Indirect Taxes

Value Added Tax (VAT)

Today it would be difficult to name a country that does not have some form of indirect taxes of which VAT, GST (Goods and Services Tax) and sales taxes are a part. It is particularly important to treat these taxes correctly since any errors in calculation or payment of these taxes constitutes an immediate bottom line hit since these taxes are not in general deductible for corporate income taxes.  

How Does VAT Work?

VAT is designed to be a tax on the end user, not on businesses which merely act as collection points. Very simply, a business (A) is required to charge VAT at rates prescribed by the tax authorities on its goods or services – this is called “output” tax. Other businesses (B) will charge VAT on their sales to business A – to A this is VAT payable on its purchases of goods or services – called “input” tax.

At the end of a reporting period, A will pay over to the relevant tax authority the difference between the output tax (taxes on its sales) and its input tax (the tax it has had to pay other businesses for its purchases from them).

At the end of the reporting period A will also prepare a “VAT Return” summarizing this information and submit to the relevant tax authorities.

Other terminology for similar taxes are GST (Goods and Services Tax) in Australia and Canada, State Value-Added Tax (ICMS), Federal Value-Added Tax (IPI,) Municipal Service Tax (ISS,) Federal Gross Receipt Contributions (PIS-PASEP/ COFINS) in Brazil, Consumption Tax in Japan among others.   

What Do These Terms Mean?

VAT Exempt: This means that the businesses activities fall within the categories of activities which have under current legislation been “exempted” from VAT i.e. to which VAT does not apply. An example in the UK is hospital and medical care treatment provided by a hospital, nursing home or clinic. The drawback here is that unlike zero-rated, exempt items are not treated as taxable. No tax is payable, but equally, the person making the supply cannot normally recover any of the VAT on their own expenses.

Zero-Rated Supply: This means that the goods are still VAT-taxable, but the rate of VAT to be charged to customers is 0%. Goods can move between the different rates of VAT depending on legislation then in force.

Reverse Charge: A reverse charge occurs when instead of the supplier being required to charge VAT, the recipient or buyer is required to account for the VAT. This generally occurs on intracommunity supplies (i.e supplies within the EU) between VAT registered traders.

Outside the scope of VAT: These are goods and services that are not part of the VAT system at all. An example is payroll. However, the importance of this concept for non-EU based businesses is that certain services to a non-EU customer are outside the scope of VAT i.e. no VAT needs to be charged or paid.  

Fiscal Agent: Where a non-EU company needs to register for VAT, the route of appointing a Fiscal Representative allows the company make use of and benefit from all the facilities of the EU VAT system, without having to register for any other purpose in the EU. The Fiscal Representative will normally require a deposit for the risk taken. In addition, the tax authorities are likely to need a bank guarantee to cover the VAT on imports which is reclaimable. The Netherlands has implemented a special regime under Article 23 of the Dutch VAT Act which allows importers to avoid the immediate payment of VAT upon importation of goods.

Who Needs To Register?

Generally any business whose sales exceed or are likely to exceed a certain threshold – these amounts vary with each country. An organization will be considered to be a business if it carries out economic activities with a view to profit. In most countries a business can elect to register for VAT even if it does not meet the registration thresholds to enable it to recover the VAT charged to it by other businesses.   These are general guidelines, for more information on your specific country or situation, please connect with us.