New VAT Rules on Place of Supply of Services
Following the implementation of the EU VAT Package on Jan 1st - an increase in VAT from 15% to 17.5%, the package is designed to ensure that VAT on supplies of services is borne in the member state of consumption. SSON spoke to Richard Woolich, Partner at DLA Piper UK LLP last year about the impending implications this may have on businesses who are based within the EU.
SSON: Richard, can you please give us an overview of the VAT Package law which is due to come into effect January 1st next year.
Richard Woolich: The VAT package constitutes the number of measures which are being introduced across all the jurisdictions of the EU. The main part impacts the supplies of cross-border of supply services - which means services supplied across jurisdictions and either from the EU to outside the EU or from outside the EU into the EU. It covers the supply of services as opposed to the supply of goods.
The reason behind the package is two-fold: a realization that the way of charging VAT should remain within the country of consumption and modern business with increasing use of the internet and increasing globalization has meant that VAT in some cases is no longer taxed in the country of consumption but in the country of the supplier or elsewhere
There is also an intention to simplify and deregulate and cut down the opportunity of fraud by taking more business to business supplies outside of VAT by being subject to the reverse charge instead. There is quite a lot of complication in the new rules but for a business to business supply - the general rule will become that the supply takes place in the jurisdiction of the recipient and a business to private consumer supply will take place in the jurisdiction of the supplier – these are the general rules, although there will be exceptions to both.
SSON: Can you tell me more about the exceptions to the rule and where they will apply?
RW: There are various different exceptions. They are based on the principle that VAT should be taxed in the jurisdiction of consumption. So it is things like land related services, where the rule is the supply takes place where the land is and that will now include hotels. And it will include other types of supplies, where the place of performance is more consistent with where that service is enjoyed. There is another exception around hiring a means of transport. Restaurant and catering services as you would expect take place where the restaurant is. And other sorts of services where it is more consistent with the principle of consumption that they are not treated for VAT as taking place where the supplier or the recipient of the supply belongs. You should always check the objections before applying the general rules.
SSON: The fact this VAT package affects the supply of services as opposed to the supply of goods – can you explain the difference and how this affects organizations?
RW: The rules concerning the supply of goods have always been different from the supply of services and this will remain. When you have a supply of goods, it has never really mattered who is supplying what to who – what matters is where the goods are going. So exports of goods from the UK to outside the EU have no VAT– it doesn’t really matter who the buyer is.
SSON: Richard could you also give us an indication of other areas that the revised VAT package will affect.
RW: The changes to the supply of services rules will come in over a period of five years. And the last of the rules in 2015 will deal with electronic services and that is to give businesses time to adjust to the changes, because there are quite significant changes for EU business supplying services to non-business customers of digitized electronic services. So that is to give EU businesses as much time as possible to change charging arrangements.
Apart from this, they are introducing, from 1st of January 2010 administrative changes which aim to cut down on fraud and make sure that the governments of the different jurisdictions can keep their eyes on what is going on. Those who supply business to business services cross-border will for the first time have to fill out a new form called a recapitulative statement which will cover supplies made cross-border to VAT registered businesses. It covers those services which are taxable not those which are exempt – i.e. taxable in the jurisdiction of the recipient. It means that there are systems changes that businesses should be making right now to make sure they are able to access the information to transfer into the new statement which will need to be submitted within 21 days at the end of each calendar quarter and 14 days if it is done by hand.
HRMC have quite rightly said that firms and the businesses should be collecting the VAT registration numbers of their business customers now so they can evidence their business to business supplies on which no VAT is charged and have the information ready for the recapitulative statements.
SSON: How will the VAT package affect the globalization of businesses?
RW: I think in lots of ways it will simplify matters in that the VAT won’t have to be charged on so many business to business supplies. The customer business will have to take account of the reverse charge in its jurisdiction and that means that instead of local VAT needing to be charged, it will be accounted for in the jurisdiction of the recipient in its VAT return and if that business can recover all its VAT - say it is a manufacturer or a retailer or otherwise carrying on a fully taxable business for VAT, then it should be just an accounting entry and it will save the burden and the cash flow cost of having to pay VAT and seek to recover it under the EU directive which enables businesses to reclaim VAT incurred in different jurisdictions. The changes will have a huge impact on partially exempt businesses such as banks and insurance companies, which at the moment outsource their back-office services – say outside the EU and don’t incur any VAT cost at the moment at all. From the 1st of January 2010, there will be a VAT cost for the first time because those services instead of being treated as supplied in the country of the supplier outside the EU will now be treated as supplied in the UK. So the business should be looking to see what extra costs by the bank / insurance companies under the reverse charge these changes bring, because there will be a real VAT cost for the first time.
Indeed over a period of time there may be some banks and insurance companies who will prefer service providers to outsource in the UK, because there will be no longer a VAT saving to be made by outsourcing outside the UK especially as more and more countries outside the EU are bringing in a form of value added tax, such as the goods and services tax and this also adds to the risk of having double value added tax - VAT outside the EU in the country of the supplier and then in the EU under the reverse charge. So the mechanism of VAT cross-border is only going to increase in complexity and in cost for businesses who can’t recover all their VAT.
SSON: You mentioned earlier some organizations that offshore or outsource may be exempt from this tax – can you expand on those?
RW: Those companies who can recover all their VAT will not suffer a cost - it will just mean an accounting entry as they will be able to recover the VAT they pay.
SSON: What different business procedures will businesses have to take in order to comply with the new rules?
RW: Yes - they should review their cross-border contracts to see how they will work under the new regime. They have also to make sure that their accounting systems are changed. Businesses who receive services from outside the UK will have to record the reverse charge in the UK much more diligently than before, even if they are fully taxable. And as part of the package, the time of supply will be changing for the reverse charge. For a single service, it will be the date of completion of the service or payment if earlier. There are different rules for continuous supplies of services where the invoice period will be the date of the supply - the period covered by the invoice and if there isn’t any invoice for the whole year - there will be a deemed supply on the 31st of December which is causing some concern amongst businesses although HMRC have said that they promise to be flexible.
I think the first thing to say is that they will have to make sure their accounting systems can pick up the tie of supply in the reverse charge.
Checks will have to be made to make sure that the registration numbers of business customers are picked up and where the customers are not registered for VAT in their jurisdiction, but they still maintain they are in businesses, then alternative evidence of that business status from the local chamber of commerce for instance needs to be obtained and put on file. And there also needs to be more regular checks of VAT numbers to make sure they are correct.
One good change is that from the 1st of January a new simplified system coming in for reclaims of VAT incurred in different jurisdictions is being introduced. It is being computerized and it is also going to be possible from January 1st to make your claims through HMRC ( if you are a UK business ) sent onto each of the different jurisdictions where the VAT has been incurred, but that will speed up and simplify the recovery of VAT incurred in different jurisdictions. The jurisdictions have to pay interest for delays.
Then there is for the first time a climate for businesses who make cross-border services to record those services in a recapitulative statement, which is a special form which details each supply to each VAT registered business offshore so information needs to be made quickly down-loadable at the end of each calendar quarter into this special form which needs to be submitted to customs in times.
SSON: Richard, do you foresee that this ruling will have implications on organizations that may have Shared Services Centers based in locations like Bangalore – is it going be as financially attractive for organizations to set up offshore as it has been up until now?
RW: For fully taxable businesses it should be just accounting changes - making sure that they are able to record all the supplies – they should be aware they know the rules where the supplies are taking place and if they have global contracts to make sure they understand where the VAT is going to be charged. So for taxable business the impact should not be a great as it may be for partially exempt business who could have a real cost arising from these changes.
Global contracts will need extra care – it is important that the parties know where the VAT is going to be charged. And rules called the use and enjoyment provisions allow jurisdictions to lay down overriding rules to tax the service in their jurisdiction and the application of these rules may cause confusion especially in recession.
SSON: How will the average customer like you and I be impacted by new VAT package?
RW: Well of course any extra cost – we all know that this is passed onto the customer, whether he knows it or not!
SSON: Can you tell us a little more about the ‘use and enjoyment rule’ and how this will be implemented?
RW: This is where a jurisdiction has the ability to say that if a service is enjoyed in its jurisdiction it can tax it in its jurisdiction – it has the potential to drive a ‘coach and horses’ through the changes. And we still don’t know at this point how jurisdictions are going to interpret that rule. Currently, the UK is just sticking to what they had previously but other countries may see this in a different way. Of course there is the case that most jurisdictions are way behind the time-table to implement the changes.