VAT: Incoterms and the place of supply

VATIncotermsand theplace ofsupplyJo Bello considers how varyinginterpretations of an ECJ decisionhave complicated the analysis ofmultiparty and chain transactions42 TAXADVISER – December 2007With the increase in the complexity ofsupply chains, considering the placeof supply of goods becomes moreand more important. This issue was put underthe spotlight last year, when the EuropeanCourt of Justice (ECJ) released its decision inthe EMAG case (see the June 2006 issue of TaxAdviser, p 6 ).In the period since the EMAG decision wasreleased, rather than bringing clarity, thevarying interpretations of the decision haveincreased the complexities involved inanalysing these transactions. I shall discusshere how, following that decision, incoterms(international contract terms) now interactwith the place of supply of goods inmultiparty and chain transactions.Intra-community tradeFirst, let us consider the VAT rules for intracommunitytrade. The place of supply ofgoods within the EU is the place where thegoods are physically located when they aresold, or ‘made available’. For cross-bordermovements, this is generally the place wherethe goods are when they start their journey.Where the supplier is sending goods from thecountry where it is established and thecustomer is receiving goods in the countrywhere it is established, determining where theplace of supply is becomes relativelystraightforward. Complications begin to arisewhen goods are being shipped to a thirdlocation; or the middle party is not VATregistered in the EU; or the middle party isestablished or VAT registered in both thesource and destination member states – whothen makes the zero-rated supply and whomakes the acquisition? One of the things thatEMAG makes certain is that there can only beone zero-rated supply in a chain.The opinion of the ECJ’s Advocate General(AG) also suggests that in determining whichsupply is the zero-rated one it is important tolook at where the acquisition takes place.Instead of looking at which supply qualifies forzero-rating in the source country and basingthe place of supply of everyone else aroundthat fact pattern, consideration should begiven to who is responsible for acquisition.Therefore, in determining whether zeroratingis applicable, one should consider whois responsible for the acquisition in thedestination member state. Where more thanone party treats its supply as being zero-ratedfrom the source country, there is a clear riskthat the VAT authorities will make anassessment for VAT on the party that is onestep back in the supply chain, not to mentionimpose penalties. Understanding theincoterms could help in avoiding such errors.The AG’s opinion in the case of EMAG turnsour attention to asking which party has

VATWhere the incorrect treatment is applied,the potential costs can be highorganised the transport so that they will bethe party that has the ‘right to dispose of thegoods as owner’ at the point goods leave andarrive in member states of despatch andacquisition. The ECJ decided that this factorshould be taken into account, but it is not toodecisive. Interestingly, in many territories, theimpact of taking into account who thetransporter is in a supply chain can makedetermining where the place of supply is morecomplicated. It can be the incoterms thatprovide further information to help determinethe place of supply.Incoterms are a set of commercial terms,agreed in contracts between sellers andpurchasers, which determine who bears therisk for the goods while in transit and whoincurs what costs. Incoterms range from EXW(ex-works) – the supplier provides the goodsat the factory gates and the customer isresponsible for collecting the goods, to CIF(cost, insurance and freight) – the supplier isresponsible for delivering the goods to thecustomer’s premises, for all costs (includingimport duties), insurance and freight. Theincoterms are a shorthand way of setting outwho is responsible for the key costs and risksof getting the goods from A to B. They do notdetermine when legal title to the goodspasses. That said, many sales contracts willstate that the legal title passes in accordancewith the incoterms, although that istechnically not in accordance with what theyare designed to achieve.So how can incoterms help determine theplace of supply for VAT purposes? Where aperson in the supply chain is the partyresponsible for bringing the goods into acountry, according to the incoterms, thissuggests that they could be making theacquisition from a VAT perspective.The main complication in multipartytransactions arises when two or more of theparties in the transaction apply the sameincoterm to the transaction; then there arisesthe question of who exactly is the partypaying the import duty or making the exportdeclaration – both parties cannot beresponsible for the same thing, surely. If theincoterm on the final leg of a three-part chainis EXW then, according to the incoterms, thefinal customer is responsible for the deliveryand the dispatch from the member state andtherefore for making both the despatch andthe acquisition. If the incoterm on the first legof a three-part chain is EXW, then accordingto the incoterms, the second party in thechain is more likely to be consideredresponsible for making the acquisition.One risk that was highlighted in the EMAGdecision is where one party is making theacquisition but the goods are delivered to theend customer, commonly known a dropshipment.It is important to ensure that, inthese circumstances, the acquirer is confidentthat it is correctly charging local VAT and thatits customer will be able to recover it. Incircumstances where the customer isresponsible (under the incoterms) forarranging delivery, it could be difficult for themiddle party to argue that its VAT has beencorrectly charged.This is particularly an issue for suppliers thatsource products from a variety of locations aswell as from local stocks. When the salesinvoices are raised to the customer, it may notbe clear where goods will be sourced from,and so the supplier’s preference in thissituation would be to charge local VAT on allsupplies. In these circumstances, getting theincoterms correct to meet the desired VATtreatment will be helpful and will minimise therisk that VAT recoveries by customers are notrestricted.The incoterms could also interact withtriangulation in certain member states. Forexample, in Germany, use of triangulation isnot available where the supply is arranged bythe final party in the chain. Therefore, if thesupply is EXW between the second and thirdparties, it might not be possible to use thetriangulation simplification, and the middleparty will be forced to register for VAT inGermany. Apart from the administrativeburden of an additional VAT registration, thereare again cash flow consequences of waitingfor a refund of the VAT that the local suppliercharged.ExportsThe rules for zero-rating exports, movementsof goods to a place outside of the EU, areslightly different from the rules for zero-ratingintra-community supplies. The place of supplyremains the place where the goods arephysically located when they are sold, ormade available. However, both the EU and UKVAT legislation specifically state that the rulesare different depending on who arranges thedelivery of the goods. So, incoterms can havea greater influence here.Where the supplier is arranging delivery, thesupply is usually eligible for zero-rating,assuming that the exporter is able to retainevidence that the goods have left the sourcecountry.Where the customer arranges delivery ofthe goods, there is a quirk to the VAT rulesand, just to complicate matters, the SixthDirective and the UK rules are subtly different.According to Article 146 of the recast SixthDirective, where the customer arranges theexport (typically this is where the incoterm isEXW), the supply is only eligible for zeroratingby the supplier where the customer hasno fixed establishment in the source country.This differs from the UK law, which says that inthese circumstances, zero-rating by thesupplier is only possible where the customer isnot VAT-registered in the UK. Again we cansee that in making the decision to zero-rate itis necessary to understand the customer’staxable status and to understand the impactof agreeing the correct incoterm.To sum upThe issues arising from incoterms can oftenseem just more administratively complex,rather than causing any real financial burden.However, where mistakes are made and theincorrect treatment is applied, the potentialcosts – particularly outside the UK – can behigh.On supplies made, the single biggest issueis often the cash flow cost of getting the VATtreatment wrong – delays in receiving VATrefunds from VAT authorities as well as delaysin receiving VAT payments belatedly chargedto customers. An error in incorrectly zeroratinga supply can lead to largemisdeclaration penalties and interest. This is inaddition to paying the VAT, which may bedifficult or, at best, time-consuming torecover. Where VAT has been incorrectlycharged, this can cause relationship problemswith customers who are refused VAT refunds,and again cash flow delays can beencountered in recovering overcharged VATfrom VAT authorities. On supplies received, itis important to understand that, where VAT ischarged, it is possible to recover it.Too often, transactions are entered intowith little thought for the implications arisingfrom the contract terms, which are often notreviewed or agreed by the finance function ina business. This is especially the case whereparties to supply chains are contained within acorporate group.Don’t assume that the VAT treatment oftransactions in supply chains are withouterrors or potential risks. Review the incotermsin international supply contracts and considerwhether changes to these terms could resultin any additional benefits.Jo Bello is an indirect tax director atPricewaterhouseCoopers LLPTAXADVISER – December 2007 43