The Chartered Tax Adviser Examination May 06 APPLICATION AND INTERACTION QUESTION 4 - VAT AND OTHER INDIRECT TAXES Suggested Solutions
Answer Part Draft Letter to Bob Armstrong From: Alex Douglas To: Jane Hammond Date: 5 May 06 Subject: ACB (UK) Ltd Hi Jane I have attached my draft letter to Bob Armstrong for your review as requested. Draft letter Bob Armstrong ACB (UK) Ltd Hightown HT XX Lock & Luckhurst LLP London WC99 8XX Dear Bob 5 May 06 Operational Issues Thank you for your letter dated 5 April 06. I am writing with the advice you requested. Executive Summary You have requested clarification about some operational issues and advice about the tax issues arising from the new line of business. We have explained the mechanism known as 'triangulation' which frequently applies in your supply chains. With reference to recent problems in the supply chain, we have concluded that ACB (UK) Ltd should register for VAT in Spain in order to import the goods sourced from the USA. For the goods sent to the USA for repair, we would suggest that you demonstrate the rate of repair that would be available from an alternative repairer. We recommend that the company continues to lease IT equipment held at the Irish processing centre rather than selling it, thus avoiding the need to register. Regarding the new line of business, we would advise that the supply and installation contract is a single supply of goods for VAT purposes, with the consequences that follow. When calculating the quantum of double tax relief that is available for income taxed overseas, we advise that you can benefit from the lower of the treaty rate or the overseas domestic rate of tax. We would advise against using an office in Switzerland for processing new orders, with a preference for one in an EU country.
) Recent problems in the supply chain You asked me to clarify the VAT administration involved with orders from Europe. (i) Triangulation The customer in Italy places an order for goods with the UK company, which in turn places an order with your Austrian company to deliver the goods direct to Italy. Thus there is one movement of goods, from Austria to Italy, but the invoicing trail is different. Your Austrian company must invoice ACB (UK) Ltd (ACB) for the goods, which in turn must invoice the Italian customer. This process, within a supply chain involving three European Union (EU) member states, is known as 'triangulation', for which there are special rules. mark Step is the invoice from the Austrian subsidiary to the UK company. The supply of goods from one EU member state to another is known as a 'despatch'; there is no requirement to charge local VAT, but the company acquiring the goods must charge itself VAT (called acquisition tax) which it may recover, resulting in no VAT cost for your business. Thus the Austrian invoice may be zero-rated, on the assumption that it enters ACB's UK VAT number on the invoice. marks Step then involves the UK company 'acquiring' (effectively agreeing to take delivery for VAT purposes) of the goods in Italy. Under the basic rules, as recipient of the goods, it must register for VAT in Italy and enter the acquisition tax charged on its Italian VAT return, which it claims back. mark Step 3 is for the UK company to raise an invoice for the goods under its Italian VAT registration, charging Italian VAT to the Italian customer. mark If ACB is to arrange to supply goods across Europe, this will require many VAT registrations leading to administrative complexity. A measure known as 'simplification' will assist here, provided that the intermediary company is not registered for VAT in the member state to which the goods are delivered, and the customer in that state is registered. mark The measure entails disregarding the sale, for VAT purposes, by the UK intermediary company to the end customer in Italy, and is achieved by amending the invoice raised by the UK company. It will now be a UK VAT invoice, showing details of the triangular transaction, and must include a specific narrative on the invoice, "VAT: EU Article 4 Simplification invoice". The UK intermediary should exclude the sale from its UK VAT return and also from a return for reporting movement of goods, INTRASTAT. marks There are other administrative measures required: the intended procedure must be notified to HM Revenue & Customs (HMRC). The transaction must also be recorded on a return known as an 'EC Sales List'. You will appreciate that you should comply with all the above procedures for any transactions using simplification. Thus it is possible that failures may have occurred. mark (ii) Equipment sourced from the USA The triangulation simplification arrangements do not apply in these circumstances because the supplier of the goods is situated outside the EU. We therefore need to consider the VAT rules applying when goods are imported into the EU from a place outside the EU. mark The goods are to be shipped from the USA to Spain. The EU is a customs union, which means that the EU member states have no Customs Duty barriers between them, but have a common Customs Duty tariff against goods from outside the EU. As well as Customs Duty, import VAT will have to be paid on importation at the domestic rate in Spain, which is %. mark The first step is to identify who is responsible for importing the goods into Spain, which must either be the US supplier or ACB (UK) Ltd, as the intermediate supplier.
The trade terms are Ex Works, which means the following: The buyer bears all costs and risks involved in taking the goods from the seller's premises to the desired destination. The seller's obligation is to make the goods available at his premises (works, factory or warehouse). This term represents the minimum obligation for the seller. mark ACB will therefore be responsible for importing the goods. In order to do so, ACB must pay the import VAT and customs duty at the Spanish ports or arrange for an agent to do so on its behalf. ACB will receive a certificate for the VAT paid. In order to recover the VAT, ACB would need to be registered for VAT in Spain. It would then invoice the onward supply of the goods to the Spanish customer through an invoice raised under its Spanish VAT registration number. ACB could recover the import VAT incurred through its Spanish VAT return. marks (iii) Repairs sent to the USA I note that you send goods for repair to a regular supplier in the USA. The goods for repair all originate from inside the EU. The term 'Community goods' refers to goods that either originate in the EU or, if imported from outside the EU, the required Customs Duty and similar charges have all been paid. Such goods, known as having Community status, are free to circulate within the EU without any liability to pay further customs charges upon movement between member states. mark Normally when goods are exported outside the EU they lose Community status, and duty must be paid on their full value at re-importation. Outward processing relief (OPR) is a trade facilitation measure available for the re-importation of Community goods which have been exported outside the EU for process or repair. mark The amount of duty relief available on the re-imported product will depend on the type of process the goods underwent while outside the EU, and the duty rate applicable to the goods originally exported outside the Community. If goods are exported for repair and this does not take place, Returned Goods Relief (RGR) can be used on re-import if the goods remain unaltered. We will discuss RGR in more detail in the section below. mark If goods are repaired in return for payment, the import duties are calculated on the cost of the repair. However, this is conditional on the cost not being influenced by any relationship between the exporter and the repairer. mark You have stated that you receive repairs at a favourable rate, which I believe HMRC are querying. You may need to demonstrate that the rate is a full market rate for the work; in other words if you provide the same volume of work to an alternative repairer that you could obtain a similar rate. mark (iv) Services provided to loss adjuster ACB has been engaged by the loss adjuster, a UK business, rather than by the French insurer or the French insured party. Thus this is a business to business (BB) supply between two UK VAT registered persons. mark The loss adjuster may not have recognised the existence of a UK supply or may believe that the place of supply of the services was in France where the work was carried out. UK VAT legislation recognises that certain services are supplied where the service is performed. However, the relevant UK VAT Notice lists the following among the examples of services which are not supplied where performed: scientific services which include a recommendation or conclusion. These are services of consultancy or provision of information. 3
Thus these services follow the general rule, and are deemed to be supplied in the UK where the customer is established and subject to UK VAT at 0%. marks The contractual terms of your engagement are not clear, including whether a VAT clause existed. Assuming this was not the case, HMRC would expect you to pay over tax from the net proceeds you have received. This means a VAT liability of 0/0 x 90,000 = 5,000. mark In order to receive the full consideration of 90,000 that you expected, you would need to charge an additional 8,000 to the loss adjuster and produce a tax invoice. However, it would be advisable to obtain their agreement, which may not be forthcoming, before doing so. mark (v) Irish processing centre The equipment lease rentals by ACB to the Irish company are BB supplies of services which are deemed to be supplied in Ireland. Thus they are outside the scope of UK VAT and the Irish company must charge itself the tax under what is known as the reverse charge mechanism. mark You have questioned whether your VAT reclaim was valid. In order to lodge a successful claim to the Irish tax office, the following points must be observed: The claimant must not have a business establishment in the member state of refund (Ireland), The claimant must not make or have made any supplies of goods or services in that member state, other than goods or services for which the reverse charge applies, The VAT claimed is recoverable as input tax (unlike, say, VAT on entertaining), The VAT claimed is attributable to business activities of the claimant in its own state (the VAT relates to invoicing by the core business in the UK). Thus assuming you have applied correctly through the HMRC electronic portal, we would not envisage any problems with payment of the claim. marks The Irish Revenue must notify the claimant upon receipt of the claim. It must then notify its decision to approve or refuse the application within four months of the date of receipt. Should it require more information, it may request this from either the claimant, HMRC, or from third parties. In total the Irish Revenue has up to eight months from the date of receipt of the application to reach a decision. If the claim is accepted, payment must be made within 0 working days following expiry of the decision deadline, and interest will be due to the claimant if the payment is late. marks You intend to sell the equipment in about two years. You should note that a supply of goods takes place in the country in which the goods are located when their transport to the customer begins. Thus the goods will be liable to Irish VAT. Given that an EU Directive reclaim has been made for the refund of the Irish VAT charged on these goods, the law will require ACB to register for VAT in Ireland for the purpose of making this supply in two years time. However, this does not affect the treatment of the equipment rentals which will remain subject to the reverse charge. marks Having an additional VAT registration is an unwanted administrative burden. You may instead wish to consider leasing the equipment to a third party customer in Ireland until it reaches the end of its useful life and can be scrapped without you making any supply. The lease rentals would then remain subject to tax in Ireland under the reverse charge mechanism. mark 4
) Business expansion Supply and install contract - VAT issues You intend to offer separate contracts for the supply of equipment and for the installation work. However, having separate contracts does not necessarily determine the VAT treatment. It is important to consider whether this is a single supply, consisting of different elements, or a multiple supply of separate services and goods. The issue is whether there are one or more elements constituting the principal supply, with others that are ancillary to the principal supply. mark The customer anticipates receiving scientific equipment to carry out a function in its power station, i.e. a supply of goods. Therefore we consider the installation work to be ancillary to the main supply rather than an aim in itself. The overall contract will be invoiced from the UK to a business customer in another European country. The goods will be supplied at the zero rate of VAT, with responsibility for accounting for the VAT shifting to the overseas customer. mark Direct tax issues A UK resident company is liable to corporation tax on its worldwide profits and may also be liable to pay tax overseas on any profits attributable to a 'permanent establishment' (pe). This term means a fixed place of business through which business is carried on. It includes especially: a) a place of management; b) a branch; c) an office, factory or workshop; d) a mine, oil or gas well, a quarry or any other place of extraction of natural resources, or e) a building site or construction or installation project. For category e), a pe only exists where the work lasts a reasonably long period of time. The length of time will be specified in the relevant double tax treaty. The UK treaty with all major European countries specifies a period of months. (A double tax treaty is an agreement between two nations over the taxation of income and profits that may arise in both states). marks As you state that installation work typically takes six months, there should be little risk of an overseas liability for direct tax for this work. mark The equivalent term for an onshore presence in VAT legislation is 'fixed establishment'. Liability to account for VAT may arise from transactions occurring over a much shorter period of time. Our advice to David Barnes regarding the exhibition in Germany will illustrate this. mark Whereas we do not see any direct tax liability arising from the supply and install contracts, the same will not be true for the royalty income from the scientific equipment installed in power stations. If a company has income from a source in one country and is resident in another, it may be liable to pay tax in both countries under the respective tax laws. mark ACB (UK ) Ltd will in due course pay corporation tax on the royalty income at UK rates. To avoid double taxation, the UK has negotiated double taxation treaties with most major trading nations which may reduce the rate or preclude a charge in one country. Even if there is no treaty, the UK will provide unilateral relief from UK tax up to the overseas tax paid on that income. marks 5
Returned Goods Relief The heavy duty equipment will be transferred to locations within and outside the EU, and then back to the UK, following installation. The movement of the goods within the EU will be in 'free circulation', which means no requirement to charge Customs Duty on their movement. There are no EU reporting requirements involved. mark However, some heavy duty equipment will leave the EU to go to Moldova. Goods exported from the EU can, in certain circumstances, be re-imported with relief from Customs Duty. Where goods leave the UK under the OPR regime, and are returned to the UK in the same state as they were when originally exported, another form of relief known as Returned Goods Relief (RGR) will apply. mark RGR is not needed for goods moving between the UK and Switzerland as they are part of the EFTA (free trade arrangements). Goods can move under Community Transit instead. bonus mark There is a three year time limit on the goods being re-imported. As the installation projects typically last six months, this will not be a problem. mark When the heavy duty equipment is re-imported, import VAT will not be due if those goods remain in the same state. So if RGR applies, no import VAT is payable. This is subject to the three year time limit discussed above. mark New Swiss office You propose to open a new office in Switzerland to process orders from central Europe. You should note that Switzerland is not a member state of the EU, so the simplification procedures described above will not apply. Suppose a customer from Poland places an order at the Swiss office for goods to be sourced from the Austrian warehouse. There will be two transactions to invoice, although only one movement of goods. Goods cannot be supplied to the Swiss entity as things stand without a local VAT charge. Instead the triangular transaction chain needs to be re-examined. There are two alternatives: the Swiss entity should either register for VAT in Austria or in Poland. mark If the Swiss entity registers in Austria, then Austrian VAT would be charged on the supply of goods. This may be recovered through the Swiss entity's Austrian VAT return, but involves a cash flow issue. The Swiss entity will invoice the Polish customer under its Austrian VAT registration. This will be zero-rated as a despatch of goods. As a VAT registered company in Austria, the Swiss entity would need to enter details of the sale on a 'recapitulative statement' (the Austrian equivalent of the EU Sales List), and may also need to report the sale on an Intrastat Supplementary Declaration. mark Alternatively, if the Swiss entity registers in Poland, then the Austrian company will zero-rate a despatch of goods to Poland. The Swiss entity accounts for acquisition tax on the goods entering Poland, which has no tax cost. However, it must charge Polish VAT on its invoice to the Polish customer under its Polish VAT registration. This again involves a cash flow issue. As above, as a VAT registered company in Poland, the Swiss entity would need to enter details of the sale on a 'recapitulative statement' and also possibly the Intrastat Supplementary Declaration. mark The preferred state for registration is that with the lower VAT rate, arriving at the lower cash flow result. However, on the assumption that the Swiss entity is intended to process orders from a number of central European states, we would not recommend this route given the additional administrative work involved for multiple VAT registrations. Rather you should use an office in an EU country with an existing VAT registration or continue to process orders through the UK. mark 6
3 Intellectual property rights Intellectual property rights give the owner the right to prevent other persons from using the know-how in their business. A patent gives the owner a virtually exclusive monopoly to exploit a product or process over a period of time. mark In the UK the patent will be registered with the Intellectual Property Office in Newport in accordance with the Patent Act 977. The patent is granted for 5 years, with the right to renew annually up to a maximum of 0 years. mark For a patent to be granted, the invention must satisfy these criteria: it must be functional or technical, relating to how something works, what it does, what it is made of, or how it is made; it must be new and not have been made public; it must involve an inventive step, and not be obvious to someone with a good knowledge of the subject; and it must have an industrial use, that is, it must be capable of being made or used in an industry. marks All intellectual property rights are territorial. A UK right does not affect activities taking place outside the UK. Thus to achieve protection under the patent elsewhere it is necessary to register the patent in all other applicable states. This can partially be achieved by filing a single patent application to the European Patent Office. This is an organisation consisting of 38 countries, including all EU member states. It offers inventors a uniform application procedure which enables them to seek patent protection across a number of states. mark There will be some territories which are not members of the European Patent Office, for which separate application will be necessary. mark Please let me know if you require anything further Yours sincerely Jane Hammond Tax Partner ---------------------------------------------------------------------------------------------------------------------------- Please let me know if you need anything further from me. Regards Alex Total for this part of the question 55 marks 7
Part Technical E-mail to David Barnes From: Alex Douglas - Lock & Luckhurst LLP To: David Barnes - ACB (UK) Ltd Date: 5 May 06 Subject: Exhibition Dear David Jane Hammond has asked me to respond to you about your e-mail of 7 April 06 concerning the forthcoming exhibition in Germany. Firstly we would recommend that all exhibition fees, admission charges and sponsorship be invoiced from your German subsidiary. As we are looking at supplies to be made in an EU country, the starting point is to consider the EU VAT Directive (006//EC). Article 44 of the Directive sets out the general rule for the place of supply of services for business to business (BB) transactions. The supply is deemed to take place in the country in which the customer is established rather than the supplier. There are, however, exceptions to the general rule for certain BB supplies of services. The right of admission to an event such as a fair or exhibition is where the event takes place - refer Article 53. The mere right to occupy a stand at an exhibition, without other services, is a supply connected with immoveable property, and is taxed where the stand is situated. This arises from Article 47 of the VAT Directive. marks Exhibition fees HMRC Brief /0 is relevant to the exhibition stands. The brief was issued after discussions between HMRC, the European Commission and EU member states to resolve the issue of differing treatment of supplies in the various member states, which lead to double taxation. The intention was to introduce harmony over the application of the rules. The UK confirmed its view that the supply of specific stand space at an exhibition is a supply of land and thus is taxed where the land is situated. However, where stand space is provided with accompanying services as a package, this package is no longer seen as a supply of land but is taxed under the general place of supply rule when supplied to business customers. mark Thus where a supply of a stand is to be made at the German exhibition in isolation it will be a single supply of land, taxed locally in Germany. However, given that the stand is to be supplied as part of a package of services, it will be seen as a general rule supply, taxed at the customer's location. mark Admission charges The place of supply of admission to the German conference will be in Germany where the event takes place. Thus German VAT is required on admission charges to all customers worldwide. mark If the event is organised from the UK by ACB (UK) Ltd (ACB), then the company would need to register for VAT in Germany, even if the event only lasts a few days. There may also be deemed a temporary onshore presence, with a possible direct tax liability arising. As the group comprises a subsidiary company already registered for VAT in Germany, we would strongly advise you to sell the tickets through that company. This will reduce your administrative effort, and remove the onshore presence from a direct tax perspective. However, the corollary is that a transfer pricing adjustment would need to be made because the German company carries out administration services on behalf of its UK parent company. 8
A small part of the profit would need to be retained in Germany, assuming all exhibition proceeds would otherwise be passed back to the UK. marks For attendees at the exhibition or conference from Germany, the VAT is recoverable as input tax, subject to German VAT rules. For attendees from other EU member states, the VAT on these charges can only be recovered by an EU Directive claim to the German tax authorities. For companies outside the EU it will ordinarily be an additional cost, although a claim to the German tax authorities may be available under the EU 3th Directive. marks 3 Sponsorship The sponsorship charges are for advertising services which fall under the general BB rule; i.e. they are taxed in the member state of the recipient. Thus the invoice is outside the scope of VAT, and should indicate that the supplies are subject to the reverse charge for customers established in the EU. VAT only needs to be charged on domestic supplies. mark 4 Travel packages The provision of travel, accommodation and admission as a single package may represent an attractive option for customers. Under UK legislation, the tour operators margin scheme (TOMS) is a special scheme for businesses that buy in and re-sell travel accommodation and certain other services under their own name. (The scheme is not limited to travel agents or tour operators). The consequence of TOMS is that VAT cannot be reclaimed on goods or services acquired, either from the UK or other EU countries, for resupply as margin scheme supplies. The margin scheme supplier need only account for VAT on the margin. The scheme prevents businesses having to register for VAT in every EU member state in which the supplies are enjoyed. marks The margin scheme applies in other EU member states. Thus if a UK based margin scheme supplier has a fixed establishment in more than one EU country, the supplies will fall within the scope of the specific TOMS rules in that country. If the packages were to be sold by ACB (UK) Ltd, the supply would be deemed to arise in Germany as the UK company has a fixed establishment there. This means that the supply is within the scope of German VAT and a VAT registration would be required. Alternatively if the packages were to be sold by the German subsidiary, the supplies are within the scope of German VAT rules but there is need for a further VAT registration. 3 marks We would recommend that the travel packages be sold by your German subsidiary and should represent an attractive selling point. However, this initiative would need to be balanced against the additional VAT complexities that would arise from such transactions. mark I trust this is suitable for your purposes. Regards Alex Lock & Luckhurst LLP Total for this part of the question 6 marks 9
Part 3 E-mail to Jane Hammond From: Jane Hammond - Lock & Luckhurst LLP To: Peter Trumper - ACB (UK) Ltd Date: 5 May 06 Subject: Corporation Tax Dear Mr Trumper Thank you for your e-mail of 30 April 06. I set out below my workings as requested. Capital allowances Tax WDV brought forward 45,000 Additions in year - 45,000 Capital allowances at 8% (8,00) Tax WDV carried forward 36,900 Corporation Tax mark Profit before tax per accounts 485,000 Add: Entertaining and legal fees 0,000 Depreciation 5,000 50,000 Deduct : Capital allowances (8,00) Profits chargeable to Corporation Tax Depreciation 5,900 Corporation Tax at 0% 0,380 Deferred Tax mark Capital allowances 8,00 Depreciation (5,000) Timing difference (6,900) Deferred tax movement at 0% (,380) FRS0 Reconciliation / proof of tax mark Actual tax charge 0,380 Tax effect of permanent differences (0,000) x 0% (4,000) Tax effect of timing differences (6,900) x 0% (,380) Expected tax charge based on the accounting profit 485,000 x 0% 97,000 marks 0
T accounts Corporation tax creditor account 3//5 Bank: CT payment 35,000 0/04/5 Brought forward 35,000 3/03/6 Balance C/F 0,380 3/03/6 Corporation tax (P&L) 0,380 Deferred tax provision account mark 3/03/6 Deferred tax (P&L),380 0/04/5 Brought forward 3,000 3/03/6 Balance carried forward,60 Please let me know if you require anything further. Regards Alex 3,000 3,000 mark Total for this part of the question 7 marks Overall mark allocation The marks are allocated as follows: Part Part Part 3 Presentation Total VAT 33 5 48 Direct taxes 6 9 Customs Duty 0 0 Law 6 6 Accounting 5 5 Presentation & Higher Skills 55 6 7 00
Marking Guide General topic Part ) Recent problems in the supply chain Triangulation Definition of triangulation Acquisition and despatch Registration in Italy to acquire goods Raise invoice under Italian VAT registration Discuss simplification procedure Consequences of simplification: invoice specification and exclusion of transaction from returns Notifications and entry on EC Sales List Marks Import Triangulation does not apply Customs Union (Duty) INCOTERMS and responsibility to import Payment of import VAT, raise Spanish tax invoice Customs Duty Define Community goods Define OPR Rate of relief / RGR Valuation for repair or replacement, arm's length value Conclusion as to valuation Loss adjuster Recognition of parties to contract Place of supply of services / UK VAT due Absence of VAT clause / need to produce tax invoice Irish processing centre Leasing of equipment is a reverse charge supply Conditions for EU Directive refund claim Time limits for repayment Sale of goods liable to Irish VAT EU Directive reclaim means requirement to register Suggestion to continue leasing in Ireland Business expansion Supply & install contract Distinction between single or multiple supply Conclusion / Supply zero-rated by UK company Direct tax (pe, DTR) Permanent establishment - definition Conclusion on liability Comparison with fixed establishment (VAT) Liability to tax in more than one country DTR available / unilateral relief Returned Goods Relief Free circulation for Community goods Availability of RGR (not needed for Switzerland)* Time limit for return of goods No import VAT if RGR applies * bonus mark for EFTA and Switzerland
Swiss office Simplification does not apply - register in another EU state VAT consequences of Austrian registration VAT consequences of Polish registration Recommendation Intellectual Property Rights Define IPR Method of registration Criteria for granting patent Registration with European Patent Office Separate application needed in other states 55 Part ) Exhibition - VAT considerations BB general rule for place of supply and exceptions HMRC Brief /, exhibition stands supplied as a package Place of supply for conference admission and liability VAT registration and transfer pricing VAT recovery for attendees Sponsorship a reverse charge supply TOMS general principles TOMS rules in all EU states Consequences of sale of packages by UK and German companies Conclusion Part 3) Accounting Capital Allowances working Corporation tax working Deferred tax workings FRS0 Reconciliation / proof of tax T accounts for Corporation Tax and Deferred Tax 6 7 Presentation Total 00 3