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What Does a US Tax Professional Need to Know about VAT

COST Canadian Tax Workshop for U.S. CompaniesOctober 2nd, 2014

James Freed - KPMG LLP – ChicagoKarl Frieden - Council On State Taxation, Washington DC

Agenda

Overview of Global VAT VAT Compared to Retail Sales Tax VAT Terminology and Rates – a Recap Global VAT Risk and Management Will the U.S. Continue to be “Tax Exceptional”?

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Overview of Global VAT

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Growing Importance of VAT

VAT is a concern for companies doing business globally Many governments are shifting the emphasis from taxing

earnings and gains to taxing consumption Many governments use VAT as first tool in fiscal policy

− Reduce to stimulate consumption− Increase to reduce deficits

Almost 160 countries have a VAT regime− U.S. is only OECD country without VAT− In Canada, regime is known as GST/HST− Other countries considering VAT include many in the Middle

East EU average VAT rate is above 21.5% (and rising) Trend is towards increasing rates and anti-avoidance

measures to defend yields and reduce the “tax gap”

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VAT Enactments Timeline

1969 1974 1979 1984 1989 1994 1999 2004 20092014+

11 21 24 34 47 92 123 137 152>160

Countries Countries Countries Countries Countries Countries Countries Countries Countries Countries

Source: OECD, Consumption Tax Trends 2012; WNT Research

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Shift to Indirect Taxation

OECD Tax Revenue by Sector as Percentage of Total

Source: OECD, Revenue Statistics1965 1970 1975 1980 1985 1990 1995 2000 2005 2011

0

5

10

15

20

25

30

35

Personal income tax

Corporate income tax

Social security contributions

Property taxes

VAT

Sales tax

Other consumption taxes

Evolution Average Standard VAT Rates in the EU

Source: European Commission, VAT Rates in the EU, July 2014

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 201418.0%

18.5%

19.0%

19.5%

20.0%

20.5%

21.0%

21.5%

22.0%

Evolution average standard VAT rate in the EU

VAT Compared to Retail Sales Tax

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VAT vs. Sales and Use Tax

VAT is imposed at the national government level whereas Sales and Use taxes are generally imposed at the sub-national level − Any U.S. consideration of VAT would necessarily involve issues of

coordination with state and local sales taxes− Canada and India (proposed) are examples of multi-level VATs in a

federal system− India (current) and Brazil deal with multiple levels largely by dividing

(as opposed to sharing) tax bases

VAT rates are typically high in comparison to Sales and Use tax rates− Standard VAT rates between 15%-27% vs. average Sales and Use

tax rates of around 7.5%− VAT does have reduced rates, super reduced rates for certain

categories of products/services and zero rates

VAT vs. Sales and Use Tax (cont.)

VAT generally applies to inter-company relationships whereas Sales and Use tax frequently exempts inter- company transactions (as sale for resale or exempt transactions)

− VAT grouping in certain countries allows disregarding inter- company transactions for VAT

VAT typically applies to a much broader tax base of goods and services whereas Sales & Use tax generally only applies to goods and a limited number of services − When properly designed with full input tax recapture through

credits, VAT allows taxation of all transactions without burdening business inputs

− Burden of tax falls on final consumption− Avoids “errors” of current sales taxes and the impact on business

inputs that have “doomed” efforts to extend sales tax to service transactions

VAT vs. Sales and Use Tax (cont’d)

VAT refers to “place of supply rules” to determine where VAT is due, whereas Sales and Use tax generally refers to “nexus” for jurisdictional rules. − Collection obligation under VAT generally determined by turnover

or receipts from within a jurisdiction.− There is no “physical presence” limitation placed on the collection

of VAT compared with the “Quill” restrictions on sales and use taxes

VAT is a multi stage consumption tax whereas Sales and Use tax is typically only levied at point of final consumption− Companies have to manage both output tax and input tax

Collect and remit output tax Claim refund of input tax (if allowed)

− VAT under “management” is on average 30 to 35 percent of a company’s non-US revenues. For example, a company with $10 billion in non US sales will have approximately $3 billion of

VAT under management.

VAT Terminology and Rates – a Recap

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VAT Terminology

Note the focus on movement on goods/services, rather than movement of money

• VAT charged by businesses on sales made to their customers• “Output” meant to reflect outgoing sales

Output Tax

• VAT spent by businesses on qualifying business expenditures• “Input” meant to reflect incoming purchasing

Input Tax

• VAT terminology for a “sale”• Goods: tangibles; Services: intangibles

Supply

• Payment received in return for the supply of goods or provision of services• According to the EU, “everything received in return for the supply of goods

and services, …”Consideration

• Situation in which seller of services (usually foreign) is not liable for VAT, and instead buyer is required to account for VAT; commonly applied on intra-EU transactions

Reverse

Charge

Mechanism

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VAT Rates

• EU VAT rates range from 15% to 27%. Average EU VAT rate is above 21.5%—somewhat less in ASPAC and LATAMStandard

• Any rate lower than the standard rate• E.g., basic food stuff, books—usually political decisionReduced

• No VAT is charged, but seller has a right to credit input tax• E.g., exported goods and services• Aka “Exempt with credit”

Zero-rated

• No VAT is charged, but the seller has NO right to credit input tax• E.g., certain financial, medical and education services• Aka “Exempt without credit”

Exempt

• Not within the scope of VAT in the jurisdiction concerned• E.g., charities and non-business

Outside Scope

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Global VAT Risk and Management

Impact of Effective VAT Risk Management

VAT is a transaction tax – must be considered for every purchase (input VAT) and every sale (output VAT), and even some movements of own goods between some countries and states− The total amount of output and input VAT managed by a

company represents the “VAT through-put” Not simply an “in and out” tax, as not all VAT may be

recoverable

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VAT Throughput

Example (fully taxable business)

In millions, USD:

Sales $5,000

Purchases (3,000)

Salaries (1,000)

Transfer price adjustments (500)

Net Income 500

Income Tax (30%) 150

Total Output VAT (rate 20%) 1,000

Total Input VAT (rate 20%) 600

Total VAT flow through the business 1,600(*)

(*) Total VAT represents 28 percent of company gross sales (including price adjustments)

Global Challenges

VAT credits vs. refunds

Cashflow VAT

system

Import restrictions

Multiple indirect taxes

and jurisdictions

Difficulties with VAT refunds

Importer of record must be owner to recover VAT

Proposed reform

Current reform

Proposed introduction

Import valuation

issues

Various rate changes

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Reform in 2015

EU – Sourcing changes for 2015

What Happens if You Get it Wrong?

Underpaid VAT liability

Budget plans inadequate to cover unexpected VAT costs

Financial losses e.g., the VAT becomes a real cost if irrecoverable or never paid out by the tax authorities

Penalties and interest imposed by authorities can be up to 200% of the tax due, if not mitigated

Closer future scrutiny of processes by the tax authorities

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What Happens if You Get it Wrong? (Cont’d)

The impact of material VAT liabilities on financial statements

Damage to business relationships− Customers being assessed for incorrectly charged VAT

recovered on purchases− Raising VAT-only invoices in attempt to mitigate own

liability Cost of correction

− System updates/implementations− Evaluation of errors and reporting outputs

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Will the U.S. Continue to be “Tax

Exceptional”?

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Taxes as a Percent of GDP – 2012

Source: OECD Tax Revenue Statistics, January 17, 2014

Mexico*

Chile

United States

Australia*

Korea

Turkey

Switzerland

Ireland

Slovak Republic

Japan*

Canada

Poland

Estonia

Portugal*

New Zealand

Spain

Greece

OECD*

Czech Republic

United Kingdom

Iceland

Germany

Luxembourg

Netherlands*

Hungary

Norway

Austria

Finland

Sweden

Italy

Belgium

France

Denmark

0 10 20 30 40 50 60

The U.S. has a low tax burden (combined fed-eral, state and local) relative to Gross Do-mestic Product.

*= 2011 Data

Tax Revenue Distribution – 2012 Taxes by Type as Percent of Total Taxes

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Income Social Security Property Consumption

Source: OECD Tax Revenue Statistics, January 17, 2014

The U.S. relies relatively more on income taxes and significantly less on consumption taxes than other OECD countries

Long-Term Budget Outlook is Still a Concern

2013 2023 20380%

5%

10%

15%

20%

25%

30%

Components of Federal FinancesAs Percent of GDP

Interest

Health

Soc. Security

Other

20.8% 21.8%

26.2%

-- Revenues

19.7%

18.5%17%

Calculations based on Congressional Budget Office, The 2013 Long-Term Budget Outlook, revised October 2013

Contact Information

Karl Frieden

Vice President and General Counsel

Council On State Taxation

202.484.5215

kfrieden@cost.org

James Freed

Senior Manager

KPMG LLP

312.665.2627

jfreed@kpmg.com

Thank You

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