Welcome Guest | Login
Increasing liberalisation of the gas and electricity distribution sector has led to an urgent need for a review of indirect tax rules and VAT in particular. This is in order to ensure that such indirect tax rules are compatible with the need for correct and simple VAT taxation of such supplies. Most importantly it should be clear to all market players what the consequences of these indirect tax rules are, bearing in mind that indirect taxes are meant to be passed on to the consumer and should therefore (in principle) not create a burden for businesses.
By Rogier Vanhorick.
Currently, the opposite is true. Where consumers have contracts for fixed prices, businesses usually suffer the unexpected indirect tax costs and administrative burden which typically become apparent after the deal has already been done. Even more so, it seems that in certain EU countries the unclear VAT treatment of certain transactions gives local tax authorities a certain freedom in their own interpretation often resulting in double taxation. At average VAT rates of 20% throughout the EU this is obviously a substantial hindrance for free trade and has proven to be a real deal breaker. In the past, as electricity and gas markets were a rather local affair, limited to trade within each country's borders, accordingly with national and fairly straight forward VAT rules, the VAT treatment of electricity and gas has not given rise to serious problems. All supplies were, in principle, subject to VAT and such charged VAT was normally recovered by business customers in their VAT returns. However, the new markets have brought new international VAT problems, such as the question of the taxation of cross border deliveries in energy products and the taxation of transmission and import costs which have never been considered before. This article describes in brief the basic and most eminent VAT problems which arise in international electricity and gas trade and addresses the very recent proposed solution by the EU commission in this field.
Problems in determination of place of supply for VAT
The most eminent problem for VAT taxation is that under Article 5(2) of the Sixth VAT Directive of 17 May 1977 (77/388/EEC)1 electric current, gas, heat, refrigeration and the like are considered tangible property. In this respect it is recognised that the place of supply rules for cross border transactions in tangible property are not sufficient when it comes to electricity and gas transactions. The nature of electricity and gas makes it particularly difficult to determine the place of supply for VAT. Where VAT taxation in principle follows the physical flows, which do not coincide with the contractual relationship between the seller and the buyer, this results in obvious problems because invoice flows will never reflect the actual physical flows. This often leads to double taxation in two or even multiple countries. In dealing with cross border transactions, EU countries have not always showed a consistent interpretation of the Sixth VAT Directive. For example, according to the German tax authorities, electricity can only be delivered in the country where it is metered. As a result, a foreign trader is, according to the German tax authorities, usually supposed to carry out domestic deliveries in Germany subject to German VAT for transactions usually treated as zero-rated intra-community deliveries of goods by other EU countries. It is therefore currently very difficult to get a clear understanding of the application of the rules for the place of supply for VAT because of the differences in civil law of the EU countries and differences in local interpretation by the tax authorities of the EU countries. Also there seems to be a lot of confusion between traders themselves on the subject of VAT taxation at certain delivery points.
There is a myth around the trading floors of many companies that there are delivery points that are exactly on the border between two countries 'at border' in no-man's-land and therefore are in neither jurisdiction and hence free from taxes such as VAT. This is clearly a misinterpretation as the EU VAT rules do only foresee in certain designated tax free areas such as VAT warehousing and Customs warehousing where specific licenses have been obtained for these areas, usually by the warehouse keeper. Such special regimes in principle do not apply to 'at border' points or no-man's-land. (For VAT purposes, transactions within EU territory are in principle subject to VAT: no-man's-land does not exist for VAT). Consequently, at the end of the day a point of taxation has to be determined for VAT purposes in a specific EU country and where multiple interpretations are possible this is obviously not a good thing.
Commission proposal for VAT simplification
The proposal of the European Commission of December 5th 2002 on the place of VAT taxation for transactions in natural gas and electricity2 aims to bring a halt to double taxation and actual VAT costs and may provide for a substantial reduction in the administrative burden for energy businesses. Therefore, this proposal is perhaps a step in the right direction for a simplification of VAT rules which should neutralise the possibility of imposing a tax barrier by the local tax authorities in EU countries. However, the big question is whether the proposal will ever see the light of day and if so when?
Here we summarise the proposal and newly suggested rules and comment on their relevance in practice and problems which may still arise.
The Commission has concluded that applying the provisions of the current VAT system, in particular the exemption for intra-EU supplies and the taxation of intra-EU acquisitions to supplies of gas and electricity, currently gives rise to unnecessary problems. The Commission proposes to amend the rules on the place of taxation in order to facilitate the functioning of the internal market for energy. These new rules take into account the specific nature of the goods involved since, as discussed above, this is the main reason why the current arrangements for the taxation of supplies between traders established in different EU countries cannot be applied properly. One basic principle for the VAT treatment of goods - i.e.. that they are taxed where they are physically located - is abandoned for these supplies. Derogation from this principle is justified by the simple fact that it is in most cases impossible to establish a link between the transaction and the physical flow of goods. It should be borne in mind that the proposed solution is in the proposal stage where it is presented to the Council. Before this proposal may be accepted and thereby allow changes to be made to the Sixth VAT Directive and applied in practice, some time may pass. An exact time frame cannot be estimated. Hence, until the proposal comes into force in due time the proposed changes as described cannot currently be applied in practice. The proposed solution is summarised below.
Summary of proposal
The proposed solution will eventually result in an effective place of VAT taxation at the place of consumption. This is achieved via introduction of new place of supply rules with a main distinction in:
1. VAT Rules Trading Stage
Supplies of gas and electricity for resale purposes (all chains before final use) will be subject to VAT in the EU country of the buyer. This will be implemented through addition of a new article 8(1)d of the Sixth VAT Directive.
To simplify VAT taxation, this taxation principle will be combined with a reverse charge mechanism whereby the liability to report VAT is shifted to the customer (with immediate VAT deduction so that no cash flow loss occurs) if the supplier and the buyer are not established in the same territory. This is implemented through addition of a new article 21(1)f Sixth VAT Directive.
2. VAT Rules at Final Stage of Use & Enjoyment
Supplies of gas and electricity at the final stage, mainly from distributor to final consumers, will be taxed with VAT at the place where the actual consumption takes place (this will in practice mean that VAT is due in the EU country where the electricity or gas is metered at the buyers premises where use occurs). This will be implemented through addition of a new article 8(1)e Sixth VAT Directive.
3. Exemption for Import from Non-EU
In order to avoid double taxation an exemption for import of electricity and gas from non-EU countries is introduced by addition of a new article 14(1)k Sixth VAT Directive.
4. Place of Supply of Directly Related Services (Transmission and Access)
The place of supply of services directly related to the supply of gas and electricity is changed so that the provision of access to and the provision of transport or transmission by electricity grid and gas pipeline is subject to VAT where the customer (except non-entrepreneurs in the EU) resides in accordance with Article 9(2)e Sixth VAT Directive.
Remarks
Overall the result could yield a substantial VAT simplification where it concerns intra EU transactions in gas, electricity and the provision of directly related services. On the one hand it takes away the uncertainties and any discussion with respect to metering and delivery points. In general, the place where a business customer is established seems to be an unambiguous criterion and therefore should in principle not give rise to multiple interpretations. On the other hand, in my view the proposal has also been quite successful in steering well away from the problematic match of invoice flows with actual physical flows. In VAT technical terms, the proposed solution seems to be rather straight forward and therefore in comparison to other previous proposals it should be easy to understand and leaves little room for further discussion. It should however be borne in mind that this principle for supplies of goods, which is a VAT treatment common for supplies of services, is a revolutionary breach
of the ground rule for VAT taxation of goods which is at the place of physical location. Therefore, one may question whether such an ambitious and daring proposal would have a realistic chance of being accepted by the Council and implemented into the Sixth VAT Directive.
There are also some minor critical remarks to be made and some fine tuning may prove necessary. The proposed changes will mostly benefit international traders and businesses who have an international network and frequently deal with cross border supplies and chain transactions. Hence, businesses who mostly supply to customers within the same EU country seem at a relative disadvantage because of the cash flow disadvantage which arises naturally from an actual levy of VAT compared to the application of the reverse charge.
Take the example of a supply within The Netherlands to a Dutch business customer by an exclusively local Dutch supplier compared to an international trader. The local Dutch supplier does not have a foreign non-Dutch establishment and should supply the Dutch customer with 19% Dutch VAT. Depending on payment conditions, such charged VAT usually leads to a small cash flow disadvantage for the buyer if he has paid the charged VAT amount to the supplier before he has been able to reclaim this VAT in his own VAT return. The cash flow loss occurs at the side of the seller, if he has remitted the charged VAT towards the tax authorities within the appropriate time period mentioned by law and the buyer has not paid its invoice including VAT to the supplier. The international trader has the possibility of using, for example, its German branch or making a triangular supply via another non-Dutch subsidiary. By doing so, the supply by the non-Dutch establishment to the Dutch business customer would
not require an actual levy of VAT and payment of VAT towards the tax authorities. The Dutch customer simply reports and deducts the VAT in accordance with the reverse charge mechanism in its own VAT return. The question is whether this slight benefit for international suppliers is a serious issue. In the provision of international services, this principle has existed for many years and has not lead to significant distortions. Also, it should be noted that actual VAT planning may not be worthwhile considering other tax consequences like Corporate Income Tax and Transfer pricing issues. Therefore, in my view this slight issue would not lead to heavy distortions and does not seem problematic.
A more serious remark is in respect of the qualification of "use for resale purposes." In practice, businesses may not be able to earmark their purchases in accordance with a specific use. Even more so, how should the supplier establish the exact use of its buyer for "resale purposes" compared to the final stage of use. Take the example of a non-established trader who supplies gas to the trading division of a local generator. Should the foreign supplier assume that the gas is always used for firing the generator and should VAT taxation take place at the place of actual use? Or is the foreign trader able to invoice without VAT if the trading division of the generator confirms that they will onward sell the gas. This distinction probably means the difference for the foreign supplier of an extra VAT registration and filing of additional VAT returns in cases where an extensive reverse charge provision (like in The Netherlands and Belgium) for supplies by foreign to
local businesses does not
exist (as is the case in Germany). A solution should be found for this issue. Perhaps in the form of a declaration by the buyer in which they confirm their intended use. However, this leaves quite some room for interpretation and misuse. In my view, this problem could have been solved by replacing "use for resale purposes" in the Commission's proposals by "use for VAT taxable purposes." By doing so, the optimal and desired result - VAT taxation at final use by private consumers who are not entitled to recover VAT - is achieved without problems of having to qualify resale use. As a means of establishing use for VAT taxable transactions the VAT number of the customer is usually sufficient.
As a last remark, although the VAT treatment of transport and the right of use of cables and pipelines has been clarified, it is in my view regrettable that no provision has been made for other directly related services like for example auction services. It may still be necessary to clarify which services actually qualify as transport and the right of use of cables and pipelines, otherwise there would still be room for discussion. For example, are reservations for import capacity for electricity in itself and the associated administrative charges to be considered as transport services or services consisting in granting the right of use of cables and pipelines? In my view, it would have been preferred if other directly related services in connection with granting the right of use to pipelines and cables or transport would have been added to Article 9(2)e Sixth VAT Directive.
Conclusion
Overall, the result could yield a substantial VAT simplification where it concerns intra EU transactions in gas, electricity and the provision of directly related services. This is therefore obviously a good step in the direction to facilitate the functioning of the Single Market for energy and supports the liberalisation of the electricity market at EU level in accordance with Directive 96/92/EC. Some small remarks can be made, but in my view the framework does provide a clear and simpler VAT treatment which could support the liberalisation of the energy market to a large degree. In any case, it takes away a number of possible barriers which local tax authorities could impose in the field of VAT taxation. We should reiterate here that the proposed solution would constitute a revolutionary breach of the ground rule for VAT taxation of goods which is traditionally connected to the place of physical location. Therefore, we could question whether such an ambitious and daring proposal has a realistic chance of being accepted by the Council and implemented into the Sixth VAT Directive. The big question therefore, is if and when the proposal will be implemented and whether it can be used in practice. For the time being it will be very important for businesses in international electricity and gas trade to be aware and oversee the various VAT consequences which their (anticipated) transactions may have and avoid an actual VAT cost. At VAT rates of 20% throughout the EU in average such costs could far outweigh any trading margin and will remain an important potential barrier for trade if such costs materialise.
Rogier Vanhorick Senior Manager & VAT specialist VAT group/Energy Chemicals & Utilities group Ernst & Young Rotterdam Marten Meesweg 51 3068 AV Rotterdam Postbus 2295 3000 CG T: + 31 10 4068887 E: rogier.vanhorick@ey.nl
