VAT and Transfer Pricing: smooth sailing, or a perfect storm?
Value Added Tax (“VAT”) and transfer pricing (“TP”) are generally regarded as two separate fields of law. Adjustments to one area have limited and, moreover, foreseeable consequences for the other area. It is relatively smooth sailing, as the two topics have a different focus. VAT taxes consumption as an indirect tax, whereas transfer pricing affects the direct taxes due, by determining the right price for transactions between associated enterprises. Although VAT and TP appear to be isolated topics, once every so often, TP and VAT provide the elements for problems and stormy weather. Unless these are properly navigated, you may find yourself stuck in a perfect storm.
In this article we will focus solely on the so-called ‘primary adjustments’ to intercompany pricing, meaning adjustments applied by the local tax authorities. However, our conclusions may also apply if you adjust your intercompany pricing based on the TP model in place (e.g. a year-end adjustment).
VAT is probably the most well-known indirect tax and generates the most revenue for tax authorities. VAT is a transaction-based tax and it is levied on supplies of goods and services. Under the EU VAT Directive, a supply of goods or services is taxable for VAT purposes if it is carried out for a consideration.
Simply put, a supply is only taxable for VAT purposes if parties have agreed not only that the supply will be provided, but also what consideration will be paid in return for that particular supply. This consideration will constitute the taxable amount for VAT purposes.
The EU VAT Directive acknowledges the possibility that an ‘open-market value’ may have to be used under certain conditions, to determine the taxable amount of a supply of services, in order to prevent tax evasion or tax avoidance. However, not all EU Member States have made use of this option. The Netherlands is one of the States that has not. Therefore, the general VAT rules, as outlined above, apply in the Netherlands.
TP falls within the scope of direct taxation. Briefly put, TP sets the rules for transactions within a multinational enterprise (“MNE”), for corporate income tax purposes. These rules are based on the ‘at arm’s length’ principle, and are aimed at ensuring that the conditions of a transaction within an MNE do not differ from a comparable transaction between independent entities on the open market. If a transaction between related parties is not ‘at arm’s length’, the transaction needs to be adjusted. This adjustment must lead to conditions that are in line with those that would have applied, had the transaction been performed between independent parties.
TP vs. VAT
TP is focussed on establishing a conceptually objective outcome (i.e. the arm’s length standard), whereas VAT is levied on the basis of the subjective price that has as a matter of fact been paid between parties. Therefore, it would appear that a TP adjustment would not often affect VAT. However, this is a misunderstanding. A perfect storm may gather, if a TP adjustment affects the taxable amount for VAT purposes. This would require a direct link between the supply and the consideration received (including the adjustment for this supply).
Whether or not a TP adjustment affects the VAT position depends on the nature of the TP adjustment. Does the adjustment change the entire remuneration of a company? Or does it only change the remuneration for the initial supplies?
In this respect, the EU VAT Expert Group has provided non-binding guidelines on the potential VAT consequences of TP adjustments. Based on these guidelines, it is important to identify a specific consideration, a specific supply and, most importantly, a direct link between the supply and the consideration received. If these three elements are present, the TP adjustment will most likely have VAT consequences.
At first sight, this seems quite clear. Unfortunately, however, determining whether a TP adjustment has VAT consequences, is not always that simple in practice. The circumstances and conditions under which a TP adjustment leads to a VAT adjustment, are very specific and should be checked on a case-by-case basis.
Issues to be considered
Issues to be taken into account when determining whether TP adjustments will have VAT consequences are, amongst others:
- Is there a payment between associated enterprises?
- How is the price determined, and what transfer pricing method is used?
- Is it possible to link the payment to a specific (initial) transaction?
- In which part of the chain do the payment and transaction take place?
- In which country would the transaction be taxable?
Furthermore, it is worth noting that TP adjustments could also have consequences for the customs valuation, and that such consequences may in turn influence the VAT (e.g. the taxable amount used to determine the import VAT). Similarly, the customs valuation adjustment may also affect the (non-recoverable) customs duties in cases where goods imported are subject to such duties.
MNEs should always consider the (VAT) consequences of TP adjustments, since there is not a clear set of rules to determine whether or not the TP adjustment will have VAT consequences. This is all the more important given the significant risk of penalties.
Many MNEs will currently be affected by the COVID-19 pandemic and its consequences. Supply chain, financial flows, risk allocation and even staff allocation could be affected, which could subsequently lead to additional or amended TP adjustments. Companies may notice their sales revenues decreasing or increasing, depending on the sector in which they are active. Due to these unforeseen changes in revenue, additional TP adjustments may be required to ensure that the price of transactions within an MNE remains ‘at arm’s length’. If these additional TP adjustments relate to specific transactions, this could trigger VAT consequences.
Of course, we understand that your first priority will always be to keep your business running smoothly. However, maintaining control of your tax position should be part of this. Therefore, it is always important to consider and compare the tax position of your company in each country or location, particularly in the case of TP adjustments. This should allow your company to batten down the fiscal hatches and prepare for a potential ‘perfect storm’. Within the Baker Tilly network, VAT specialists and TP specialists from all over the world work together closely, in order to help you weather any storm. We can assist your business in arranging your set-up as efficiently as possible, while mitigating potential risks.