivative contracts, which could be introduced as early as 2014.

2. , available at http://www.oecd.org/greengrowth/environmentalpolicytoolsandevaluation/48164926.pdf

Applying higher rates is just one way to increase indirect tax revenues; others include broadening the tax base of an existing VAT/GST system, increasing the

compliance and enforcement.

Many countries are currently in the

systems. In developed markets, long-

standing VAT systems need to adapt to the demands of a 21st century digital economy. In emerging markets, which are experiencing economic developments at a fast pace, indirect tax systems need to adapt to keep pace. In India, for example, a new nationwide GST is ready to be implemented and only awaits agreement between the central and state governments. The new Indian system is intended to replace almost all existing

4

A number of new free trade agreements (FTAs) are expected to enter into force in 2013, thus further reducing the amount of customs duties imposed on global trade; examples include the agreement involving the EU and Peru and Colombia, Montenegro and the European Free Trade Association, and Hong Kong with the European Free Trade Association, and Indonesia and Pakistan. Nearing completion are, among others, the trade agreements between Costa Rica and Peru and between Canada and India, and negotiations are in various stages of completion for a range of others.

of revenue and costHowever, the situation is not always that straightforward. Although customs duty rates are generally reducing for international trade, these taxes still play a

budgetary needs. In many cases, duty rates on many goods and materials remain high.

Unlike VAT/GST, duties charged at one stage in the supply chain are not offset against taxes due at later stages, so duties form part of the cost base of affected goods. In addition, customs clearance procedures can add to the time and related costs of moving goods cross-border. And even where FTAs exist,

many businesses are not actually

because they cannot or do not meet the qualifying conditions.

ProtectionismMore generally, global trade may be hampered by the current economic climate, which is encouraging protectionist tendencies, as evidenced by

Doha Rounds. Non-tariff barriers have grown substantially in recent years, many in the form of health, safety or environmental requirements. The WTO reported 184 new trade-restrictive measures enacted between October 2010 and April 2011 and 182 between October 2011 and May 2012.

In addition, where countries are not bound by FTAs, import duties are still a common and often-used means to steer trade and production. For example, to boost the development of sugar cane production toward meeting the raw sugar

companies, effective 1 January 2013 Nigeria now applies a 0% import duty on machinery for local sugar manufacturing industries, but it has increased the total

from 35%, and raw sugar tariffs increased from 5% to 60%.

Non-tariff barriers have grown substantially in recent years

indirect taxes levied at the state and national levels, minimize exemptions and do away with the current multiplicity of taxes. Similarly, China is in the process of replacing its current business tax on services with a broader-based VAT through a series of VAT pilots. In the end, it is intended to amalgamate all forms of China’s turnover taxes into the VAT.

In the EU, the European Commission has launched a comprehensive reform of the existing VAT system. The Commission has

for further action in the coming years. The aim is to move to a more modern VAT system, which should be simpler, more

changes can be expected in the near future, such as the adoption of a one-stop-shop registration for all taxpayers’ duties or a standardized EU VAT return.

The US is still far from implementing a federal VAT. Currently, states apply their own consumption taxes, most of which are single-stage taxes on the sale of goods. But, even in the US, a trend can be seen toward states extending the scope of their current sales taxes. While sales

purchases of physical goods, it is the market in electronically supplied services (such as digital music distribution, internet downloads or telecom services), which is growing fastest. An increasing number of states are, therefore, trying to expand their current sales tax to cover electronic goods and services or are trying to create a “nexus” for out-of-state vendors to constrain sellers to collect sales taxes on remote sales.

With more than 150 countries now operating a VAT/GST system and international trade still growing, it is becoming more important than ever to provide a global framework for a consistent interaction of all these different systems. For a number of years, the OECD has been working on developing international VAT/GST guidelines, which could provide the basis for such a

framework. This initiative gained momentum following the OECD’s Global Forum on VAT, held in November 2012. The forum brought together more than 85 country delegations from all continents together with international organizations, academics and businesses to explore key policy trends and their impact for tax administrations and businesses.

Finally, governments have discovered that also on the administrative side, the

drastically improved — which increases tax revenues. There are many approaches taken by governments, but an important one is to create common interfaces and reduce gaps in the system. This is (among others) one reason why many governments are enforcing the use of

In December 2012, we conducted a survey of Ernst & Young Indirect Tax professionals in 39 countries and asked them about indirect tax compliance requirements.3

39 countries surveyed require VAT/GST

mandatory basis, 12 states have an

and just two countries do not offer or

Almost 95% of countries surveyed have “mandatory”

3. The survey included the following countries: Australia, Austria, Belarus, Brazil, Canada, Chile, China, Cyprus, Czech Republic, Denmark, Egypt, Finland, Germany, Greece, India, Indonesia, Italy, Kazakhstan, Latvia, Malta, Moldova, Morocco, New Zealand, Norway, Pakistan, Peru, Portugal, Romania, Russia, Singapore, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland, Tunisia, Turkey, Ukraine.

57%

35%

Mandatory

Optional

Not available

8%

The growing importance of indirect taxes to governments places more pressure on tax administrations to enforce compliance. This focus is leading to greater scrutiny of taxpayers’ affairs through more frequent and more effective tax audits and greater consequences for errors.

informationIn Europe, where VAT rates are highest,

carousel fraud, involving organized criminal gangs exploiting how VAT applies to cross-border trade, have shown that VAT systems are vulnerable to such attacks and they have alerted

governments to the need for vigilance. As a consequence, tax administrations in all parts of the world are putting a greater focus on indirect tax compliance and enforcement.

Our recent survey of Indirect Tax professionals in 39 countries indicates that, in the large majority of countries, the number of tax audits has increased in recent years and is likely to increase further in the future (Figure 4). Only six countries reported that audits had decreased; even then, in some cases, while the number of audits carried out was said to be lower, the amount of additional tax levied due to tax audits is

contradictory, but it can perhaps be explained by tax administrations carrying out more targeted audits; 24 out of the 39 countries already use specialized IT tools such as audit software to detect irregularities or suspicious patterns in taxpayers’ tax returns.

In our survey 16 countries indicated that the tax administration exchange information about taxpayers’ VAT affairs with other countries. These countries are mainly found in the EU, where the common VAT system requires an extensive information exchange. On a global scale, the multilateral Convention on Mutual Administrative Assistance in Tax Matters, which is open to all interested countries, facilitates exchange

Increased focus on enforcement

The impact on business

considerably eases processing of VAT/GST returns for tax administrations and makes administration faster and more

data enables tax administrations to use IT-based audit tools more easily, which can help to combat fraud and evasion.

administrations’ different requirements and tax administrations’ increased audit capacities means that greater focus must

indirect tax compliance processes to avoid an increased risk of incurring penalties.

17%

65%

18%

Increased

Decreased

Stayed the same

More than 70% of countries surveyed report VAT/GST

penalties are increasing

of information on all compulsory payments to the general government except for customs duties.4 In the last two years, more than 50 countries have either become signatories to the convention or have stated their intention to do so. This will lead, without doubt, to increased international cooperation. But, even if countries do not (yet) share information, they increasingly exchange information internally, between different authorities and departments (e.g., with customs or social security authorities). Only four out of the 39 countries we surveyed do not share any information at all.

“honest” taxpayers too?There is nothing to be said against stricter compliance enforcement if it actually

damages the overall economy and tax compliant businesses, which suffer competitive disadvantages. The other side of the coin, however, is that tax administrations have generally become more wary toward all taxpayers; they are less open to entering into discussion, and

administrations increasingly apply a strictly formal approach not considering

This is bad news for all “honest” businesses, which want to be compliant, even more so as our survey shows that formal mistakes (e.g., missing information on invoices) are still by far the most frequent reason for indirect tax adjustments, be it an additional tax charge or the denial of input tax recovery (Figure 5). In addition, we observe a tendency for tax administrations to pay out input tax surpluses with increasing delay — if at all — or to reject an input tax claim based on bad faith, stating that the claimant should have known that his supplier did not correctly handle the tax.

At the same time, many countries are applying stricter penalty regimes in the case of non-compliance and mistakes. In our survey, 27 of the 39 countries reported that penalties are increasing, and only three saw a decrease (Figure 6). Fines are generally imposed faster and

for timing issues, such as late payment, where in the past tax administrations were more lenient on these issues (for example, Austria, Germany, Pakistan and New Zealand).

4. www.oecd.org/ctp/eoi/mutual

41%

16%

10%

10%

23%

Formal mistakes (e.g., missing or incomplete invoices, receipts)

Incorrect qualification of turnover (e.g., incorrect tax rate �exempt instead of taxable)

Incorrect calculation of input VAT pro-rata

Inconsistencies between declared VAT and annualfinancial statements

Other

Increased

Decreased

Stayed the same

8%

72%

20%

• Consider how indirect taxes align to your corporate strategy

• Formulate and establish indirect tax management and reporting structures

• Assign high-level responsibility for indirect taxes (e.g., by appointing a VAT Director)

• Clearly allocate responsibilities between tax,

•tax impact

• Analyze the impact on VAT/GST, excise and customs costs and reporting before entering new markets

• Use advanced technology (ERP systems, automated diagnostic tools)

• Streamline reporting and accounting systems used within the company

• Assure proper documentation and archiving of all relevant transactions

• Proactively identify potential issues and seek

• Adopt appropriate key performance indicators to monitor compliance and performance

• Keep up to date with developments, especially in key countries

But it is precisely their continuing existence that indicates that they are important and long-term developments. All of these trends, be it higher rates, changes in the VAT/GST system or improvements in the way authorities administer the taxes, have a direct impact on businesses, which need to keep abreast of these changes.

Indirect taxes are not easy to manage.For example, excise duties, such as carbon taxes, change quickly and represent a high compliance risk because they typically operate differently in each country. Taxpayers who collect VAT/GST

risks of carrying the tax burden and eventual penalties themselves if they do not correctly manage the tax.

With tax administrations assessing taxes more thoroughly

mistakes will be found has risen considerably and will remain high. Also, as indirect tax rates increase, the consequences of mistakes become more severe. This is particularly true for businesses that do not recover VAT/GST in full (e.g., because of VAT exempt activity) such as banks and insurance companies. But higher rates also have

incur VAT/GST in foreign jurisdictions, which is not refunded quickly or, which they do not or cannot recover (e.g., because of an absence of refund schemes for non-residents or because of complicated refund procedures).

As indirect tax administrations are turning increased attention to enforcement — including joint audits with other taxes and even other countries — these activities may disrupt business activity. Large assessments for underpaid

even for compliant businesses.

More than ever, it pays to proactively manage indirect taxes. Establishing a clear indirect tax strategy aligned to your overall business strategy will help you keep your business up to date with the rapidly changing tax environment and avoid additional costs and risks of poor compliance or missed opportunities.

On 11 March 2013, Ernst & Young conducted a webcast on Indirect

tax in 2013businesses in 2013 and beyond:

• VAT/GST rates are increasing

• Excise duties are on the rise again

• Free trade is increasing but is meeting protectionist challenges

• Tax administrations are focusing on compliance and enforcement

The continued importance of indirect taxes to governments around the world reinforces the need for global businesses to be informed and responsive. Our discussion examines the trends, challenges and implications of the constantly changing VAT/GST rules and other indirect taxes around the world.

If you would like to listen to this discussion, the webcast archive is available at www.ey.com/webcastsIf you would like to access Indirect tax in 2013 it is available at www.ey.com/indirecttax2013

Global update

Continuing a trend, 2013 is proving to be another challenging year for indirect taxes. Governments around the world continue to rely on indirect taxes to bolster economies. Key trends in indirect taxation include increasing VAT/GST rates, an increase in free trade agreements and rising excise duties. Globalization and emerging technologies continue to increase the levels of cross-border trade meaning that taxpayers need to be aware of customs, VAT/GST and excise developments in many countries.

Displayed in this graphic are some of the indirect tax changes (agreed and proposed) that have taken place across the world recently and that are due to take place later in the year and beyond. These changes supplement those set out in our recent report, Indirect tax in 2013,1 and in previous editions of Indirect Tax

.

March 2012: free trade agreement with South Korea

May 2012: free trade agreement with Colombia

October 2012: free trade agreement with Panama

Canada

1 January 2013: Quebec — QST applies at the rate of 9.975% to taxable supplies

1 April 2013: British Colombia transitions back to a provincial sales tax (PST)

1 July 2011 to 31 December 2013: introduction of temporary additional reduced rate of 9% applies to certain sectors of the economy (mainly related to tourism)

1 January 2013: VAT on hotels and accommodation increased to 25.5% from the reduced rate of 7%

Temporary VAT rate increases (standard rate raised to 17.5% from 15%, reduced rate raised from 7.5% to 8.75%) that came into effect on 1 December 2010 have been extended

1 February 2013: amusement machine license duty (AMLD) will be replaced by a new machine games duty (MGD). Two MGD rates apply: 20% and 5%

1. Indirect tax in 2013, Ernst & Young, 2013, www.ey.com/indirecttax2013

26 December 2012: reduction of the number of applicable rates from seven (0%, 1.6%, 10%, 16%, 20%, 25% and 35%) to three (0%, 5% and 16%)

14 January 2013: standard rate of VAT increased to 18% (from17%)

13 January 2014: standard rate will increase to 19%, reduced rate will increase to 9% (from 8%)

1 January 2013: VAT introduced to replace the former sales tax. The standard VAT rate is 15%

1 January 2013: previously abolished reduced VAT rate to be reinstated for certain goods and services

1 January 2013: cash accounting system becomes available for small businesses

1 January 2013: VAT implemented (replacing GST)

1 April 2014: consumption tax rate will increase to 8% (from 5%)

1 October 2015: consumption tax rate will increase to 10% (from 8%)

1 August–31 December 2012: VAT pilot arrangements expanded to cover 10 additional locations

VAT pilot to be further extended in 2013

1 August 2013: transportation services and selected technology services will be subject to VAT on a nationwide basis.

Railway transport, postal and telecommunication and other industries will also be included in the forthcoming VAT Pilot expansion but no effective date is yet available.

1 January 2013: new invoicing rules implemented

1 January 2013: the long-term lease of means of transport to non-business customers is taxable where the customer is established

package to be introduced

1 January 2013: VAT rates rose by 1% — standard rate is now 24% and the reduced rates are now 10% and 14%

1 January 2013: standard VAT rate increased to 21% (from 20%), reduced VAT rate increased to 15% (from 14%)

1 January 2016: single uniform VAT rate of 17.5% will apply

1 July 2013: standard VAT rate will increase from 21% to 22%

India

Proposed introduction of a new GST to replace most of the state and central indirect taxes currently in force, date of implementation not yet agreed

1 January 2013: excise rates on certain categories of goods increased in line with the EU accession engagements of Bulgaria

1 January 2013: excise duty on cigarettes increased

Croatia

1 January 2013: zero VAT rate abolished — items previously taxed at this rate now subject to 5% VAT rate

1 July 2013: Croatia joins the EU

France

1 January 2014: France plans to increase its standard rate of VAT from 19.6% to 20%

A pilot VAT refund scheme began in July 2012 and is expected to run until 30 June 2014

1 January 2013: excise duty increased on wine by 5%, on ethyl alcohol by 15% and on other types of alcoholic beverages by 20%

1 January 2013: excise duty rate for tobacco products increased

VAT is a major source of risk and opportunityKenneth Leung T: +86 10 58153808 E: kenneth.leung@cn.ey.com

Robert Smith T: +86 21 22282328 E: robert.smith@cn.ey.com

VAT is an important component of the China government’s tax regime. as the share of tax revenue coming from VAT is higher than in many developed countries around the world. Based on

China collected more than one third of its entire tax revenue in the form of VAT. The China Tax Bureau (CTB) collected over 27% on domestic transactions and approximately another 8–10% is collected by China Customs on imported goods.

amounts of VAT. On top of that, China’s VAT rules differ from many other countries and the system is in a constant state of change.

VAT, in theory, is seen to be a neutral pass through tax that only moves across the

statements and does not impact the bottom line. In principle, VAT is passed through by offsetting input VAT, paid by the company to suppliers and/or Customs, against output VAT collected from customers. For export-oriented entities, they would apply for a refund of the input VAT paid since there is little, or no, domestic sales and such transactions do not charge output VAT.

It is a myth that China’s VAT is simply a

VAT in China is far from neutral with sticking VAT, blocked input credits, cascading costs and other unique technical matters that can result in

bottom line (although these costs are probably not directly visible as they are rolled into various accounts). A number of recent examples include both foreign and Chinese companies having to make large

statements, due to VAT related errors or fraud.

Chin

a

Figure 1. China tax revenues in 2011

Domestic Consumption TaxImport VAT and Import Consumption TaxBusiness TaxCustom DutyCorporate Income TaxIndividual Income TaxOther Taxes

Domestic VAT

3%

27%

8%

15%15%

14%

7%

11%

Note:import VAT and import consumption tax arecollected by China Customs and are not broken outin the MoF statistics.

The following questions can help to assess your level of understanding regarding whether you know enough about your China VAT:

• How much VAT throughput is being processed by the organization on a monthly or annual basis?

• What is the VAT position of the organization on a regular basis (e.g., input VAT carry forward, net VAT payable, pending export VAT refunds, etc.) and do these positions seem

• Are certain non-recoverable VAT costs incurred, either through non-VATable activities, export VAT “leakage,” VAT transfer out, etc? Are these amounts known, managed and possibly reduced?

• How do company staff keep up to date with the rapid pace of regulatory change? Is anyone responsible for proactively reviewing new developments for impact to the company or does the company only responding reactively?

• How are our VAT accounting transactions conducted in the system and by whom? Is the accounting system linked to the Golden Tax System (GTS)?

• Who is managing the VAT return preparation and reporting obligations? Are they able to accumulate the necessary data to accurately complete the returns on a timely basis? Where is the source data gathered from and how

VAT return?

means it is critical for companies to clearly understand how China’s VAT

be higher than anticipated, companies also usually have opportunities to

know about the complexities of China’s VAT regime, then it is clear that the “pass through” low risk myth cannot be true. That is, there are high levels of risk and opportunities that should be explored.

Not surprisingly, the VAT costs and risks rise with the complexity of the legal entity type and the quantity of daily transactional processing. This is exacerbated in China since many companies have “mega-entities” that are part of an intricate global supply chain, and which process huge volumes of transactions. Each link in the supply chain may suffer VAT costs or “leakage” that

Unfortunately, this is a common, but less known, occurrence in China. Consider the following types of actual VAT costs incurred by a company operating in China that can impact the bottom line: include

• Export VAT “leakage”

• VAT treated as non-creditable and required to be “transferred out”

• Blocked VAT on certain non-creditable expenditures

• VAT directly related to exempt BTable services

• Deemed VAT sales amounts that are not passed on to customers

• Input VAT paid but the invoice not

days)

• Input VAT invoices without proper documentation

• City Construction Tax (CCT) and Education Surcharge (ES) taxes that are assessed on VAT payable amounts

• Input VAT paid by a toll manufacturer

• refunds or extended periods of input credit delays.

Based on our experience, it may take

collate and analyze a company’s VAT data because this information resides in many different systems and parts of the organization. Identifying this data is not an established practice at most companies yet, so it can be time consuming just to locate where the appropriate information

company in the long-run. Management is likely to be surprised about the size and magnitude of the unexplored VAT, but this reaction could spur a renewed interest in trying to manage this tax.

Recent years have seen large and small regulatory changes that need to be understood by companies who wish to be successful in China. For example, there have been over 500 updates to regulations from different agencies in each of the last few years, so it not surprising that tax staff may miss an important VAT regulatory development that impacts the business.

The VAT Pilot is a start to addressing the challenges stemming from the

system where services, intangibles and other items covered by the BT (Business Tax) regime do not interact with the items covered by the VAT regime. Many have asserted that these tax policies resulted in “double taxation” since BT and VAT are not creditable against each other. Unlike other countries with a merged GST regime, China has more cascading tax costs and blockage of VAT that otherwise would be creditable.

The VAT Pilot transitioned three categories of BTable items to the VAT regime and introduced two new rates along with a 0% rate for certain services. It is designed to test the outcomes arising from the transition of certain BT services to VAT. The Shanghai VAT Pilot was launched in January 2012 and has affected over 120,000 new “in-scope” VAT taxpayers.

of China’s indirect taxing system

The VAT Pilot also sets the scene for future VAT regulatory developments. Eight additional locations have been added and we expect the Authorities will rapidly expand the Pilot to other locations, and that other services will eventually be folded into the GST regime. Rapid expansion of the Pilot to new locations may actually accelerate an overall reform

different sets of rules that create cross-border transactions even within China.

Based on our experience, it is challenging to fully understand and appreciate how China VAT affects a company. Especially since the governing regulations and VAT accounting treatment vary greatly from other internationally recognized systems.

with these developments could be a full time job for one or many staff.

Unfortunately, most companies do not have dedicated VAT resources with either

time to monitor, read and comprehend the frequently changing regulations. They are not able to develop insights into the implications for the company or how to respond appropriately.

The VAT work in China requires more of everything — more transactions, more documentation, more paper, more invoices, more steps in the process, more data, more returns, more involvement of the CTB — which can overwhelm resources

compliance. In order to overcome the additional workload created by all the “more,” it is important to understand how the major components of VAT link together in the organization.

It is not surprising that once companies understands all of these important factors that they decide to dive deeper into their China VAT. How should they begin this journey?

China is quite unique in that most companies will have numerous legal entities performing different functions and this affects VAT in different ways. A starting point for assessing how to prioritize companies could be based on variations of the types of VAT transactions and VAT complexity of the type of legal entity and processes. It is important to note that this is not the only way to prioritize companies, nor does this equate to VAT risk — even a small legal entity with limited transactions can have high levels of risk. It can even be the smaller companies that have the most

understanding of the regulations and incomplete processes.

Leasing • Mo vable property leasing 17%

Transportation • Tra nsportation services 11%

Modern • R&D and technology services

• Info rmation technology services

• Cul ture and creative services

• Log istics auxiliary services

• Aut hentication and consulting services

6%

• All VAT pilot services 3%

• Oth er exempt or zero rates services stipulated by the MoF and SAT 0%

focused projects that help to bring VAT operations to the surface, such as: VAT process reviews; Discovery data analytics; reconciliations between ERP and VAT data; etc. Dedicated efforts at each legal entity will usually identify areas of strength, areas for improvement and potential savings opportunities that can set the agenda for future action to be taken by responsible VAT staff. Notwithstanding this, Figure 3 below seeks to provide a high-level idea of how types of legal entities may be plotted along the continuum of variations of transactions and overall complexity to assign a priority of where to start. By diving into the depths of China VAT,

reduced risks, improved compliance,

and bottom line.

Figure 3: How to prioritize whereto focus on China VAT?

Mega companyExport and domestic manufacturer, largesales volume, trading and distributionactivities, R&D, bonded and non-bondedtransactions etc.

Large scale manufacturerMixture of domestic and export sales

In-scope service companyR&D, transportation, servicecompany or other providing in-scope Pilot services now subjectto VAT

Simple manufacturerMostly domestic

FTZ trade company

FICE trade company

Vari

atio

nsof

VAT

tran

sact

ions

VAT complexity

Less

More

Low High

Export manufacturerMostly export-oriented production

To learn more about China’s VAT system and to understand how to effectively manage VAT risks and opportunities when doing business in China, please refer to our recent report A look inside China’s VAT system. This report can be downloaded from our website at

http://www.ey.com/CN/en/Services/Tax/Managing-China-VAT-risks-and-opportunities

By diving into the depths of China VAT,

risks, improved compliance, decreased costs and

the top and bottom line.

On 5 February 2013, Ernst & Young conducted a webcast about how China’s VAT regime works to give insight into the following topics:

• China’s VAT regulatory landscape

• Lesson learned from the 2012 VAT Pilot experience, planned VAT Pilot expansion in 2013 and the future overall VAT reform

• China VAT — how it all links together

• Potential VAT risks and opportunities

• Managing VAT — where to go from here

Rapid changes to China’s VAT regulations, coupled with the lack of proactive or strategic management of VAT operations, could

VAT processes and accounting treatments in China make it

remain “hidden” for some time.

If you would like to listen to this discussion, the webcast archive is available at www.ey.com/webcastsThis webcast is offered in conjunction with our report A look

which is available at www.ey.com/indirecttax

Colombian VAT has followed the traditional value-added system for many years and has grown increasingly complex and onerous for businesses. Previous tax reforms have seen the introduction of new and varied VAT rates, restrictions to the recovery of VAT were incurred and free-trade zone regulations have created special regimes, all of which have led to increasing compliance and administrative burdens being placed on businesses.

New tax reform makes important changes to the VAT systemAleksan Oundjian

T: +57 1 4847297 E: aleksan.oundjian@co.ey.com

Diego Casas T: +57 1 4847050 E: diego.e.casas@co.ey.com

Gustavo Lorenzo T: +57 1 4847225 E: gustavo.lorenzo@co.ey.com

On 26 December 2012, the Congress of Colombia enacted a tax reform that seeks to simplify VAT legislation in the tax code. This reform means that major changes have been introduced to VAT rates, taxable goods and services, VAT recovery

In this article we provide an overview of the VAT system that was in place before the 2012 tax reform, the changes to the VAT system as a result of the tax reform and the potential impact of these changes.

In Colombia, VAT is applied to the sale or import of tangible goods into the country and the provision of services within the territory.1

The rate of VAT applicable depends upon the type of goods or services supplied.

The general VAT rate in Colombia was 16%, but rates for certain products ranged from 1.6% to 35%. Additionally, an exempt/zero-rate category existed along with a category for “excluded supplies” on which no VAT was chargeable. The difference is that there was a right to recover VAT paid on purchases (input tax) incurred in making exempt/zero supplies but no right to recover input tax incurred in relation to excluded supplies.

The recovery of VAT in Colombia followed the normal VAT rules in that input tax could be offset against VAT charged on sales (output tax). However, input tax credit was limited to the output tax rate charged on the corresponding sales. For example, if the input tax incurred was 16% but the VAT charged on sales was a 10%, a VAT refund could be claimed only up to 10%. The remaining 6% had to be treated as part of the cost of the good or services acquired.

In cases where both taxed and non-taxed goods or services were purchased in relation to a supply of goods or services, additional calculations were required to determine input tax recovery (credit proportionality calculation).

If a VAT credit was earned in a VAT period (input tax exceeded output tax), the taxpayer was in a VAT refund position. However, VAT refunds for excess input VAT were available only for exporters (exempt operations). Taxpayers who did not qualify as an exporter had only refunds over excess withholding VAT, while a credit for excess input VAT had to be carried forward for future offset without any possibility of a refund.

The impact of the VAT recovery for companies was huge as the rate limitation created VAT cash traps that increased business costs. The complexity of the

situations where the VAT recovery

The tax reform of 2012, Law 1607, addressed many of the issues arising from the previous VAT system as follows:

Many of the multiple VAT rates were eliminated, leaving only three rates: 16%

and services and 0% for exempt goods (that allows the refund of the creditable VAT paid). The excluded category was also retained.

However, the items included in the 5%, exempt and excluded categories were

not taxing utilities, medical services, basic goods, household rents and transport services) while others address business, economic or political interests (e.g., reduced taxation on agricultural goods and services, oil and gas activities, pharmaceutical goods, exonerating certain goods instead of others, health care insurance plans, hotel services and restaurants).

Colu

mbi

a

1. Further information on the Colombia VAT system can be found in , www.ey.com/GL/en/Services/Tax/Worldwide-VAT-GST-Sales-Tax-Guide---Country-list

it possible for more businesses to request refunds, which until 2012 were available only for exporters and for excesses derived from the withholding tax system. The new rule states that a taxpayer may request a refund for a VAT credit that originates from a VAT rate difference (that is, from paying VAT at a higher rate on inputs than the rate charged on

once a year, after the income tax return

rule still constitutes a relief for companies that normally have lower output tax rates, which previously had to carry forward any VAT credit excess for an uncertain (even

returns).

On the downside, however, a new restriction has been introduced for companies that have had an extended pre-operational period.

In these cases, companies accumulate input tax arising from services received, especially in the mining and oil and gas industries, and credit all the input tax

receive. When such companies were treated as exporters, this situation meant a right to claim a refund of the VAT credits, thus creating a collection gap for the Government. The tax reform disallows accumulated credits for refund purposes, allowing only a refund for the input tax paid in the same bimonthly period in which the sale was executed.

This rule creates a cash trap for start-up companies in this situation as no refund is immediately available. They will need to carry forward the accumulated input VAT and offset it against output tax in future periods, provided that enough output VAT is generated. No refunds are paid, except for refunds of withholding tax.

For exporters, the situation is more

which means that the input tax incurred cannot be recovered at any time. The tax reform did not address this situation and, unless regulations are enacted to create a mechanism to recover that input tax, exporters will be left with an input tax credit they cannot use in a short period of

impact and may also increase the tax basis for equity-based taxation, as such input tax will be deemed to be an asset for the purpose of calculating these taxes.

Another interesting change is the possibility for taxpayers to take a tax credit in their income tax returns for the VAT incurred on capital goods acquired either locally or from abroad. Traditionally, the VAT would have been treated as part of the cost of the asset, with no input tax recovery. This new rule restricts the amount of tax credit to the level of VAT collected by the Government for the year when the asset was purchased. Once the collection goal set for that year is exceeded, each 10 million tax units (approximately US$150 million) in excess of the goal gives one percentage point of recovery of the VAT paid, up to a maximum of 16%.

Companies will need to be aware of the new rules. The initial VAT paid will be treated as part of the cost of the asset.

tax year following the year of acquisition, an adjustment for tax purposes may be required if a company uses the tax credit made available by the Government when it announces the recovery percentage.

Using the tax credit will affect the depreciation tax basis of the asset for that year. Companies will need to evaluate whether taking an income tax credit is

depreciation, in the light of their mid- to long-term tax planning strategies.

Another of the major VAT changes introduced by the tax reform relates to

income. Depending on its gross income of the previous year, a taxpayer is obliged

bimonthly. The higher the gross income the more frequent the VAT returns. This change is important as the threshold will be revised only once a year and input tax

respective returns.

Newly formed companies will be at a disadvantage as they cannot reference the previous year. In this case, the company will automatically be required

required to make anticipated payments of the tax (but apparently with no input tax offset). Although this rule has a pending Government regulation, the lack

A new restriction has been introduced for companies that have had an extended pre-operational period.

The frequency of VAT return

taxpayer’s income.

of input tax recovery may create a severe

into account when planning investments in Colombia.

In addition to VAT, Colombia also has a consumption tax system that is similar to sales tax in other countries. It differs from VAT in that there are no credits created in the transactions between sellers and buyers in the consumption tax system. This tax was created to complement the VAT rate reduction for the automotive and shipbuilding industries, which had VAT rates of 25% and 35%, respectively, but are now subject to the general 16% rate. Consumption tax applies in addition to the VAT on the import or sale of affected goods. The consumption applies an additional 8% or 16% tax, the rate depending on the free on board (FOB) value of the goods. This means that consumers will have to pay a combined 24% or 32% rate of tax (VAT plus consumption tax) on certain goods.

Some of the changes made to the VAT and consumption tax system as a result of the tax reform have created issues and complexities. Consider the changes made to the taxing of restaurant services. These

services, but then consumption tax was extended to restaurant services at rate

restaurant services as an excluded service does not apply if the restaurant business is conducted under a franchise or concession agreement. In these cases VAT still applies, but consumption tax will not apply. This rule creates a particular complexity in the application and interpretation of how these taxes interact as the rules leave a gray area about which kinds of businesses qualify under the franchise/concession exception.

Through the tax reform, Colombia is taking important steps toward making the VAT system more user-friendly, and it is aimed at setting an environment to facilitate foreign investment in the country to allow foreign companies to recover VAT paid locally or to pay VAT without having other tax exposures. However, there is still a lot of ground to cover and there are still major areas of concern, especially for start-ups and for companies involved in activities that are covered by the consumption tax regime.

Consumption tax applies in addition to the VAT on the import or sale of affected goods.

On 1 July 2013, Croatia will, after years of negotiation, become the 28th Member State of the European Union, subject to the

States. In this article we look back at the history of VAT in Croatia and recent changes, and we look forward to what’s required for harmonization with EU VAT law. These changes will have a

outside of Croatia that do business with Croatian customers.

Accession to the EU

Croatia

Marko Starcevic T: +385 1 5800 925 E: marko.starcevic@hr.ey.com

Denes Szabo T: +385 1 5800 900 E: denes.szabo@hr.ey.com

The Croatian system of taxation of the supply of goods and services is based on the Value Added Tax Act, which was introduced in 1995 and came into effect on 1 January 1998. The standard VAT rate at the time the tax was introduced was 22%. This rate has gradually increased over the years to the current standard rate of 25%.

Since its introduction, the VAT system in Croatia had been amended many times. Early changes mainly concerned the extension of the tax exemptions. Initially

services such as services provided by banks and insurance/reinsurance companies. Further VAT exemptions were gradually introduced and were applied to activities such as gambling and the importation of promotional products. A zero rate has also been introduced for certain goods and services such as bread, milk, books, certain drugs, implants,

screenings.

The reduced rate of 10%, which applies to accommodation services, newspapers and magazines, was introduced at the start of 2006. Due to the global economic crisis

and the subsequent need by the Croatian Government to increase revenue, the standard VAT rate was increased from 22% to 23% in 2009.

In March 2012, the standard rate was further increased to 25%. At the same time, the 10% reduced rate was extended to certain products (including sugar, oils and fats, water, and baby food). Furthermore, the right to deduct input VAT for the purchase and rental of vehicles intended for personal transportation was abolished. The VAT incurred on business entertainment costs also became entirely non-deductible.

As of 1 January 2013 the 10% reduced VAT rate applies to supplies of food and nonalcoholic drinks, as well wine and beer in restaurants and pubs. Although the zero VAT rate had to be abolished by the date of EU accession, the Croatian Government decided to abolish it early and replace it with a 5% reduced rate on 1 January 2013. The 5% rate also applies to the importation of boats used for sports and entertainment that are customs cleared by 31 May 2013 and have been placed under temporary import procedure.

compliance with EU VAT legislation, the Ministry of Finance published a draft of the VAT Act on 24 January 2013. Following a few amendments, the act is undergoing parliamentary procedure. Once the Parliament accepts the VAT Act it should come into effect on 1 July 2013, the date Croatia accedes to the EU. However, an exception applies to certain provisions relating to the taxation of supplies of land and buildings, which are expected to come into effect on 1 January 2015.

Accession to the EU means that numerous changes to the current VAT legislation will apply, such as the concept of intra-Community supplies and acquisitions, new place of supply rules for services, distance selling rules, new rules for electronically supplied services and new reporting requirements. Details of some of the changes and their potential impact on Croatian businesses and their customers are outlined below.

Croa

tia

Given the relatively high VAT rate in Croatia (25%) compared with that charged in some other EU Member States,

tempted, after EU accession, to shop by mail order to buy goods in other EU countries where a lower VAT rate applies. The distance selling rules apply throughout the EU to prevent cross-border shopping by mail order, which could lead to distortions of competition. Under the rules, EU distance sellers who exceed the limit in another EU Member State are required to charge local VAT.

Under the new rules, supplies of goods

customers in Croatia will be taxable in Croatia if the value of the supplies exceed the distance selling threshold. This threshold is set at HRK270,000 (approximately €35,700). If the threshold is exceeded, the place of supply will be deemed to be in Croatia, and the supplier will be liable to register for VAT purposes in Croatia (and charge and account for Croatian VAT on its sales).

Effective 1 July 2013, the VAT rate applicable to the sale of daily newspapers and magazines will change from 10% to 5%. However, the 10% VAT rate will still apply to the sale of periodical (i.e., not daily) newspapers and magazines. This distinction will necessitate accounting and compliance changes for businesses in this sector.

After EU accession, the term “import” will apply only to importations of goods from outside the EU. Goods in free circulation in the EU acquired from other EU Member States will no longer be treated as imports; instead, they will be treated as intra-Community acquisitions.

Instead of paying VAT at the time of importation, it will be possible for VAT-registered importers to report and deduct import VAT on their VAT return, subject to receipt of the permission from the tax authorities. This method (sometimes called “postponed accounting

advantage compared with the old system, where import VAT may have been payable at the time of the export but could not be recovered until the next VAT return. Postponed accounting effectively removes

imports from outside the EU and intra-Community acquisitions on which the VAT is self-assessed and recovered using the reverse charge mechanism.

In addition, imports of goods intended for immediate intra-Community supply by the initial importer will now be exempt from VAT.

been introduced for chain transactions involving the buying and selling of goods between three different taxable persons registered for VAT in three different Member States (ABC transactions),

provided the goods are transported

recipient (C). If prescribed conditions are

intermediary in the chain (B) to avoid VAT registration in Croatia.

However, businesses involved in chain transactions need to be aware that, as drafted, the Croatian rules may be more restrictive than in other countries. The draft VAT Act prescribes that

chain is made by a taxable person who is neither established nor registered for VAT purposes in Croatia. This rule is stricter than the practice of other EU Member States, which require only that the “acquirer” (i.e., the taxpayer in the middle) is not established in the destination country (the country of the

Effective 1 July 2013, new place of supply rules will apply in Croatia. The current general rule for the place of supply of services, which taxes services by reference to the location of the supplier, will be changed. With certain exceptions, under the new rules, if services are provided to a taxable person, they will be taxed based on the location of the customer using the reverse charge mechanism.

The VAT self charged by the service recipient will be deductible without the recipient actually making VAT payment (insofar as it has the right to deduct VAT).

This is a change from the current legislation whereby the precondition for making a deduction is that payment has been made to the tax authority.

Currently, one of the biggest problems facing Croatian businesses is the issue of insolvency. As a result, the announced cancellation of the cash accounting scheme triggered much public discussion and commentary by the business community, especially self-employed entrepreneurs. According to the draft VAT Act, effective 1 January 2014, self-employed entrepreneurs who are VAT registered will be required to pay VAT based on invoices issued (using the accruals method) and not upon collection of the consideration from customers. This change will

will be required to account for VAT on supplies before payment.

late or never pays as there is no bad debt relief prescribed by the Croatian VAT Act.

Currently, the transfer of land (including agricultural and building) is not subject to VAT but is subject to the real estate transfer tax (RETT) at 5% (payable by the acquirer). Transfers of land will remain subject to RETT until the end of 2014. Effective 1 January 2015, the supply of building land will become subject to VAT while the supply of other types of land will become exempt from VAT.

The supply of buildings constructed after 1 January 1998 is currently subject to VAT, whereas supplies of older buildings are within the scope of RETT. Effective 1 January 2015, the supply of buildings and attached land older than two years (starting

Taxpayers will be able to opt for taxation when making supplies of land and buildings which are otherwise exempt. The option to tax may be exercised provided that the purchaser has the right to deduct the total amount of VAT.

44

In addition to the current monthly/quarterly VAT and the annual VAT returns, certain taxpayers will be obliged to submit the EU acquisition list (a report on intra-Community acquisitions of goods and services) and the EU sales list (a report for intra-Community supplies of goods and services).

Taxpayers will also be obliged to report, for statistical purposes, details of transfers of goods within EU Member States (Intrastat reporting) provided the prescribed threshold value of intra-Community acquisitions and supplies of goods is exceeded (for 2013 the threshold is set at HRK1,700,000, which is approximately €227,000).

These EU trade reporting requirements will place additional compliance and administrative burdens on affected businesses.

Since 2010, foreign entrepreneurs without a taxable presence in Croatia have been entitled to a refund of VAT incurred in Croatia, provided they do not perform taxable supplies of goods or services in Croatia and that reciprocity applies between Croatia and the claimant’s country. Reciprocity currently applies with Germany, Poland, Serbia, Slovenia, Switzerland and the UK.

These rules will not apply after 1 July 2013; instead, from the date of EU accession, a new refund procedure will apply, in line with EU rules. Taxpayers established in other EU countries will be entitled to request a refund of Croatian VAT paid. The request will be made electronically, through the electronic portals of the tax authorities in their own countries. Taxpayers who are not established in the EU will be entitled to request a refund of the Croatian VAT by applying to the Croatian tax authorities. However, the reciprocity condition will still

Although not yet incorporated into the Croatian VAT Act, Croatia is considering

in some EU Member States regarding consignment and “call-off stock.” Under this system, foreign entrepreneurs selling goods stored in a warehouse in Croatia would not be liable for VAT until a customer took the goods from the warehouse, who would be required to account for the acquisition.

supplier would not be required to register for VAT in Croatia with respect to call-off stock located in Croatia. This

reducing compliance burdens for international supply chains — for example,

A VAT Bylaw, which, it is hoped, will eliminate some of ambiguities in the draft, should be published within three months from the date when the VAT Act is

related to the payment of VAT at import should be published within four months following EU accession.

The new legislation is eagerly awaited. The new rules will bring challenges for entrepreneurs, for their customers and for the tax authorities — as well as suppliers and customers in other parts of the EU who trade with Croatia. We fully expect questions and challenges in interpretation and application of new legislation to arise, as well as inconsistencies with the EU VAT Directives. Businesses need to be aware of the new rules and prepare for their implementation as far as possible. Forward planning is crucial if IT, business and reporting systems are to transition smoothly to the new system on Day One of EU Accession.

The new rules will bring challenges for entrepreneurs, for their customers and for the tax authorities — as well as suppliers and customers in other parts of the EU who trade with Croatia.

Forward planning is crucial if IT, business and reporting systems are to transition smoothly to the new system

on Day One of EU Accession.

Now you can access Global Tax Guides on your tablet. With information on more than 150 jurisdictions, the world of tax is

Download your EY Global Tax Guide app via or

46

In this article we discuss the EU VAT considerations regarding transactions involving shares that give the holder rights of ownership or possession over immovable property. Based on the differences in legislation between EU Member States, the sale of the shares can be within the scope of VAT in the country of the supplier, the recipient and/or in the Member State where the immovable property is located. The differences in VAT treatment,

create both risks and opportunities for the seller and/or the recipient when going through a share deal.

VAT considerations for transactions in shares representing immovable propertyStefan van Krimpen

T: +31 88 40 71522 E: stefan.van.krimpen@nl.ey.com

Marcel Mählmann T: +31 88 40 78376 E: marcel.mahlmann@nl.ey.com

Indirect taxes such as VAT are an essential part of the tax considerations when planning an acquisition of a company. However, even where VAT is taken into consideration, VAT costs can arise, both as a result of the VAT position of the buyer and because the EU Member States may treat similar transactions differently for VAT purposes.

transaction also has consequences for the VAT deduction rights of the seller. Furthermore, companies may want to limit any VAT registration and/or other

VAT planning before going through with a share deal is therefore highly recommended.

In researching this article, we have looked at the differences between the EU Member States with respect to transactions in shares representing immovable property.

One important consideration for the VAT treatment of a sale of a company that owns immovable property is to determine whether the supply is treated as the sale of the shares in the company (i.e., intangible property) or as the sale of tangible property (i.e., as representing the underlying immovable property that the company owns). The difference in these two approaches may affect the VAT treatment of the sale, the VAT compliance obligations of the parties to the transaction and the VAT recovery on related costs.

In general, a supply of goods, if performed for consideration, within the territory of an EU Member State and by a VAT taxable person, is in principle subject to VAT. The term “supply of goods” means the transfer of the right to dispose of ”tangible property” as owner,

immovable property. The sale of shares, however, is considered a service and is, in principle, exempt from VAT, based on article 135(1)(f) of the VAT Directive. The VAT incurred on expenses related to a share transaction that is exempt from VAT is deductible if the buyer is established in a non-EU country and generally not deductible if the buyer is established in an EU Member State.

Euro

pean

Uni

on

48

1. Article 15(2)(c) of the VAT Directive (2006/112/EC) 2. Accessed via the CJEU website, http://curia.europa.eu.

within two years after it has been put to use. 4. Article 47 of the EU VAT Directive 2006/112/EC

However, EU Member States have the option to regard the supply of “shares or interests equivalent to shares giving the holder de jure or de facto rights of ownership or possession over immovable property or part thereof”1 as “tangible property.” Further to the decision of the European Court of Justice (CJEU) in the DTZ Zadelhoff case (C259/11),2 the Court decided on 5 July 2012 that if an EU Member State has implemented this optional VAT legislation related to interests in immovable property, the sale of shares in these circumstances is treated as a “supply of immovable property” under the legislation of that EU Member State.

The supply of immovable property (or part thereof), and of the land on which it stands, is taxable in the EU country where the property is located. In principle, the supply of immovable property (or part of it), and of the land on which it stands, is exempt from VAT. As an exception to this exemption, the Member States can consider the supply of new immovable property3 and the supply of building land as VAT taxable. Furthermore, the EU Member States have the option to treat the supply of immovable property as subject to VAT if the VAT taxable person meets certain conditions laid down in the particular Member State and if the taxpayer chooses to opt to tax the property that otherwise would be exempt.

Whether or not the sale of shares is treated as a ”supply of immovable property” is particularly interesting for determining the country where the transaction is subject to VAT. The place of supply of services related to immovable

property is the place where the immovable property is located. This is in contrast to the rules for the supply of shares that are subject to VAT in the place where the recipient is established when the latter is a taxable person.

In researching this article, we have investigated the implementation of the option to treat shares and equivalent interests in immovable property as tangible property by the various Member States. This investigation found that seven Member States have implemented this option or apply rules that have similar effect.

These Member States – Denmark, Estonia, France, Lithuania, Poland, Portugal, and Spain – treat transfers of shares as supplies of immovable property. In these countries (except for Estonia), the place of supply for the shares and services related to the shares is the country where the immovable property is located.4 In addition, most of the EU Member States that treat shares and equivalent interests in immovable property as tangible property apply various conditions or interpretations related to this treatment: for example, a threshold with respect to the assets of the company (e.g., Denmark), a threshold with respect to the number of the shares in the company that is being transferred (e.g., Portugal), or the nature of the interest that may qualify as “interest equivalent to shares” (e.g., Lithuania).

In these seven countries, although the transfer of shares is not subject to the VAT exemption for the transfer of shares, in principle, the VAT exemption for the transfer of immovable property or land may apply. However, all of these countries have also implemented the option to tax for supplies of immovable property. Therefore, in practice, the transfer may be subject to VAT.

If a business is involved in a share deal that represents immovable property, the parties should carefully review how the transaction and the related transaction costs are to be treated, especially if the immovable property and the supplier are located in one of the Member States that have implemented the exception that treats shares and equivalent interests in immovable property as tangible property.

In particular, it may be interesting to analyze whether the transaction can be structured as a taxable transaction of

new immovable property) or whether the seller can opt for taxation, as this may also affect the VAT recovery of the transaction costs of the seller. Below are three examples of the potential outcomes of these share deals.

If a business is involved in a share deal that represents immovable property, the parties should carefully review how the transaction and the related transaction costs are to be treated

This article discusses at a high level the EU VAT implications regarding deals for shares that give the holder rights of ownership or possession over immovable property. Based on the differences between the VAT legislation of the various EU Member States, the sale of the shares could either be subject to VAT or be VAT exempt in the country of the supplier, of the recipient and/or in the Member State where the immovable property is located. This

creates both risks and opportunities for the seller and/or the buyer involved in a share deal of an immovable property company. If a business is involved in transactions involving shares in companies representing immovable property, a detailed review should be conducted of the complicated VAT rules to determine how the transaction and the related transaction costs are to be treated — and what alternatives are available.

France has implemented the exception to shares in immovable property. If a French company sells the shares of a company whose assets consist of immovable property located in France, it may prefer to opt for a VAT taxable supply of immovable property in France for VAT deduction purposes. In this case, the buyer of the shares (whether established in France or not) will be charged French VAT. Whether the buyer can recover this French VAT depends on its VAT position and the activities it will perform with respect to the shares/immovable property.

Denmark has implemented the exception to shares in immovable property, but Germany has not. If a German company sells shares in a company whose assets consist of immovable property located in Denmark, the Danish tax authorities would argue that the place of supply is in Denmark. This would lead to VAT registration and VAT compliance requirements for the German company in Denmark.

If a Danish company sells shares in a company whose assets consist of immovable property located in the Netherlands, the transaction is not taxed. Under Danish rules, the transaction would be considered to be VAT taxable in the Netherlands, while under the Dutch rules the transaction would be considered to be VAT exempt. The buyer would therefore not incur VAT on the acquisition, but the Danish seller would have the rights to full VAT recovery on costs related to the sale (provided the sale of the property would normally be taxable), as Denmark considers it a supply of immovable property.

A revised internal instruction on customs valuation was issued by the German Federal Ministry of Finance in September 2012. Although the document is designed to

processing of intercompany transactions and how far these transactions are subject to audit.

Marianna Matokhniuk T: +49 6196 996 25736 E: marianna.matokhniuk@de.ey.com

Frank-Peter Ziegler T: +49 6196 996 14649 E: frank-peter.ziegler@de.ey.com

Germ

any

The implications of the revised instruction are rather contradictory. On the one hand, it reinforces the willingness of the customs authorities to accept the transaction value for related-party transactions and to recognize transfer pricing documentation as valid proof of arm’s-length transactions. On the other hand, it introduces a range of indicators

the price, which implies that a wide acceptance of the transaction value

globalized world is forcing industries to restructure their supply chains and integrate their processes to cut production costs. The companies that can deliver faster and cheaper will succeed. One of the ways that multinationals strive to become more competitive is through “vertical integration” — that is, structuring different stages of production within a single group of companies. Apart from reducing the production cost, intercompany trade allows production processes to be closely controlled, ensuring the quality of the goods and

intercompany trade, according to the

Organisation of Economic Co-operation and Development (OECD), accounts for about 60% of US goods imports from OECD countries,1 and it is predicted to increase. To take only the two biggest global players — the EU and the US — intercompany imports from the EU into the US amount to US$231 billion annually.2 The value of related-party imports into the US exceeds US$1 trillion (about 48% of all imports).3

Nothing good comes easy. The bitter side of intercompany trade is transfer pricing. Intercompany trade includes not only a transfer of goods, but also a transfer of services, intangible property, know-how and technology. The value attached to these items is covered through transfer prices.

Intercompany transfers facilitate the effective allocation of resources, taking into consideration applicable income tax rates in different jurisdictions. However, intercompany trade is, in itself, marked by

on their books (to reduce their tax burden), but at the same time, group tax considerations may require them to align

group strategy. These differences can be

Even if all the tax issues are resolved, the applicable customs duty rate for a

solely the cost of the goods sold (COGS) plus, potentially, a certain portion of operating expenses.

between two separate taxing authorities in the same country — for instance, a tax authority that collects and administers taxes on corporate income and a customs authority that administers duties on imports. And both may be very interested in the same transactions.

Because intercompany transfers may serve as a means of redistributing the

jurisdictions, tax authorities rigorously patrol such transactions to ensure the correct taxable base. On the other hand, since such transactions take place across international borders, customs authorities verify that the relationships of the parties

when the taxable income is high and the deductibles including the value of the imported goods are low. The customs

the imported goods is high to secure high duty collections. Such contradictory interests lead to contradictory rules and requirements.

1. “Intra-Firm Trade: Patterns, Determinants and Policy Implications,” Organisation for Economic Co-operation and Development, 2011.2. “Related Party Trade Report, 2011,” United States Census Bureau News, www.census.gov/foreign-trade/Press-Release/2011pr/aip/related_

party/rp11-exh-1.pdf. 3. Ibid, www.census.gov/foreign-trade/Press-Release/2011pr/aip/related_party/rp11-highlights.pdf.

Despite notorious tensions, both authorities agree that the value of intercompany transactions should be based on the arm’s-length principle, i.e., that it should be comparable to the market price paid between unrelated parties. However, the acceptable ways of arriving at the arm’s-length price are rather different: tax authorities assess the transactions on the year-end basis, while customs authorities scrutinize each transaction separately. Moreover, the methods used to determine the correct value do not always coincide. Although among the various transfer pricing methods approved by tax authorities, the cost-plus method is generally preferred by the customs authorities, but it is not a rule.

The customs valuation is primarily done on the basis of the transaction value — the price actually paid or payable for the goods when sold for export to the customs territory of the European Community. One of the conditions for using the transaction value method is that “the buyer and seller are not related and, if they are, the transaction value is still acceptable.” If the parties to a transaction are related,4 acceptance of the transaction value will not be automatically denied. Customs authorities will subject such transaction to further scrutiny, and the transaction value might still be recognized as a proper basis for valuation, provided that the relationship between

5

In its revised internal instruction on customs valuation, the German Federal Ministry of Finance has introduced a range of so-called “indicators, signaling a

doing this, the German authority is effectively seeking to limit the possibilities for reducing the customs duty burden by means of price manipulation.

It is important to note that the list of the indicators was included in the instruction as a part of the body text and not by means of examples, which are used in the instruction in some places. This means

consider these indicators during any customs clearance procedure or customs audit.

Among the factors that appear on the list are some rather routine transfer pricing exercises undertaken by multinational groups to adjust prices between companies, including retroactive year-end and periodic price adjustments, compensatory payments, and adjustments within a target margin scheme. Although these mechanisms are considered legitimate from an income tax perspective, they will now prompt a

of the transactions involved. In the end, customs might conclude that the relationship between the parties

transaction value is no longer applicable. Thus, another method of customs valuation will come into question and, consequently, the calculation might become more complicated and, in the end, lead to higher customs duties.

In this context, it is clear that customs issues should be considered in planning any transfer pricing strategy. A higher customs duty burden often counterbalances income tax reductions achieved through redistribution of the company’s resources. Involving customs professionals in this process can help companies reconcile these contradictory

Moreover, due consideration of the customs issues in designing a transfer

in the transfer pricing documentation — can anticipate and exceed the expectations of the customs auditors and smooth the audit process.

There is some good news in all of this.

still possible — with bit of planning — to make it all work. The instruction now regulates price decreases and price increases. Companies can avoid unpleasant surprises by submitting all the documents regarding price adjustments to the customs authorities in advance. It is important to note that price adjustment arrangements should clearly appear in the written contract and should be presented to the customs authority at the time of the importation.

Arguably, it should be possible to get a refund of duties overpaid in Germany arising from price adjustments that reduce the customs value of imported goods, provided written contracts include a respective clause. Unfortunately, so far there is no formal program for reporting

4. See Art. 143, Community Customs Code Implementing Provisions.5. See Art. 29(2)(a), Community Customs Code.

The acceptable ways of arriving at the arm’s-length price are rather different: tax authorities assess the transactions on the year-end basis, while customs authorities scrutinize each transaction separately.

regulations, it is still possible — with bit of planning — to

make it all work.

retroactive transfer pricing adjustments in Germany similar to the U.S. Customs and Border Protection Reconciliation Program.6 In the EU, there is a special regime for incomplete customs declarations, which allows provisional values to be submitted at the time of the importation.7 Alternatively, importers can make use of a post-clearance examination of the customs declaration and revise their import entries for the preceding three years.8

The German customs instruction also offers another opportunity: an advance non-binding ruling, which assesses prospective price adjustment arrangements by a special valuation division of the German customs authority.

Tax provisions require companies to have transfer pricing studies on hand for relevant related-party transactions. Although such studies might contain information that is useful for customs purposes, the reference points for tax and customs purposes do not fully coincide, so customs will consider these studies merely as an indication of a possible arm’s-length transaction. While tax authorities compare the economic operator under review with other companies with a similar business function and delve into the books of the local taxpayer, the customs authorities make their comparisons on a product level. They may review comparable imports in their customs clearance databases to determine a reasonable price.

The good thing is that control over the transfer pricing documentation lies entirely in the hands of the company concerned. That means it is possible to

issues in one set of documents. This is especially true, taking into account the next novelty in the customs internal instruction.

One of the most important provisions of the revised instruction is that a company’s transfer pricing documentation will be recognized among the proofs of an arm’s-length transaction. By implementing this provision, the German Federal Ministry of Finance reinforces the proposals of the International Chamber of Commerce (ICC) and the ICC Committee on Customs and Trade Regulations, as well as Commentary 23.1 of the Technical Committee on Customs Valuation at the World Customs Organization (WCO) to accept the transfer pricing documentation and decrease the pressure on multinational corporations. Understandably, advance pricing agreements (APAs) or transfer pricing

companies themselves that can highlight the information relevant for customs purposes and can make the transfer pricing documentation talk in their favor before the customs authorities.

6. “The Formula for Success in Post Importation Adjustments,” CBP Trade Newsletter, www.cbp.gov/linkhandler/cgov/trade/trade_outreach/trade_newsletter/newsletter_trade_3qtr.ctt/newsletter_trade_3qtr.pdf, July 2012

7. See Art. 254, Community Customs Code Implementing Provisions.8. See Art. 78, Community Customs Code.

Multinational groups of companies that do business in and with Korea may face an increased risk of customs audits in the coming year. Korea Customs claims that roughly 70% of total customs assessments arise from multinational companies and that this percentage shows that multinationals represent a higher risk of underpaying import duties and related taxes.

Customs to focus audits on multinational companiesScott Fife

T: +82 2 3770 0963

Dong O Park T: +82 2 3770 0964 E: dong-o.park@kr.ey.com

Due to shortfalls in customs revenue collections in the past year compared with previous years, Korea Customs has announced its intention to increase the number of customs audits this year. It is expected that company-level audits will increase by over 50%, possibly affecting up to 130 companies. Along with company-level audits, Korea Customs will continue to conduct planned audits, free-trade agreement (FTA) origin audits, foreign exchange investigations and other aspects of its compliance review programs. Overall, it is expected that the total number of companies audited this year could be more than double the amount audited last year.

Korea Customs has also announced that it will be focusing on multinational corporations that have large volumes of related-party sales with their local Korean entities. Companies that have not been audited in the past four years and/or that have import levels of greater than US$50 million may also face a greater risk of being audited this year. Companies with high duty rates or high-value luxury goods are also likely to be selected for audit.

In general, Korea Customs may audit the following aspects of a company’s import/export business:

• Customs valuation

• Non-trade-related payments (royalties and commissions, etc.)

• Duty refunds

• Foreign exchange transactions

• Overall compliance with import/export regulations

• And other areas based on the company’s business

Customs authorities utilize their highly developed IT system to assist in these audits. This system allows them to track

on a transaction-level basis down to the line items on the invoice. This allows them to very quickly spot “outliers” and anomalies that may indicate an area where the importer is not compliant with local regulations. This also helps the

as well as transfer pricing adjustments.

commonly focus on and use as reasons to challenge the related-party pricing.

As companies look to mitigate potential risk from these audits, it will be important to have a detailed understanding of the business’s import/export compliance status in Korea. It will also be important to understand how the company’s import prices compare with the prices applied in that industry in general, to help to identify potential areas of risk where Customs could claim that the related-party status of the buyer and seller have had an impact on the import price.

Companies with royalty payments, buying commissions, cost-sharing agreements or other similar payments should also carefully review how they have treated these payments from a customs valuation perspective and analyze potential risk and how this may be mitigated.

Kore

a

Recent changes in Slovak legislation mean that taxpayers may be liable for their supplier’s unpaid VAT. Is your company at risk of having to pay VAT on your supplier’s behalf?

evasion, a VAT law amendment has been introduced with effect

provisions for the joint and several liability for unpaid VAT. Under the new rules, the VAT payable by a supplier would become payable by a customer who is a VAT payer. According to the new legislation, the customer will be held liable for VAT stated on the invoice that was not paid by the supplier to the Slovak tax authority, if certain conditions are met.

Joint and several liability for your supplier’s unpaid VATMarian Biz

T: +421 2 333 39130 E: marian.biz@sk.ey.com

Juraj Ontko T: +421 2 333 39110 E: juraj.ontko@sk.ey.com

This legislation will not apply where the

he did not know or could not have known that the supplier would not pay VAT.

In February 2012, the Financial Directorate published a list of approximately 1,400 “risky” VAT payers. Any VAT payer who continues to enter into with transactions with listed entities can be held jointly and severally liable for unpaid VAT.

VAT payers who enter into affected transactions face the risk of receiving an

from the end of the calendar year in which the transaction was carried out.

The main consequences of such an assessment are:

• Financial:

•

may be a potential issue for the

may draw negative attention from the company’s auditors and other regulators.

• The obligation to pay the VAT may have a negative impact on the VAT

has to be paid before it can be recovered.

• Legal: the VAT payer must undertake an administratively complex process to claim the VAT paid as input tax.

• Operational: the new rules may have an impact on business processes (e.g., procurement) if companies have to assess the integrity of their suppliers and on their supply chains if companies need to change their suppliers to avoid doing business with “risky” taxpayers.

The introduction of this VAT amendment will require additional compliance and administrative burdens for businesses in Slovakia. All businesses will need to check if they are at risk of being held jointly and severally liable for unpaid VAT.

To assess the risk, companies operating in Slovakia should ask themselves:

• What measures should we adopt to protect us from payment of unpaid VAT (e.g., including protective clauses in our contracts)?

• What measures must we put in place to identify our trade with “risky” companies?

• prove that we could not have known that the supplier will not pay the VAT?

• Do we have proper resources at the right place (e.g., for regular monitoring

reliability of suppliers)?

Slov

akia

Businesses will need robust and effective end-to-end processes to ensure that they are protected against any potential VAT payment on behalf of their suppliers.

A robust and effective process will:

• Enable management and reduce costs related to compliance

• Minimize disruption to the business.

An example of such a process is set out below:

Identify “risky” companies

• Review new suppliers

• Review existing suppliers

• Review all suppliers periodically

Monitor sources for identifying “risky”

companies

• Financial authority list, internal blacklists, media search

•

•

Analysis and action

•

• Employees using what-if scenarios

• Lessons learned transferred to checklists

• Continuous process improvement — burden minimization, effectiveness of processes

Documentation

• Complete and consistent documentation to present to the tax authorities

• Preparation of templates used for the respective stages of the process

examination of all suppliers. It is therefore important that companies implement processes to assess the risk of being held liable for a supplier’s unpaid VAT as soon as possible.

Latest views and analysis from Ernst & Young’s tax professionals

TradeWatch is our global customs and international trade publication. The March 2013 issue spotlights free trade agreement opportunities and challenges in the EU. It also includes reports on

www.ey.com/Customs

Indirect tax in 2013

With change comes complexity

The continued importance of indirect taxes to governments around the world reinforces the need for

and examines their implications and impact for businesses. It also includes country updates from around the world.

www.ey.com/indirecttax2013

www.ey.com/tpc

This is the 12th edition of , our client-facing magazine that

rapidly changing tax landscape, interviews with our clients and tax administrations, and a roundup of the most timely and relevant tax legislative and administrative developments from around the world.

Understanding how the regime works to effectively manage VAT risks and opportunities

China’s VAT system is one of the most complex in the world. Although companies generally assume that VAT in China is “neutral,” in reality they are often net payers of VAT and can incur

and how to effectively manage VAT risks and opportunities.

http://www.ey.com/CN/en/Services/Tax/Managing-China-VAT-risks-and-opportunities

www.ey.com/vatguide

Our Worldwide VAT, GST and sales tax guide helps you understand how indirect taxes will affect your company abroad. Chapter by chapter from Albania to Zimbabwe, this guide summarizes consumption tax systems in 101 jurisdictions and the European Union.

With the development of new technologies and the increased use of the internet, new commercial activities and delivery terms are emerging on a regular basis. E-commerce is becoming more popular all around the world. But current legislation in many countries struggles to meet the taxation requirements of these “new” transaction types. Due to increasing volumes of online transactions, the taxation of electronic commerce has become a hot topic in a number of countries, including Turkey.

Online sales and services to non-business customers — who is liable for the VAT?Cansu Yagci

T: +902 1 236 85428 E: cansu.yagci@tr.ey.com

Sedat Tasdemir T: +90 212 368 5257 E: sedat.tasdemir@tr.ey.com

In this article, we look at the issues regarding the taxation of e-commerce in Turkey and the possible response of the country’s Ministry of Finance, based on reports in the Turkish press. Currently there is no mechanism for collecting VAT from overseas suppliers or from Turkish non-business customers. The questions that the tax authority has to address include: does VAT apply to these transactions? Who is the taxpayer responsible? And how can the VAT be collected?

In Turkey, the press has recently reported that the amount spent on internet applications that Turkish customers downloaded to their mobile phones had reached US$200 million in the past four years. The fast progress in technology and the high volume of online transactions will probably attract the Ministry of Finance’s attention. The revenue administration’s view is that downloaded applications are

subject to Turkish VAT and that the party liable for VAT in Turkey is the foreign company that provides the content. However, unlike in the EU, there is currently no mechanism for foreign companies to register only for VAT in Turkey if they are not physically located in the country. The Turkish tax administration may, therefore, look to the person downloading the content to declare and pay the VAT on this transaction. But this also creates problems, as it is not known how this VAT can be collected from individuals.

The impact of this issue could determine the future of reverse charge VAT since the liabilities of individuals and nonresident foreign companies in the Turkish tax system look set to change drastically.

Turkish VAT law stipulates that services are deemed to be performed in Turkey if the services are rendered in Turkey or if

Turkey. Therefore, services procured from

of the service is in Turkey. This rule, therefore, makes Turkey the place of supply for a service supplied electronically

to a recipient in Turkey, even if the service provider is not resident in Turkey and does not supply the service from a place of business in the country.

When services are rendered in Turkey by an entity that is not physically located

service in Turkey must account for VAT via the reverse charge. If the recipient of the service is a taxpayer in Turkey, then VAT is due. But what happens if the recipient of the service is not a VAT taxpayer?

By its nature, VAT is a transaction tax, and its application does not depend on companies or persons. According to the regulations about joint responsibility, tax may be claimed from any person who is party to a taxable transaction. Besides, none of the articles of the VAT Law makes any distinction between individuals and companies in terms of securing VAT.

Turk

ey

If a Turkish recipient receives a supply of services from an overseas service provider, the Turkish customer may be treated as the party responsible for the tax. The responsible party is liable to fully and accurately calculate and declare the tax that it is liable to collect, and to pay the accrued tax on time.

But can this obligation apply to an individual who is not a VAT taxpayer? The new wording of a VAT General Communiqué Series (Number 117) regarding the reverse charge mechanism appears to establish a strong foundation for the ministry’s intention to tax individuals in these circumstances.

The Turkish tax system does not currently allow persons to register for VAT purposes only. In Turkey, a legal entity comes into existence upon its registration in the Trade Registry, and it is subject to an inspection of its “workplace,” which must exist physically. After the inspection, a

makes the legal entity a taxpayer, not only for VAT purposes, but also for a number of other taxes.

If a company does not physically exist in Turkey, it is not obliged to become a taxpayer there, even for activities

Under the current rules, there is no mechanism enabling an overseas company to register for VAT purposes

in Turkey. It therefore does not seem possible for the Turkish tax administration to collect tax from overseas companies that are not required to register for tax liability in Turkey.

However, we understand that the Turkish tax administration is determined to collect tax on these transactions. Therefore, we believe that it would be no surprise if the administration were to focus in the near future on individual Turkish residents who download internet applications or shop online to require them to account for any tax. However, a non-business customer may not even be aware that it may be liable to pay any VAT due.

Although it is not yet known how these taxes will be collected, considering the increased use of technology and electronic controls to track online activity, the Turkish tax administration could well develop the means to identify the nonresidents who supply these services and their Turkish customers. Payments for programs downloaded from the internet (particularly from websites of nonresident companies), or for online purchases of goods, are almost exclusively made using credit cards. Therefore, these transactions could be tracked by using bank databases, and VAT could be assessed using the credit card statements of individuals who purchase these services. However, the banking industry may be unwilling to assume another VAT declaration obligation.

With the assistance of our Ernst & Young colleagues, we have conducted a brief review of 35 countries1 that have a VAT system regarding the treatment of e-services for VAT purposes. A summary of the responses provided show that:

• In 31 of the countries surveyed, programs downloaded from the internet are subject to VAT.

• The four countries that do not apply VAT to e-services are Albania, Egypt, India and Lebanon.

• In the 27 EU Member States, VAT applies to electronically supplied services, supplied by nonresidents. Currently, if the customer is a VAT-registered business, it accounts for VAT in its EU country of residence using the reverse charge mechanism. In general, if the customer is not a VAT-registered business, the responsibility for accounting for VAT rests with the supplier.

• If the supplier is resident outside the EU, it is required to charge VAT in the customer’s country of residence (this may be done by registering in one EU country, but the supplier must calculate the VAT due in each country separately).

• If the supplier is resident in the EU, it is required to charge VAT in its country of residence — for example, e-services supplied by a German business to a resident in the UK are taxed at the German VAT rate.

6. Albania, Austria (EU), Bulgaria (EU), Croatia, Cyprus (EU), Czech Republic (EU), Denmark (EU), Egypt, Estonia (EU), Finland (EU), Germany (EU), Greece (EU), India, Ireland (EU), Italy (EU), Jordan, Latvia (EU), Lebanon, Lithuania (EU), Luxembourg (EU), Malta (EU), Moldova, Netherlands (EU), Norway, Poland (EU), Portugal, Romania (EU), Russia, Serbia, Slovakia (EU), Slovenia (EU), Spain (EU), Sweden (EU), Switzerland, and the United Kingdom.

• These rules will change in 2015 so that the supplier will, in all cases, be required to charge VAT according to the customer’s country of residence.

• In most of the countries surveyed, it is possible to be liable for VAT without being a taxpayer in general. The exceptions to this rule are Lebanon, Moldova and Russia. In order to be a VAT taxpayer in these countries, a person must be or become a taxpayer for all purposes.

• 17 of the countries surveyed advised that individuals resident in the country may become VAT taxpayers.

• 25 of the countries surveyed advised that legal persons that have not registered for tax liability in the country may become VAT taxpayers.

In summary, this questionnaire demonstrates the variety of mechanisms created by various countries for applying VAT to content downloaded from the internet. We can conclude that in countries where it is possible for overseas companies to register for VAT purposes only, VAT can be applied to e-services.

On the other hand, in countries whose legislation does not allow overseas companies to register for VAT purposes only, the taxation of these services is problematic.

As mentioned above, of the countries, surveyed only three (Lebanon, Moldova and Russia) do not allow overseas companies to register for VAT purposes only. Let us look at the VAT treatment of e-services in these countries.

In Lebanon, programs downloaded from the internet are not subject to VAT, but this is not the case in Russia and Moldova. If a company resident in Russia provides these services, they are deemed to be subject to VAT, whereas, if they are provided by a company that is not resident in Russia, they are not subject to VAT because there is no mechanism for charging it.

Moldova does not allow registration for VAT purposes only, but these services are subject to Moldovan VAT as they are rendered in Moldova. Similar to Turkey,

taxation method to address this issue.

The dramatic increase in the volumes of programs downloaded from the internet may lead the Ministry of Finance to focus on this matter and collect VAT either through enabling VAT-only registrations as in other countries or through another tool to be developed in order to apply withholding in this context.

In conclusion, the main legal fact that should not be disregarded is that

VAT, and if these services are procured from those whose place of residence, workplace, legal headquarters or business center is not located in Turkey, the party responsible for the VAT payment is the

party may not have to be registered for VAT to be responsible for the payment.

64

The European Court of Justice (CJEU) has ruled against taxpayers in relation to fund management services provided to pension funds and in favor of taxpayers with respect to advisory services provided to special investment funds. What is the impact of these rulings in the UK?

Impact of CJEU decisions on the VAT exemption for fund managementMitchell Moss

T: +44 20 7951 2279 E: mmoss@uk.ey.com

David Bearman T: +44 20 7951 2249 E: dbearman@uk.ey.com

Andrew Bailey T: +44 20 795 18565 E: abailey1@uk.ey.com

Gabby Donald T: +44 20 795 11667 E: gdonald1@uk.ey.com

On 7 March 2013, the CJEU released its long-awaited decisions in the cases of

1 and

2 relating to the VAT treatment of asset management.

The issue in dispute in both cases turns on the interpretation of the exemption provided for in Article 135(1)(g) of Council Directive 2006/112/EC3 for “the management of special investment funds

exemption). Two elements are required for the exemption to apply:

1. The services must be fund management services.

2. They must be provided to a special investment fund.

The two cases the CJEU considered are each concerned with one of these two conditions:

• In Wheels, it was common ground that the services constituted “fund management,” but the issue was whether the fund manager’s customer

constituted a “special investment fund.”

• In , it was common ground that the customer was a “special investment fund,” but the issue was whether nondiscretionary investment advisory services constituted “fund management.”

The CJEU ruled against Wheels but in favor of GfBk. So why did the court reach these conclusions? And what are the implications for businesses operating in this sector in the UK? The details of the judgments are considered below.

The CJEU has considered the scope of the fund management exemption on a number of occasions. In the Abbey National case,4 the CJEU made clear that the concept of exempt “management” was a concept arising from EU law with direct effect, rather than a concept to be determined by Member States, and that it included fund administration, as long as the services “form a distinct whole,

the management of special investment funds.”

In 5 the CJEU held that the

exemption extended to “closed ended funds,” such as investment trust companies, and that, while Member States have the discretion to choose the type of funds to which the exemption can apply, this discretion is limited and must be exercised consistent with the principle of neutrality. The court further held that the purpose of the exemption is to facilitate investment in securities through collective investment vehicles, i.e., to allow private investors to spread their risk (through investing in a fund) without suffering a VAT burden.

Rather than settling the law in this area, the Abbey National and judgments have led to further disputes such as those in the present cases. In Wheels, the taxpayers sought to extend

occupational pension schemes. In , the taxpayer sought to extend the

include nondiscretionary investment advisory services (i.e., investment advice that the recipient was not obliged to follow).

Uni

ted

King

dom

1. CJEU case reference C-424/11 2. CJEU case reference C-275/113. Council Directive 2006/112/EC, , eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2006:

347:0001:0118:en:PDF, 11 December 2006.4. CJEU case reference C-169/045. CJEU case reference C-363/05

66

Let’s consider these latest cases in more detail:

Wheels is a common investment fund in which the assets of various occupational pension schemes (OPSs) established for UK employees of the Ford Motor Corporation are pooled for investment purposes. Wheels argued, on the basis of

, that the principle of neutrality required that fund management services provided to OPSs should be exempt as OPSs are the same as, or are

accepted by the UK tax administration (HMRC) to be special investment funds, i.e., authorized unit trusts (AUTs), open-ended investment companies (OEICs) and investment trust companies (ITCs). This contention was on the basis that investors’ contributions are pooled

members while achieving wider diversity and spreading risk.

The UK First-Tier Tribunal sought guidance from the CJEU on whether pension schemes should be regarded as special investment funds and whether a difference in VAT treatment of pension schemes and other funds leads to a

proceeded to judgment without an Advocate General’s Opinion.

The CJEU considered the case law. It set out the purpose of the exemption as in

(referred to above). It also set out the effect of the principle of neutrality as requiring that transactions

should not be treated differently for VAT purposes. The CJEU interpreted the term “special investment funds” to be funds that constitute undertakings for collective investment in transferable securities within the meaning of the Undertaking for

Collective Investment in Transferable Securities (UCITS) Directive. It held that such funds have as their sole object the collective investment in securities of capital raised from the public.

concluded that Wheels could not be a special investment fund, since it was not open to the public but only to Ford employees.

It was then necessary to consider whether

investment fund to merit the same VAT treatment. The CJEU concluded that this was not the case, primarily because, unlike private investors, the members of the pension scheme do not bear the risk in the investment. Employers bear that risk.

Further, the employers could not be seen as analogous to private investors as,

consequences of the investments, they did so as a way of complying with legal obligations to the employees.

On that basis, the CJEU held that a

special investment fund and, therefore, supplies of management to it would be taxable.

deals with the question of whether the VAT exemption extends to nondiscretionary investment advisory services provided to a self-managed “special investment fund.” GfBk, a German-based company, researched the securities market and provided its customer, a German

(KAG), with purchase or sales recommendations on a continuous basis. The KAG retained the right to make decisions regarding the execution of GfBk’s recommendations,

but, in practice, it merely checked whether the execution was in line with German legal and regulatory requirements. If a recommendation was in line with these requirements, it would proceed through the order system for processing, often in minutes.

GfBk argued that these services were “fund management services” to which the exemption applied. The German tax authorities rejected this argument. The German Supreme Court referred the case

and under what conditions, the exemption would include such fund advisory services.

The Advocate General gave his Opinion on 8 November 2012 and recommended that

exempt. The CJEU followed the Advocate General’s Opinion.

investment funds in similar terms to those it had used in Wheels. It then held that GfBk’s services would be exempt if they were intrinsically connected to the activity characteristic of such a fund, thereby

management functions of such a fund. In the view of the CJEU, recommendations as to the purchase and sale of assets were “intrinsically connected to the activities of a fund.” In this regard, it did not matter that advisory services were not listed in Annex II of the UCITS Directive (which was relied on by the CJEU in Abbey National), since the Annex was not exhaustive. As was clear from Abbey National, exemption was available notwithstanding that GfBk

position of its customer.

The CJEU then considered the principle of

principle was not offended by advisory services to special investment funds being exempt when such services provided to individuals would be taxable. The CJEU noted that direct investors were not liable for VAT. It further noted that the principle of neutrality would be offended if GfBk’s services were taxable, since special investment funds employing their own advisors would be at an advantage compared with those who used third parties.

Finally, the court considered that the fact that the appointment of GfBk had not been in accordance with the UCITS Directive did not prevent the services from being exempt – as it is settled case law that unlawful transactions must be taxed in the same way as lawful transactions.

The judgment in Wheelscurrent treatment in the UK and, therefore, any major impacts for businesses are unlikely. In cases where fund managers have submitted claims for repayment of VAT on the basis of Wheels, the HMRC is highly likely to reject them. In cases where fund managers have appealed against any such rejections, these appeals will likely fail where the facts are similar to those in Wheels. Equally, any actual or potential claims by funds against fund managers with respect to these issues are unlikely to succeed.

However, we note that each claim must be considered on its own merits, as differences in facts may lead to differences in outcomes. In particular, one of the grounds for the CJEU’s judgment

the CJEU would have reached a different

contribution scheme (which will come before it in future cases).

68

The judgment in followed the Opinion of the Advocate General. While this decision runs contrary to the position taken by the UK tax administration, the impact on taxpayers in the UK may be limited. Although GfBk did not have discretion, in practice, its customer entered into each transaction that was suggested, typically within minutes, having checked only that the recommended investments were not prohibited. HMRC already accepts that investment management is exempt where the third party has discretion to enter into transactions, and in the UK, we understand in practice that most such services are provided on a discretionary basis with the third party undertaking only to enter into permitted transactions.

The judgment will, however, permit a wider range of services to be provided on an exempt basis. Where services have been treated as taxable, but if the facts of the situation agree with the case, the suppliers should make claims to HMRC for a repayment of VAT if they have not already done so, and follow up on any claims that have been made. Investment management companies in such circumstances may wish to seek repayment from their suppliers of VAT paid in error.

The judgment in Wheelshistorically taken by HMRC. Unless funds or fund managers consider that there are

their circumstances and those set out in the Wheels case, fund managers should continue charging VAT on services to

Where their circumstances are different from the facts in this case, fund managers may wish to keep any claims or appeals alive pending further developments. This may be particularly the case for claims with respect to the management of

the different facts may result in a different outcome.

The judgment in the Wheels case makes it clear that such schemes are not special investment funds, since they are not open to the public; however, the question remains open whether they are

that the principle of neutrality requires the exemption to apply. The key reason that the CJEU held that the principle of neutrality did not assist Wheels was that the members of the scheme did not bear the risk of the investments. That situation

scheme, where the entire risk is with the employees. Therefore, it may be that the CJEU would have reached a different decision in such a case.

We may not have long to wait to have the answer to this point. The CJEU will

contribution pension fund is a special investment fund in two upcoming cases,

6 and ATP Pension Services.7 The PPG case also considers the extent to which employers can deduct input tax on pension-related services, and ATP considers the scope for exemption of third-party services as constituting payments and transfers.

As has happened in similar circumstances before, HMRC may take some time to consider the judgment before formally responding. Therefore, some level of uncertainty may remain for a while as to the decision’s precise impact in the UK.

We understand that there are limited circumstances where fund managers in the UK will have charged VAT in the same circumstances as in — the fund managers would typically be given discretion in order to secure exemption. However, this will not universally be the case. Even where the facts of the

6. CJEU case reference C-26/127. CJEU case reference C-464/12

case do apply, affected businesses need to take the full impact of the decision into account.

Where fund managers are entitled to a repayment of VAT, this will be on a net basis — i.e., the output tax overpaid less the input tax wrongly recovered. On an ongoing basis, the fund manager would not be able to recover the associated input tax and, therefore, the costs of the fund manager would increase. Depending on the fund manager’s partial exemption recovery method, the increase in exempt supplies may also reduce the proportion of VAT recoverable on general overheads.

Whether such costs can be recovered from the funds will depend on the terms of the contract between them. The same issues as applied between fund managers and funds in relation to repayments may also occur here, namely whether the funds are entitled to recover the gross amount of VAT paid to the fund managers over the full period permitted by claims in civil law or whether what they are entitled to is limited to the net sums recovered by fund managers from HMRC for the uncapped periods. In this regard, fund managers are likely to maximize their protection against being liable to repay funds more than they recover from HMRC by taking prompt action to make claims and keep them up to date.

likely to be in permitting a broader range of ways for third parties to provide investment-related services without the impact of VAT.

This article has focused on the UK position. However, as these are CJEU judgments, they will affect each Member State. We are aware that different Member States treat the services covered by Wheels and in different ways. Where services provided to pension funds have been treated as exempt, Member States may require VAT to be accounted for from a current date. There may also be a risk of assessments for the past depending on the nature of the national law or rulings and the national legal systems. Where -type services have been treated as taxable, taxpayers may have a right to repayments of overcharged VAT, subject to local rules.

Funds and/or fund managers who believe such changes will impact them in other Member States should take appropriate advice as to their position.

Global Director — Indirect Tax

ContactsPhilip Robinson +41 58 289 3197 philip.robinson@uk.ey.com

Customs and International Trade

William M. Methenitis +1 214 969 8585 william.methenitis@ey.com

Neil Byrne +353 1 221 2370 neil.byrne@ie.ey.com

Robert Smith +8621 2228 2328 robert.smith@cn.ey.com

Europe, Middle East, India and Africa (EMEIA)

Gijsbert Bulk +31 88 40 71175 gijsbert.bulk@nl.ey.com

Americas

Jeffrey N. Saviano New York; +1 212 773 0780 Boston; +1 617 375 3702 jeffrey.saviano@ey.com

Jean-Hugues Chabot +1 514 874 4345 jean-hugues.chabot@ca.ey.com

Indirect taxes, ranging from VAT and customs duties to environmental levies, affect the

functions, since they must be managed accurately and in real time. These often invisible

Thanks to our network of dedicated Indirect Tax professionals, who share knowledge and ideas, we can provide a seamless, consistent service throughout the world and deal effectively with cross-border issues. These include advising on the VAT treatment of

disputes and issues with the authorities.

We provide assistance in identifying risk areas and sustainable planning opportunities for indirect taxes throughout the tax life cycle. We provide you with effective processes to help improve your day-to-day reporting for indirect tax, reducing attribution errors, reducing costs and helping to ensure indirect taxes are handled correctly.

We can support full or partial VAT compliance outsourcing, help identify the right partial exemption method and review accounting systems. Our customs and international trade

and evaluate import/export documentation. Our highly globally integrated teams give you the perspective and support you need to manage indirect taxes effectively. It’s how Ernst & Young makes a difference.

© 2013 EYGM Limited. All Rights Reserved.

EYG no. DL0769

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

Any US tax advice contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

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