VAT Modernization and Competition in the Cross-border Mail Market

Paul SCHOORL – CRNI Conference, 19 November Brussels** DRAFT ** VAT Modernization and Competition in the Cross-Border Mail Market 1This paper describes the effects from the modernization of VAT obligations in the crossbordermail market. It provides an overview of recent postal VAT jurisprudence, changes tothe common system of value added tax in the Community and the effects of thesedevelopments in terms of the cross-border mail market. Cross-border postal servicescurrently provided by universal services providers are exempt from VAT both at the level ofintra-Community mail services as well as within the framework of the Universal PostalUnion (UPU).The timeliness of this paper is evidenced in the recurring discussions on the application ofVAT in the postal market and the interest of the European Commission to consider theextension of the new VAT Directive and recent European Court of Justice (ECJ)jurisprudence to the cross-border postal market. This resulted so far in an Opinion from theCommission as expressed in the Working Paper 658. 2 This working paper concerns theapplication of the exemption for “public postal services” on cross-border universal servicesas discussed by the VAT Committee. In its opinion the Commission proposes a clarificationto the application of the VAT exemption on cross-border postal services. The report raises thefollowing concerns as regards the expressed viewpoints:∗ The Commission’s Opinion favouring unequal VAT treatment between designatedoperators (DOs) and between DOs and private operators distorts competition in thecross-border postal market and contravenes the intent of Article 13 of the PostalDirective to apply a non-discriminatory remuneration treatment;∗ There are huge differences in understanding and implementation of the VATexemption in domestic postal services and within the cross-border market;1 The expressed views are the author's own and do not necessarily represent his organizational affiliation. Furthermore, theviewpoints in this paper concern the cross-border postal service alone as this market segment is significantly different from thedomestic market. This distinction includes the absence of end-to-end competition, the usage of access agreements,International treaty (such as from the UPU) or Community (provisions under Postal Directive) obligations, the higher operationalcosts of international mail services and the disproportionately stronger effects from VAT application on re-routing or remailing,the remuneration of universal service providers and the sustainability of the cross-border postal market.2 Under reference taxud.d.1(2010)13765, published on 9 March 20101

∗ Considering the strong differences in the implementation of the universal serviceobligation, the opinion of the Commission implies a reversal in the Communityefforts to accomplish a harmonised application of the postal VAT rules. This woulddrastically implicate the bulk mail segment and other segments that face differentuniversal service treatment in the national markets;∗ The decision, when implemented, could damage cross-border markets and lead toincentives for de-location of mail services outside the EU. De-location and re-routingof mail incentives would also damage the quality of the mail service not only becauseof longer travel times, but also because transit times in EU regulations do not applyfor non-EU originating mail;∗ Introducing VAT on inbound cross-border postal services is out of line withinternational treaty obligations including the principles laid down in the Constitutionof the Universal Postal Union and the Universal Postal Convention of 2008;∗ The Commission working paper does not address the main practical considerations(audit, feasibility, invoicing, etc.) and complications that need to be addressed bypostal operators leading to high transaction costs;∗ The suggested VAT structure for the cross-border postal services would impede thedevelopment of e-commerce and cross-border trade, would damage the universalservice provision and the cross-border postal market at large.This paper will discuss and explain each of these challenges whilst putting it in theframework of the remuneration practices in the cross-border market and the recent Courtjurisprudence. It will discuss the amendments to the VAT Directive and the impact of thenew place of supply rules on cross-border VAT treatment. This will be discussed in thecontext of the strongly diverging implementation of the universal service obligation (USO) inthe EU member states and the effects of fiscal neutrality. The suggested implementation ofthe new place of supply rules, in relation with the diversity in universal service definitions,not only creates further problems for transparency in the market, it also infracts with theCommunity commitments towards harmonised application of VAT rules, so strongly soughtafter by the Commission itself.To respond to this call for more certainty and transparency in the cross-border market, theCommission should consider defining the delivery of inbound cross-border postal services as2

a de facto universal service obligation, bypassing all the serious implications as discussed inthis paper. 31. THE CROSS BORDER MAIL MARKETCross-border mail has, on average a market share of about 4‐5% of total mail in Europe. 4Only in a few countries, such as Ireland or Luxembourg, the market share for cross-bordermail is significantly higher because of the size of these countries, their respective populationand their economic make-up involving a relatively stronger presence of internationalbusinesses. The total cross-border mail market (outbound) was estimated at €7 billion in 2009globally, or at $5.5 billion in Western Europe. 5Exhibit 1 – Cross-border mail marketIt is vitally important to consider the nature and the development of the cross-border postalmarket as it is distinct from other postal market segments. The cross-border market is acompetitive and de facto deregulated market segment with no cross-border end-to-endcompetition as network access involves at least two operators between collection anddelivery. 6 At the same time the cross-border mail market is highly concentrated with higher3 Article 3 of Directive 97/67/EC: the universal service as defined in this Article shall cover both national and cross-borderservices4 Cross-border or international mail defined as letters of correspondence, printed matter, direct mail, small packets.5 Adrenale (2010) and DHL (2010) http://www.dp-dhl.com/en/media_relations/media_library/graphics/crossborder_mail_market.print.html6 One exception could be ETOEs. If an ETOE in country B operated by a certain Post being the USP of country A gathers andforward mail for delivery in country A then a single operator is involved.3

market penetration by participants other than the designated national postal operators (DOs)compared to domestic markets. 7Furthermore, the cross-border market is highly concentrated market with a 19 percent of mailflow representing 80 percent of cross-border volumes (see ex. 1). This also means that themajority of the mail flows between DOs would be disproportionately damaged by costincreases resulting from VAT.1.1 Challenges in the Cross-border Mail MarketAs much as it is a fact in most of the domestic postal markets, the cross-border market ischallenged by competition from other communication platforms today. The relative marketshare vis-à-vis these platforms will continue to shrink, because of growing convergence ofonline and mobile technologies and the related decline of physical or paper-basedcommunication. This process is understood as electronic diversion or e-substitution. To acertain extent these challenges have been absorbed by tremendous operational improvementsand progression towards the current quality standards. At the cross-border level theseimprovements were supported by incentive-based remuneration schemes.Despite all these efforts, postal operators are facing major financial, operational and humancapital challenges that call on them to transform their businesses if they are to remain viablein the long-term. Resolving regulatory uncertainty and the need to address customer needsare pivotal to ensure that postal operators remain at the forefront of efficiencies for theircustomers. These challenges extend to the field of terminal dues remuneration schemes (orintercompany pricing), as these agreements take aim at market uncertainties and set standardsfor the cross-border postal service.Competition in the declining cross-border mail market is strong and growing, puttingadditional pressure on DOs to commit to their mandatory service requirements. Research bythe UPU shows that competition in the cross-border letter market has grown fromapproximately 12 percent in 2003 to reach nearly 23 percent in 2008. 8 It is in particular the7 Adrenale (2010), Market Research on International Letters, and Lightweight Parcels and Express Mail Service Items8 Consolidated data from industrialized countries as presented in extracts in Adrenale (2010), Market Research on InternationalLetters, and Lightweight Parcels and Express Mail Service Items4

apid growth of specialized services, such as cross-border expedited or deferred shipments,that are primarily going to foreign operators in this market segment. Drop-shipping andhybrid solutions such as destination printing increase the pressure on the traditional postalsystem. This process is accelerated by leading-edge electronic solutions which allow mailersto bypass the cross-border value chain up to the point of the sorting center or delivery officein the country of destination. According to a study by Adrenale (2010), as a result of thesedevelopments, the 7 percent annual growth in volume handled by competing operators hasbarely compensated for the continuous decline in volume handled by the designatedoperators. Given the complications in the cross-border mail market, it is essential that pricingand regulations (including the universal service obligation) are not putting further stress onthe cross-border postal service.1.2 Terminal DuesWithin this highly competitive market, designated operators have established cooperationmechanisms for network access on either a multilateral (REIMS) or a bilateral basis,bypassing the UPU remuneration system. In the UPU system, in order to facilitate networkaccess, the parties deliver mail supplied by another party at a fixed percentage of thedomestic rate for a 20 grams priority letter. This percentage is indicative since the UPUTerminal Dues rates are surrounded by caps and floors. REIMS is a commercial or voluntaryagreement which provides a system for terminal dues based on cost and service quality forpostal operators. The REIMS agreement pursues quality of service standards that are moreambitious than the targets under the EU Postal Directive. 9 The current REIMS agreement setsindividualized penalties for posts that do not reach the next day delivery target (afterreception at the inbound Office of Exchange). These penalties ensure that all efforts are madeto maintain a high quality of service. Today two-thirds of total European mail volumes arenot settled under REIMS agreement but through bilateral agreements between DOs oraccording to UPU standards. 10Community legislation provides for a minimum mandatory universal service to be providedthroughout the Community to all citizens, wherever they are located at affordable prices.Additionally it sets standards for national postal services and for intra-Community cross-9 REIMS is the only agreement in line with EU Directive, requiring rates to be linked to QoS and real cost of handling the mail10 Subject to changes, parties joining/ leaving REIMS, bilateral agreements, etc. Estimation from October 2010.5

order services and regulates pricing requirements. However rate systems such as terminaldues are primarily the responsibility of the postal operators, who must act in compliance withcompetition rules and other legislation, such as the Council Resolution of 1994. The 1994Resolution sets the fundamental principles on which the terminal dues system should bebased: “introducing a terminal dues system based on real costs and quality, taking intoaccount national characteristics while granting the universal service providers satisfactoryprotection against deflections of trade based on abuse of that system and making provisionfor appropriate transitional arrangements.” 11The REIMS system addressed those fundamental principles by addressing the four pillars:1. Cost-relation – Domestic tariffs as a proxy for costs2. Quality of service incentives – Ambitious targets and bonus/ malus system withpenalties3. Transitional period – Growth model for CEE postal operators (REIMSEAST)4. Protection against remailing – TDs reduce arbitrage-based ABA remail / UPU2008 ConventionBefore the end of the twentieth century, pricing loopholes and rate de-averaging provided forbypass opportunities, including hybrid drop-shipping and re-mailing. Since then, terminaldues systems (including REIMS, UPU or bilateral agreements) have moved to better costrecovery mechanisms and the introduction of quality of service features.1.3 Quality of Service in the Cross-border MarketThe EU Postal Directive (97/67/EC) set the performance objectives for all mail items at 85percent to be delivered in three days (J+3) and 97 percent within five days (J+5). The IPCUNEX system carries out quality of service tests continuously throughout the year coveringboth urban and rural areas. The measurement is end-to-end, from posting to delivery to thefinal recipient, including the time for collection, sorting, exchange and transportation.Exhibit 2 – UNEX Diagnostic Monitoring System and REIMS11 Council Resolution of 7 February 1994 on the development of Community postal services6

Provider (USP) so that the services provision between market entrant and incumbent are notcomparable. 15Under the VAT Directive (Article 132), certain activities which are in the public interest areVAT exempt. That provision does not, however, provide exemption from VAT for everyactivity performed in the public interest, but only for those which are listed and described ingreater detail. As far as these exemptions go, the Directive explicitly mentions the “publicbody” nature of the supplier. For example, the current EU VAT-exemption does not coverservices within the universal service scope provided by private operators who are notrequired to provide the universal service. Among other public services, the European VATlegislation grants an exemption to public postal services from VAT charges in all MemberStates of the EU. The 2003 Commission proposals 16 to abolish VAT exemptions wererejected by the Council and since then no significant progress was made “as Member Statesstrongly object to VAT on these supplies.” 17 In December 2009, the Council invited theBelgian Council Presidency to reconsider the existing tax arrangements in the Member Statesand to report on progress before the final Ecofin Council in December 2010. 18The application of European VAT legislation across Member States is significantlyinfluenced by the interpretations of the European Court of Justice (ECJ), whose interpretationof the provisions of the VAT Directive directly affects Member States’ application of VATrules. This is clearly seen in the case United Kingdom vs. TNT Post UK Limited (TNT Post)where the court ruling led to a new interpretation of the concept public postal services (see2.3).2.2 VAT and Fiscal NeutralityThe European Commission proposed to remove the VAT exemption for public postalservices before, in 2000 and 2003. Under both proposals the Commission made reference tothe principle of fiscal neutrality.15 The terms public postal service and universal service as well as public postal operator (PPO) and universal service provider(USP) are used confusingly in the trade, but have the same meaning in the scope of this paper.16 COM(2003) 234 final, 5 May 200317 Except the ECJ case ruling United Kingdom vs. TNT. VAT on Postal Services, Library House of Commons, Standard NoteSN/BT/337618 Press Release Ecofin Council, 16838/09, 2 December 2009http://register.consilium.europa.eu/pdf/en/09/st16/st16838.en09.pdf9

2.2.1 Fiscal NeutralityEffectively, the competition distortive effect comes in at the point where only one provider isgranted the tax exemption and the other provider is not. The principle of fiscal neutralityincludes the requirement to eliminate the differing treatment for VAT purposes for same-kindservices. However, sometimes, the services provided by two different operators can looksimilar at first, but the similarity can be ambiguous nonetheless. Where some tend to give thefiscal neutrality argument the upper hand, stating that the exemption of public postal servicesis creating distortions in a situation where these services are increasingly exposed to marketcompetition, there is also an important argument to make about the vital social role of postalservices as stipulated in the universal postal service provision of which each member statehas a statutory requirement to provide.The meaning of fiscal neutrality is opaque and viewed in relation to different phenomena. Forexample, internal neutrality is usually distinguished from external neutrality. Levying the taxin a general manner, covering all goods as well as the supply of services and the full right todeduction of input tax through the supply chain, with the exception of the end consumer,ensures internal neutrality. External neutrality provides for equal tax treatment regardinginternational trade. The VAT case at the European Court of Justice treated the principle ofinternal neutrality, whilst the external neutrality of VAT treatment is another and lessprominent matter from the viewpoint of predominantly national postal markets. 19The principle of neutrality precludes treating similar, and therefore competing, suppliesdifferently for VAT purposes. Consequently, exemptions, tax rates and special schemesshould be applied equally within a member state. The principle of fiscal neutrality wassupported in a number of ECJ cases (e.g. C-169/04 of Abbey National, concerning the scopeof the VAT exemption for management services of special investment funds). Concurrently,the universal service obligation requires the USP to provide ubiquitous service at a uniformprice and at a reasonably uniform standard of quality. These requirements do not apply tocompeting postal operators. The consideration that the removal of the exemption rule couldimpact the consumer in terms of affordable postal services and the universal commitmentmust also be given equal priority in the debate. Experiences from the past have shown that19 IPC Strategic Perspectives on VAT, October 200910

the removal of the VAT exemption could lead to price hikes. This was seen at Swedish Postwhen the removal of the exemption necessitated price regulations to provide a loophole in therate setting rules of the following years. Naturally, the rate increases exceeded the consumerprice index due to the 25 percent VAT rate. 202.2.2 Community VAT and External NeutralityInternal neutrality refers to charging similar conditions (such a general VAT rates, but alsoservice requirements) covering all products and services provided by operators in thedomestic market. External neutrality provides for equal tax treatment regarding internationaltrade. Considering the widely diverging VAT rates across the European Union, we canconclude that the introduction of VAT against strongly different rates would impede theachievement of a system based on the principles of external fiscal neutrality. Consequently,exemptions, tax rates and special schemes have to be applied equally between MemberStates. At this point consider the variety of standard VAT/ GST rates in the respective postalmarkets under exhibit 3.Exhibit 3: VAT Non-Reserved Universal Services (update 1 July 2010)30%VAT rate equal USP - CompetitorOnly USP is exempt from VAT25%20%15%10%5%0%NO FI ES NZ AU CH CA US CY LU GE NL SK FR UK* CZ AT IT PT BE IE PO HE IC DK HU SE*VAT Rate USPStandard Rate* Sweden to introduce VAT exemption universal service in 2011; UK rate increase per 4th January 201120 The increase of prices that took place between 1993 and 1995 was due to the Swedish introduction of VAT on postalservices at an initially reduced rate of 12%. At the time of Sweden’s entry into the EC, the full rate of 25% was applied.References: Post & Telestyrelsen (PTS), The Liberalised Swedish Postal Market, March 2007 and Ecorys, Annex II: MainDevelopments in the Postal Sector (2006-2008)11

2.3 United Kingdom vs. TNT UK – ECJ Court RulingThe ECJ used the preliminary ruling procedure to resolve questions from national courtsconcerning the interpretation of the VAT Directive and the exemptions as they extend topublic postal services. 21 Postal service providers in the United Kingdom operate underlicences granted by the Postcomm, the national regulating authority. Under its licence, RoyalMail is designated as the sole universal postal service provider and has therefore specificobligations imposed on it.In 2007 TNT Post UK filed a suit against Her Majesty’s Revenue and Customs (HMRC),charging that not only Royal Mail’s services should be VAT exempt now that it competes forbusiness against private carriers such as TNT. The case brought by TNT, asked a series ofquestions on the meaning of ‘public postal services’ in the context of a liberalized regimewhere a designated universal service provider competes with private operators. Following theapplicant’s view, a ‘public postal service’ no longer exists in the fully liberalized market ofthe United Kingdom, so that the exemption cannot be the USP’s alone. If, on the other hand,the exemption would be applicable to the USP alone, the question arises as to which categoryof services. In June 2008, at the European Court of Justice in Luxembourg, TNT Post UKstated its case that the British VAT rules prevent a level playing field for competitors bygranting Royal Mail an exemption for all postal services they provide. 22Ultimately, the ECJ ruled that the expression ‘public postal services’ “refers to the operatorswhich supply the services and not the services themselves, regardless of the status of theprovider of those services.” In its ruling, the definition of public postal service meant theagency that performs a certain (public) service instead of the performance of duties as suchwhich could be delivered by other than the universal service performer alone. In its ownwords: “public postal services must be regarded as operators, whether public or private, whoundertake to supply postal services which meet the essential needs of the population andtherefore, in practice, to provide all or part of the universal postal service in a member state.”One of the complications from the Court ruling is that not all universal services supplied bythe USP are exempted from VAT but only those build on the definition of public interest.21 VAT exemption for public postal services as stipulated under Article 13(A)(1)(a) of the Sixth VAT Directive.22 For example in TNT Annual Report 200812

Although TNT lost its case, the Court took the opportunity to clarify the extent of the RoyalMail's exemption. It confirmed that the VAT exemption was restricted to the provision of‘public postal services', and therefore individually negotiated postal and delivery services aresubject to VAT.The exemption provided for in Article 13A(1)(a) of Sixth VAT Directive applies to thesupply by the public postal services acting as such – that is, in their capacity as an operatorwho undertakes to provide all or part of the universal postal service in a Member State […]and the supply of goods incidental thereto. It does not apply to supplies of services or ofgoods incidental thereto for which the terms have been individually negotiated. 23 Publicpostal services and individually negotiated agreements require some further clarification,which is provided below.2.3.1 Public Postal ServicesIn its ruling the ECJ held that the exemption in Article 13A(1)(a) only applied to serviceswhich were provided by a body which could be described as 'the public postal service' in theorganic sense of that expression. They based this interpretation of the wording of Article13A(1)(a) itself. Consequently the Court held that 'public postal services' must be regarded asoperators, whether they are public or private, who undertake to supply postal services whichmeet the essential needs of the population and therefore to provide all or part of the universalpostal service in a Member State, as defined in Article 3 of the Postal Directive. 24 As far ascross-border postal services are concerned, the remuneration article 13(1) of the PostalDirective makes clear that Community cross-border mail is VAT exclusive. The provisionrequires universal service providers to respect a number of principles “[i]n order to ensure thecross-border provision of the universal service.” This makes inbound cross-border postalservices de jure and de facto a universal service.2.3.2 Individually Negotiated AgreementsPostal operators enter into worksharing agreements with some bulk mailers and offer thempostage discounts in exchange for meeting specific mail presentation criteria, such as presorting,processing, and volume. Individually Negotiated Agreements, as these agreements23 Judgment of the European Court of Justice, Case C-357/07 TNT UK Ltd. vs. Her Majesty’s Revenue and Customs24 Blackwood, Anneliese (2009), R (TNT Post UK Ltd) v HMRC Case C-357/07, Monckton Chambers13

are sometimes termed, are contractual agreements with major mailers that include customizedpricing incentives. Volume discounts are common practice in all network industries and oftenthese agreements are individually negotiated and not following pre-formulated discountschemes.In contrast to individually negotiated contract agreements stand pre-formulated contractterms or other typically standardized or published terms and conditions. The existence or useof pre-formulated discount incentives, such as for high volume bulk mail products, would initself not constitute an individually negotiated term. Council Directive 93/13/EEC of 5 April1993 on unfair terms in consumer contracts defines that “a term shall always be regarded asnot individually negotiated where it has been drafted in advance and the consumer hastherefore not been able to influence the substance of the term, particularly in the context of apre-formulated standard contract.”2.3.3 VAT on Postal Services in the UKAs an effect of the ruling, the UK Budget Note of June 2010 states that “the VAT exemptionunder Group 3 of Schedule 9 to the VAT Act 1994 (VATA) will be amended to restrict thescope of the exemption to supplies of public postal services and incidental goods made by theUSP. The exemption will only apply to supplies of services made under a licence duty,including those where – pursuant to a licence duty – the USP allows private postal operatorsaccess to its postal facilities.” 25 The measures will apply a standard tax rate to certain postalservices, but not all services. 26 The continuation of VAT exemptions to a range of products inone country different than in others would mean that the challenges of external fiscalneutrality will not be resolved. The next section will discuss the effects of VAT in the contextof the cross-border mail market.3. VAT AND THE CROSS-BORDER MARKET25 Budget Note 41, 22 June 2010, HM Revenue and Customs, http://www.hmrc.gov.uk/budget2010/bn41.htm, consulted on 5October 201026 The overwhelming majority of Royal Mail’s customers will be unaffected by the Government’s proposed changes in VAT andFirst and Second Class stamped and meter (franked) mail, Standard parcels and the large majority of Royal Mail’s otherservices will continue to be exempt from VAT.http://www.royalmail.com/portal/rm/content1?catId=400147&mediaId=118600981, consulted on 29 September 201014

VAT exemption for postal services as understood under article 13 (A)(1)(a) has always beentaken to include inbound cross-border postal services. It was never suggested that crossborderpostal services were VAT inclusive. Hence, none of the universal service providershas ever paid VAT on terminal dues. This includes Member States that do apply VAT todomestic services like Sweden.However, some confusion has arisen regarding the implementation VAT Package 2010adopted in 2008 intends to modernize and simplify the existing rules relating to cross-bordersupplies of services. This section summarizes how the changes will impact on the crossborderpostal service and discusses the areas where uncertainty and complications occurwhen implementing the viewpoints as expressed in the Commission working paper. 273.1 VAT Package 2010 and Terminal DuesBefore considering the effects from introducing the VAT viewpoints of the EuropeanCommission, it is important to treat the new place of supply rules as included under theEuropean Directive 2008/8/EC of 12 February 2008 amending the previously discussedDirective 2006/112/EC as regards the place of supply of services, in particular transport andpostal services.3.1.1 New Place of Supply RulesThe amendments as included under the VAT Package 2010 change the place of supply rulesfollowing the Commission’s strategy of modernization and simplification of the operation ofthe common VAT system. These changes were necessary because of the realizations in theinternal market, globalization, deregulation and technology change together createdenormous changes in the volume and pattern of cross-border services. It was the properfunctioning of the Community’s internal market project that required amending the rules ofsupply of services. Following the general rule as stipulated in article 44 of the Directive, theplace of supply of services to taxable persons shall be the place where that person hasestablished his business and not where the transport takes place (which is considered theMember State where the supplier is based).27 Under reference taxud.d.1(2010)13765, published on 9 March 201015

Before January 2010 terminal dues were considered to take place in the country of thereceiving DO mainly because the remuneration was paid to the receiving DO and that thedelivery service was provided in the country of destination. As a consequence the VATexemption rules of the country of the receiving DO applied. In other words, the localprovision of the VAT exemption for postal services was considered. Since January 2010, thechanges following the Council Directive treat both the sending and receiving parties on aB2B basis and terminal dues are considered to take place in the country of the sending DO.Now the VAT exemption rules of the country of the sending DO apply.Applying this principle to the cross-border postal service, the service supplied by thedelivering operator in the country of destination (Member State B) to the sending operator(customer) established in Member State A, will be located in Member State A, although theservice will physically be carried out in the country of destination (B). The place of supplyfor cross-border postal services has now changed from the country where the deliveringoperator is established (supplier) to the country where the sending operator (customer) isestablished. 283.2.2 The Commission’s OpinionThe VAT Package means significant changes to the way some firms do business in theEuropean Union. The rules affect cross-border B2B services most significantly. According tothe Commission Opinion as expressed in a recent working paper, these conditions could alsoaffect the cross-border postal service. Against this background, the Commission (DGTAXUD) takes the view that after the TNT-ruling, the exemption for the “public postalservice” in Article 132(1)(a) of the VAT Directive applies to cross-border services within theEU if the following cumulative conditions are fulfilled: 29On the “outgoing side” (in the country of departure of the mail, that is Member State A)The following conditions must be met in Member State A, since the place of supply of theservice is located in the country where the customer is established (Article 44 of the VATDirective):28 As explained in Working Paper No 658, op cit.29 Next paragraphs are quoted from TAXUD Working Paper No 65816

a) The specific cross-border service falls under the definition of “universal service”, asdefined by Member State A in accordance with Article 3 of the Postal Directive;b) The sending operator, irrespective of whether it is a private or public operator, is inMember State A acting in his capacity as a universal service provider, and thus, actsunder a “special legal regime” entailing particular obligations for him.On the “incoming side” (in the country of destination of the mail, that is Member State B)c) The delivering operator (supplying the service to the sending operator), irrespective ofwhether it is a private or public operator, is in Member State B acting in his capacityas the universal service provider, and thus, acts under a “special legal regime"entailing particular obligations for him.Only the combination of all three conditions allows the cross-border service to be VATexclusive. If one of the criteria fails, the VAT exemption would not apply. For example, theinterpretation and scope of what is included within the scope of the universal services issignificantly different between Member States. Consequently, some services will not be VATexempted after crossing the border, despite the fact that the services are considered USOproducts in the destination country. The schematic presentation of the new rules issummarized in exhibit 4.Exhibit 4: Place of Supply Rules and VAT Exemption USPCountry ACountry BClearanceSortingOffice ofExchangeTransportOffice ofExchangeSortingDeliveryOfficeDeliverySenderPPO APPO BRecipientService provided by PPO A:Outbound cross-border serviceUniversal service according to national postal regulationsin country ATerminal DuesService provided by PPO B:Inbound cross-border serviceUniversal service according to national postal regulationsin country B+ Obligation to provide inbound cross-border mailThe complications between the different national USO regimes and the effects on fiscalneutrality are further explained in 3.2. It is for the range of economic and operational impacts(as discussed in 3.3) that the supply of services rule would be best served based on the17

universal service definition of the destination country (where the service is actuallyprovided), which, as such, includes inbound cross-border services (see section 4).3.1.3 Relation to International TreatiesThe Universal Postal Union (UPU) is a specialized agency within the United Nationsframework. Practically all nations are UPU members. The common rules applicable to crossborderpostal services are laid down in the UPU Convention and its regulations. The UPUConvention has the status of a treaty which the governments of each UPU member state enterinto. The Constitution stipulates the obligation of all member states to deliver inboundinternational mail. Remuneration for international postal services (terminal dues) are laiddown in the Convention of 2008 (articles 27 and further). None of the UPU membercountries charges VAT on cross-border postal services. In light of the changed place ofsupply rule and the possible redefinition of the VAT exemption in the cross-border market,different treatment of universal service products (see 3.3) and diverging standard VAT rates(see 2.2.2) would complicate fulfilling these international treaty obligations.3.2 Universal Services in the Cross-border MarketTim Walsh (2010) raises an interesting point. He argues that it remains less clear whether“services which at national level may not be formally defined as universal services but whichembody all the characteristics of universal services [e.g. five day delivery frequencies, pricecontrols, quality of service standards, etc.] would indeed constitute ‘universal services’ forthe purpose of postal VAT.” Addressing this problem in the cross-border mail segment wouldbe a more complicated affair. Additionally, the fiscal neutrality principle risks to be breachedas it concerns rather definition (or form) and not substance, creating new obstacles in thelevel-playing field between postal markets.3.2.1 Universal Service ObligationThe postal universal service obligation (USO) is the obligation placed on universal serviceproviders (USPs) to ensure that standard mail services are reasonably and equitablyaccessible to all people wherever they reside or do business. The EU view of universalservice is firmly anchored to universality of the letter service, and much lesser so to aubiquitous general postal presence. When the EU defined the scope of the universal service,18

for example, it avoided including post office networks. This is related to the principle ofsubsidiarity (Article 5 of Lisbon Treaty) which ensures that decisions are taken as closely aspossible to the citizen and that constant checks are made as to whether action at Communitylevel is justified in the light of the possibilities available at national, regional or local level.In addition to the accessibility of the postal service, provisions concerning product range,affordability and price control, delivery models and quality of service (including transittimes) have been implemented in a strongly dissimilar fashion throughout Europe. It isparticularly the product range and competitive pressures in the market that warrant someconsideration as the dissimilar implementation of these issues leads to a further complicationof today’s non-harmonised VAT rules in the internal market.3.3.2 Scope of the USOAs said above, the interpretation and scope of what is included within the scope of universalservices differs significantly between countries. For most countries, the practicalconsequence of the applicable postal legislation means that all bulk mail printed matter oftwo kilograms or less per item is considered to be part of universal services. However insome countries this is not the case. In the Netherlands, none of the mail in the highlycompetitive sector of the market, such as bulk mail printed matter and direct mail, isexempted from VAT as bulk mail services are not included under the USO definition. Everycountry retains the VAT exemption to a different set of services according to the strongvariety in USO definitions.As indicated in figure 6 below, the definition of the USO is broadly different from oneMember State to the other. The only service that all USPs have in common is the mandatoryrequirement to delivering single piece items nationwide and cross-border inbound postalitems. Requirements related to preparation, the presentation of mail and complementaryservices (provided at retail facilities for example) differ significantly between countries.Furthermore, it is important to note is that the scope of the universal service can be extendedor varied over time. In some countries, the Government has included some products in thescope of the USO that one would expect to fall outside the definition. For instance, posterestante in the UK is an unusual extension. Periodicals and newspapers are examples of othersegments that are categorized differently across Europe.19

Exhibit 5: Definition of the USOUSO definitionSingle PieceMailBulk MailParcels Non-CounterDirect MailMail PreparationComplementaryServicesOtherUSO definitionThe Dutch postal VAT exemption is retained for all single piece (non-bulk) mail services. InGermany, the scope is slightly different, covering all mail services provided by universalservice providers suited to private households. The German definition makes a clearreference to the receiving party, very contrary to Austria. The Austrian definition extends toall C2C mail posted in (street) pillar boxes or accepted over the counter.Exhibit 6: Examples USO and VAT Complications in Cross-border MarketCountry ACountry BClearanceSortingOffice ofExchangeTransportOffice ofExchangeSortingDeliveryOfficeDeliveryBulk Mail – Country of Origin: NetherlandsBulk Mail – Country of Origin: FranceDestination BelgiumDestination BelgiumNo VAT ExemptionVAT ExemptionBulk Mail – Country of Origin: BelgiumBulk Mail – Country of Origin: BelgiumDestination GermanyDestination FranceNo VAT ExemptionVAT ExemptionBulk Mail – Country of Origin: Belgium (non USP) Destination France No VAT ExemptionSingle Piece – Country of Origin: AustriaSingle Piece – Country of Origin: AustriaParcel 20kg – Country of Origin: SpainParcel 20kg – Country of Origin: ItalyDestination SwedenDestination NetherlandsDestination DenmarkDestination DenmarkNo VAT ExemptionVAT ExemptionNo VAT ExemptionVAT ExemptiondssIn the Netherlands, Spain and Luxembourg the universal postal service includes parcels up to10 kg in weight, both regular and certified. In countries such as Austria, Denmark, Italy,France and the United Kingdom, this threshold is raised to 20 kg. In France, however, onlypostal packages weighing up to 20 kg, sent singly to the public as ordinary or registered itemsand excluding postal services provided to businesses under contracts covering multiple itemsare considered universal service. 30 Meanwhile in Germany, “in practice, the tax exemptionappears to be applied only to DPAG’s [Deutsche Post] over-the-counter parcels; VAT is30 IPC Regulatory Portal – Country Pages France and Contrat Service Public 2008 – 201220

outinely charged for bulk parcels from commercial senders.” 31 Deutsche Post and TNTapply a different weight-step for applying VAT exemptions to intra-EU parcel delivery. TNTis required to charge VAT from 20 kilograms parcel services, whereas Deutsche Post chargesfrom 10 kilograms. 32The list of number of different USO product combinations can go on endlessly, meanwhileleaving serious problems for the implementation of DG TAXUD if their viewpoints were tobe accepted. The receiving operator will face the task of identifying which item falls withinthe sending countries’ scope of USO products. In many cases, the operations staff will not beable to identify in each case whether a certain mail item in their inbound stream falls underthe definition of 'universal service' in the sending country. 33 According to the PostalDirective, inbound cross-border postal services qualify as a universal service in thedestination country, in line with ECJ jurisprudence, this service should remain VAT exempt.3.3 Impact on the Cross-border MarketThe possible implementation of the proposed VAT would lead to foregone revenue and areduction in the service quality in the cross-border market. It would damage cross-border e-commerce by creating more uncertainty and higher tariffs further impeding the completion ofthe internal market. Finally it would lead to discrimination between DOs and betweencustomers and could incentivize the rerouting of mail activities. The 1994 Resolution takesanother interesting consideration which is to “ensure that the needs of users, includingconsumers, the interests of postal sector employees as well as the contribution of the postalsector to economic, cultural and social development in the Community are taken intoaccount, when regulating this sector.” 343.3.1 Impact on Quality of Service31 Quote from: WIK , The impact of abolishing the VAT exemption for postal services provided by Deutsche Post AG, November2005. However no VAT indicated on intra-EU B2X parcels < 10kg:http://www.dhl.de/en/paket/geschaeftskunden/gewerbekunden/internationaler-versand.html consulted on 13 October 2010;32 C2X market: TNT: http://www.tntpost.nl/voorthuis/pakketten/via-postkantoor/pakket-buitenland/internationaal-pakket-pluseuropa/wat-kost-het.aspx#;Deutsche Post: http://www.dhl.de/en/paket/privatkunden/international/paket.html consulted on 13October 201033 When in the sending country, certain letters do not fall under the USO, as it is the case in some countries when they havebeen inserted directly in the sorting centre. Letters posted at a post office and letters inserted in a sorting centre will look thesame, but will require in the receiving country a different VAT treatment, according to the Commission’s interpretation.34 Council Resolution of 7 February 1994 on the development of Community postal services21

If inbound cross-border mail would be made VAT inclusive, the delivering DO’s costs willincrease significantly since only a fraction of the operational costs is deductable. As pricecontrols limit the freedom for operators to set their prices, the operator’s ability to deliver theUSO will be placed under further stress. Next to that, remailing and rerouting activities couldinvolve third countries not requiring the same quality of service standards as stipulated in theEU Postal Directive.3.3.2 Impact on e-commerceCross-border e-commerce has the potential to reshape and step up the European internalmarket for consumers through encouraging businesses to sell to consumers abroad andincreasing consumer confidence in cross-border purchases. However, according to recentEuropean Commission figures, European e-commerce is still largely fragmented alongnational lines: 150 million EU citizens regularly shop only over the Internet, but only 30million Europeans (7 percent of the population) do so across borders. 35IPC research on cross-border e-commerce shows that motivations for shopping online andshopping cross-border are predominately rational (price, convenience & product). The reportstates: “the ability to compare prices in other countries empowers the consumer with asharper view on whether they are paying the ‘right’ price. This is a key driver in Denmark,where consumers take advantage of exchange rates and lower taxes in other countries.” 36Simultaneously the expectation of high prices and delivery complications are considered askey barriers for engaging in cross-border commerce: “the level of delivery charge is crucialto online sales and should not exceed a third of the product price.” 37According to 2009 research commissioned by the European Commission, e-commerce issteadily increasing on the national level, but cross-border e-commerce continues to lagbehind. In this study, payment and shipment possibilities were cited as important barriers tocross-border e-commerce. Costs of shipment were often unclear, which creates uncertaintyfor customers to know what they are being charged for. 38 Additionally, cross-border shipmentsolutions are more expensive than using domestic services. This concern was repeated by EC35 Communication on Cross-Border Business to Consumer e-Commerce in the EU, COM(2009) 557 final, 22 October 200936 IPC Cross-Border E-Commerce Report 201037 Idem38 EC 2009 – e-commerce report find title22

Commissioner Mr. Barnier in his speech at the high level conference on postal services inValencia, where he stated that the costs for cross-border shipping were disproportionatelyhigh compared to domestic shipping rates. 39 These and other barriers towards completing theinternal market for consumers will only increase as a result of the cross-border VAT reformalong which it will damage intra-Community trade and the interest of millions of onlineconsumers.3.3.3 De-location and Rerouting of mailThe application of VAT on cross-border mail would give strong incentives to re-mailing andde-location of mail activities to circumvent higher postage costs and non-reclaimable VAT.Remailing is a practice of rerouting mail between countries utilizing different transportservices in combination with express or postal services to obtain cost advantages on behalf ofthe mailer, DOs were also involved in this practice. There are different types of remailing,such as ABA (letter mail from country A posted in country B for cross-border delivery incountry A) and ABC (letter mail from country A posted in country B for delivery in countryC). 40 In addition to that, there is non-physical remail which occurs by sending mailelectronically to a location in another Member State of the EU or outside the EU for physicaldelivery in country A.Figure 7: ABC Remail and VAT39 L’avenir du secteur postal à l’heure de la révolution numérique : une alliance encore à construire, Speech Commissioner Mr.Michel Barnier at European Commission 2nd High Level Conference Delivery Services for a Digital World Valencia, Spain 29-30 April 201040 These remailing activities are understood as physical remailing. Additionally, there is ABB as another type of remailing:Cross border mail from A taken to B where it is posted as domestic mail.23

As seen under section 3.2, introducing VAT in the cross-border market, where different VATrates and strongly different scopes of universal services apply, would contravene the intentsof Article 13 of the Postal Directive to apply a non-discriminatory remuneration treatment.Applying different VAT rates in the cross-border mail market (considering its specificnature) would constitute a breach of the principle of external neutrality (see 2.2) and createdistortions that could incentivize mail de-location and further decline in the intra-Communitymail market. The majority of intra-Community mail flows would be further affected by thesimultaneous tendencies of centralization (remail) and decentralization (local mail) as well asre-routing of mail activities based on new or more favorable constructions.3.3.5 Economic EffectsAs a result of implementing the proposed VAT rules, the costs for DOs will increasesignificantly. The significance of the problem resides in the fact that a major share of the coststructure is related to labor and therefore not reclaimable for VAT. At the same time it shouldbe considered that regulated postal operators possess very limited flexibility for priceincreases because of cumbersome price controls and approval mechanisms. Effectively thereis no room to compensate for the increased net-cost as a result from such a rule. Additionally,volumes and efficiencies would be harmed by delocation, remailing and re-routing initiativesgenerating smaller cross-border mail flows, increasing the operational costs per item.Delocation, non-physical re-routing and other processes (including incentives for e-substitution) would shrink the cross-border market in terms of both volume and revenue.Other economic effects can be expected from changes in payment channels, the presentationand preparation of mail as well as operational costs related to changing customer behavior.Simultaneously, implementing the package would introduce discrimination betweencustomers, in particular between foreign and domestic mailers as well as between those thathave local subsidiaries and those that have not; those that are located within the territory ofthe European Union and those based in third countries. It would hurt some mailersdisproportionately harder than others, depending on the scope of the universal service in thesending and destination country, the applied standard VAT rate and other arbitraryconditions. Finally, the VAT rules would discriminate between DOs operating in the crossbordermarket and operators in third countries that are not liable to VAT.26

In the situation that cross-border mail services would become VAT inclusive, this woulddirectly lead to a great number of challenges from the operational perspective. Assuming thatthe Commission’s interpretation is applied, sending DOs will need to segregate the mail intoVAT liable and VAT exempt flows. Such segregation will imply additional costs in both thesending and the receiving end. At the sending end, in the worst case, it will result in doublingthe number of dispatches to be prepared and dispatched. Preparation of a dispatch carries afixed cost regardless of the volumes dispatched.At the receiving end a split of dispatches will imply additional sampling and duplication ofaccounting forms. Further administration costs will arise due to additional checking ofdispatches in order to detect remail activities. Costly and time-consuming IT development inorder to accommodate such segregation will be required by all Operators. In addition,checking the dispatches for detection of whether VAT liable mail erroneously has beendispatched in VAT exempt dispatches and vice versa is rendered extremely costly, if it ispossible at all (due to the differences in the scope of the USO among sending Operators).3.3.6 Other Practical ConsiderationsIt is evident that the implementation of the VAT package would lead to further practicalobstacles and complications. Besides the number of terminal dues rates, transitional regimes,further complications are expected as far as different invoices need to be issued based on thetype of service provided and whether each of these services are liable to VAT or not. Thiswould result in increased complications in invoicing and payment (which taxes can bereclaimed (considering common costs)) and reduced transparency in the cross-border market.Another reason why postal VAT rules are so difficult to implement relates to how consumers,small and bulk mailers pay for their postal services. Bulk mailers use both meters (usingpayment in advance technology) and printed postage impressions (PPI) which is mainly apayment-in-arrears channel. Walsh (2010) makes the point that “it is less clear thattechnological and fiscal neutrality will be protected if VAT inclusive prices across paymentchannels are distorted due to differences in the treatment of substitutable postal productswhich, in substance, have the attributes of universal services but where the regulatory form is27

such that they are defined as non-universal services.” 42 The application of the individuallynegotiated tariffs needs careful treatment not to thwart innovative pricing solutions and resultin changes in mailers’ behaviour and incentives to operate cost-efficiently. Changes inbehaviour would also result in transaction costs arising from a different mix of products andmail preparation; invoicing and collecting revenues, and most particularly in terms ofcollecting, processing, distribution and other operational processes.Besides these implications there is a long list of smaller practical considerations which arenonetheless important because with an eventual change of the cross-border VAT regime,there are new action points for each postal service provider that need to be dealt with. This islikely to have serious consequences and, among other things, posts will need to:∗ Assess which services are involved both in country of origin as country of destination;∗ Review these to establish the customer base and whether the customers involved canreclaim VAT or not. If they cannot this represents a real price increase for thesecustomers which could inevitably lead to a loss of volumes (of which many operatorscan do without in the current climate). This may require a review of prices(considering demand elasticities) for the relevant services;∗ Financial impacts should be evaluated including impact of input credits (VAT thatcan now be reclaimed on purchases, this will be complicated as many costs arecommon costs or very limited as most costs are related to labor);∗ Possibly have discussions with tax authorities;∗ Customers will need to be informed of changes, brochures and so on updated;∗ Systems will need to be reviewed as customers who are charged VAT will be entitledto invoices setting out the tax paid. This will be straightforward for centrally billeditems but what about services paid for with stamps, meter franks or PPIs;∗ Staff will need to be trained;∗ The receiving party has to understand whether a VAT exemption applies;∗ Tax needs to be calculated, paid, deductible taxes need to be reclaimed;∗ The application of the reverse charge system for cross-border mail depends on theability of the sending Operator to correctly apply it. The receiving Operator at the42 Walsh, Tim (2010), Payment Channels and the Reform of the European Union Postal VAT¸ 18th Rutgers Conference onPostal and Delivery Economics, 201028

level of Operations and Accounting will face severe difficulties in identifying whethera certain dispatch rightfully is designated as subject to VAT or VAT exempt.Making inbound postal services VAT exclusive would avoid all these implications.4. VAT EXCLUSIVE INBOUND POSTAL SERVICESThe Commission’s Opinion as expressed in the working paper of March provides for acomplicated mechanism to decide where VAT should be applied and where not. Theimplementation of the regime as such would lead to a large number of serious implicationsand complications. Operating these rules in interaction with divergent national postalregulations in a cross-border market with sophisticated remuneration practices is a recipe forstrong economic repercussions for DOs, customers and the cross-border market at large.Considering these implications, it has become imperative for the industry and policy-makersto consider other solutions for the implementation of the new place of supply rules underDirective 2008/8/EC in the cross-border postal market.Currently, in the domestic markets, EU Member States do not only apply different VAT ratesto postal services, they also apply exemptions to different ranges of services and products.And to add further confusion to complexity, even the universal service is differentlyunderstood in all countries. As a result, the delicate balance of competition, quality ofservice, terminal dues remuneration and the requirements to fulfill the universal serviceobligation can no longer be guaranteed if the viewpoints of the EC working paper will beimplemented. The widely diverging definitions of the universal service constitute theunderlying problem causing confusion and complexity in applying VAT.As was argued in this paper, the definition of the USO is broadly different from one MemberState to another. The only services that all USPs have in common under the mandatoryservice requirement are the obligation to deliver single piece items nationwide as well ascross-border inbound services. The intent of article 3(7) of the Postal Directive is to coverboth national and cross-border services under the universal service. Under the Universal29

Postal Convention members are obliged to deliver inbound international mail. Furthermore,incoming cross-border postal services ought to be VAT exempt as they constitute a de factouniversal service and, at the same time, UPU, REIMS and bilateral agreements have not beenindividually negotiated in the meaning of ECJ jurisprudence (of case C-357/07). Consideringthe specific nature of cross-border postal services, the obligations from the UPU and PostalDirectives for inbound services, the recent ECJ ruling, the principle of fiscal neutrality andthe wide range of implications as described in this paper, VAT exemptions shouldexclusively apply to inbound cross-border postal services.1. Applying exemption to all inbound cross-border postal services is fully in line withinternational treaty obligations, in particularly as formulated by the Universal PostalUnion (UPU);2. VAT exclusive inbound postal services would reduce barriers and uncertainty in thecross-border e-commerce market, supporting Community objectives of seizing thepotential of the internal market for consumers;3. VAT exclusive inbound postal services would avoid significant practical andoperational implications that would be virtually impossible or at least very costly toimplement;4. VAT exclusive inbound postal services would stay clear from breaching the fiscalneutrality principle as it applies equally among designated operators and betweendesignated operators and private operators as far as the delivery services by thereceiving DO are concerned;5. VAT exclusive inbound postal services would reduce incidences of remailing anddelocation of mail activities and other risks that lead to foregone revenue and higheroperational costs;6. Finally, VAT exclusive inbound postal services ensure the preservation of a highquality service that operators have developed in the cross-border market over the pastfifteen years.As the delivery of inbound cross-border postal services constitutes an obligation in thereceiving country, the right interpretation of the ECJ ruling for the cross-border market wouldbe to apply VAT exemption exclusively to inbound services. As such the new place of supplyrules under Directive 2008/8/EC can be implemented without further delay and without any30

of the described complications in the cross-border postal market. It should exclusively followthe universal service definition as it applies in the receiving country – where the service isactually provided – as the point of reference for applying the VAT exemptions as understoodunder article 132(1)(a) of the VAT Directive and the recent ECJ ruling. Only this way, policycan be helpful, on both the consumer and supplier sides, to create greater levels of confidencein a sustainable cross-border service that supports the completion of the internal market forconsumers and postal services.ReferencesADRENALE (2010), Market Research on International Letters, and Lightweight Parcels andExpress Mail Service ItemsBLACKWOOD, ANNELIESE (2009), R (TNT Post UK Ltd) v HMRC Case C-357/07, MoncktonChambersDIETL et al. (2010), Impact of VAT-Exemptions in the Postal Sector on Competition andWelfare, 18th Rutgers Conference on Postal and Delivery Economics, 2010EUROPEAN COMMISSION (2009a), Communication on Cross-Border Business to Consumer e-Commerce in the EU, COM(2009) 557 finalEUROPEAN COMMISSION (2009b), Commission Staff Working Document, Report on crossbordere-commerce in the EU, SEC(2009) 283 final, 5 March 2009ECORYS (2008), Annex II: Main Developments in the Postal Sector (2006-2008)IPC (2009), IPC Strategic Perspectives on VAT, October 2009IPC (2010), IPC Cross-Border E-Commerce Report, 201031

POST & TELESTYRELSEN (PTS) (2007), The Liberalised Swedish Postal MarketMYSTERY SHOPPING Evaluation of Cross-Border E-Commerce in the EUWALSH, Tim (2010), Payment Channels and the Reform of the European Union Postal VAT¸18th Rutgers Conference on Postal and Delivery Economics, 2010WIK (2005), The impact of abolishing the VAT exemption for postal services provided byDeutsche Post AG32