EU VAT obstacles for Chinese companies
Chinese enterprises trading across the EU can be hindered by many barriers; particularly EU VAT, which can leave unsuspecting firms facing large fines or delays in deliveries.
According to figures published by Xinhua, the EU remained China’s biggest trading partner in 2008, with bi-lateral trade reaching $425.58 billion, representing a 19.5% growth from the previous year.
Given the level of business activities across the EU, it is essential for Chinese firms to keep up with the legal and taxation laws of the member states in which they operate – proper risk management in these areas is prudent if not paramount. This is particularly true in the current worsening economic climate; many European governments are cash-strapped and under increasing pressure to identify tax-raising opportunities. This is evident not only from the recent push by the OECD for greater international tax transparency but also in the increasing VAT rates across many EU member states. For example, Latvia increased its VAT by 3% to 21% in January 2009 following similar increases by Lithuania and Ireland in October 2008. There is little doubt that EU VAT has become a growth tax and the trend does not seem to be ending in the near future.
The first step to managing risk generally begins with identifying the areas of risks.
Firms that meet one or all of the following criteria generally need to factor compliance risk into their risk management portfolio:
- Engage in importing into the EU;
- Have physical presence in the EU;
- Trade goods / services across the EU.
We are seeing increasing number of Chinese firms importing directly into the EU. This makes sense from a commercial perspective since it cuts out the “middle man” which in turn allows firms to keep their margin. Firms that engage in one or all of the above activities generally need to register for VAT in each of the member state in which they operate.
Depending on the laws of the member state, failure to register may result in heavy fines (such as in the case of Italy) and delays in deliveries (for instance, importing into Poland without a VAT number). To complicate matters, registration requirements can differ significantly across the member states and generally need to be submitted in the local language. For example, foreign entities trading in Ireland do not need a fiscal representative. This requirement however is essential in Poland. Understanding and effectively managing a firm’s VAT requirements is the second step to risk management.
Obviously, compliance risk does not end with VAT registration. Firms must now manage their reporting obligations the timing of which can differ across the EU. In addition to periodic VAT submissions, firms that trade across the EU generally must file periodic EU Sales List and Intrastat List. These reporting enable EU authorities to reconcile their VAT revenue and track the level of goods sales across the EU. In terms of VAT submission, one of the challenges is for firms to identify the member state levying the VAT and determine the correct rate of VAT to charge. This can be even more complicated when services are rendered across the EU such as in the case of logistics companies. The type of services rendered determines whether the country of origin or country of destination principle is applied when determining the relevant charging state and therefore the applicable VAT rate.
As part of their risk management strategy, it is become increasingly popular for firms to outsource their VAT compliance needs. Outsourcing to firms that are expert in their field can not only help to mitigate compliance risks but is also likely to be the cheaper alternative to keeping the work in-house; this is appealing particularly given today’s economic condition where cash is king and firms are looking for ways to reduce costs.
Obviously, selecting the right outsource service provider is key to the success of this strategy. As a minimum, the provider will necessarily have the right expertise and practical experience in dealing with local authorities, particularly at times where there are grey areas of VAT or in the event of an audit. For firms transacting across the EU, the number of service providers can be an important consideration, not only from a cost perspective but also importantly, from a communication perspective. The ability to structure and coordinate a firm’s VAT needs across different member states in a seamless fashion is an important part of cost and risk management. This is a reason why many multinationals prefer to appoint a global service provider to coordinate and look after their VAT needs.
Firms that do not fall into the above category of having a physical presence or transact in the EU, but have incurred business expenses, there is the opportunity to recover cash that is lost through VAT. In order to encourage trade in the EU, the 8th and 13th Directives have been legislated to provide foreign entities with the opportunity to recover VAT incurred on certain business expenses such as:
- Training; and,
- Marketing and advertising.
Given that the standard EU VAT rate must range from 15% to 25%, the potential recovery of VAT can be quite significant. Imagine a Chinese telecommunications company that sends hundreds of delegates to the EU each year for training; now imagine the potential cash recovery on VAT.
Although the EU foreign VAT reclaim system provides the opportunity to recover cash, the recovery process in practice can be fraught with bureaucratic complexities and delays, increasing the risk of cash loss. There are significant inconsistencies in the laws of each member state and the way a piece of legislation is interpreted. For example, client entertainment is deductible in France but disallowed in the UK. Careful planning of business expenditure before they occur can result in significant cash savings in some cases.
Consideration should also be had to the reclaim requirements of each member state, such as the time period for recovery and requisite documents for recovery such as original tax invoices. Failure to observe these requirements will no doubt result in cash losses. As such, many firms have chosen to outsource this reclaim process in order to maximize potential for cash recovery and save the headache of going through the recovery motion.
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