Comments on EU place of supply of services rules: June 30, 2003.

On June 30, 2003, TEI President Drew Glennie sent the following letter to John Bain of the European Commission on the VAT place of supply of services rules. The comments were prepared under the aegis of TEI's International Tax Committee, with guidance from TEI's European Chapter and Canadian Commodity Tax Committee. Fabio DeAngelis, chair of the European Chapter's Indirect Taxes Committee, and Mark Keogan, its vice chair, contributed materially to the development of the comments.

On behalf of Tax Executives Institute, I am pleased to provide comments to the European Commission on the Consultation Paper, VAT--The Place of Supply of Services, issued in May 2003. As the pre-eminent international association of business tax professionals, TEI has a significant interest in promoting sound tax policy, as well as in the fair and efficient administration of the tax laws, at all levels of government. TEI applauds the Directorate-General Taxation and Customs Union for seeking to reduce the administrative burdens and complexity inherent in the VAT place of supply rules for services. We also commend your efforts to consult with the business community on these proposals.

TEI welcomes further dialogue on these or any other issues.

I. Background

TEI was founded in 1944 to serve the professional needs of business tax professionals. Today, the organization has 53 chapters in North America and Europe. Our 5,300 members represent 2,800 of the largest companies in the United States, Canada, and Europe. In 1999, TEI chartered its first chapter in Europe. The European Chapter encompasses employees of a wide cross-section of European and multinational companies.

TEI members are accountants, lawyers, and other corporate and business employees responsible for the tax affairs of their employers in an executive, administrative, or managerial capacity. The Institute espouses organisational values and goals that include integrity, effectiveness and efficiency, and dedication to improving the tax system. TEI appreciates the opportunity to comment on the rules for the place of supply of services.

II. General Comments

Since July 2000, the European Commission has been reviewing various proposals in the value-added tax (VAT) area. The most recent Consultation Paper reports on the current status of the review of the place of supply of services rules and outlines the framework in which the work has progressed.

TEI agrees that the initial focus for any changes in the place of supply rules for services should be limited to B2B transactions. In the short term, however, this will result in additional complexity in determining the correct place of supply for those businesses involved in B2B and B2C transactions. The European Commission should ensure that Member States appreciate the additional burden on businesses and guard against aggressive assertion of penalties.

The Institute also agrees that the current place of supply rules for services are no longer appropriate for most B2B transactions. (1) In particular, the current rules are often a barrier to business transactions because of their breadth and complexity, as well as the uncertainty that exists on their interpretation within the Member States. At the heart of any changes must be a simplification of existing rules that reduces the VAT burdens on both suppliers and customers, while ensuring that compliance with the appropriate laws is maintained.

TEI believes that it is imperative that the European Commission provide clear and detailed guidance to minimise differing interpretations by the tax authorities in the Member States. In addition, the European Commission should work to ensure that the rulings by the European Court of Justice (ECJ) in interpreting legislation are applied uniformly within the Member States.

Paragraph 3.1: Change From Origin To Destination Principle

Article 9(1) of the Sixth VAT Directive currently sets forth the general rule that the place where a service is supplied shall be deemed to be the place where the supplier has established its business or has a fixed establishment from which the service is supplied, or, in the absence of such a place of business or fixed establishment, the place where it has its permanent address or usually resides. Article 9(2)(e) provides an exception for certain services (such as assignments of copyrights or patents, advertising, consulting, banking and other financial transactions) performed for customers outside the EU or for taxable persons within the EU but not in the same country as the supplier. In these circumstances, the place of supply is where the customer has established its business or has a fixed establishment to which the service is supplied.

The Consultation Paper proposes to amend the general rule and base the place of supply of services on where the customer (i.e., the taxable person) is established (a destination rule), rather than where the supplier is established (an origin rule). In other words, the Commission proposes to make the destination principle in Article 9(2)(e) the general rule. The Commission believes that such a change would (i) limit the instances where a supplier is required to register for VAT purposes in a Member State other than where it is established, and (ii) increase reliance on the reverse charge (or self assessment) mechanism where a taxable person receives services from a person not located in the same Member State. (2) For ease of administration, TEI applauds this move from the origin to the destination principle of taxation.

With the move to Article 9(2)(e) as the general rule, the reverse charge mechanism will become more widely used. It is important that the Commission ensure that the rules for accounting for, and recovery of, the reverse charge VAT are harmonised among the Member States. For example, some EU countries (such as Italy) now require a business to issue a "self invoice" before the reverse charge VAT can be recovered. This requirement is burdensome and unnecessary and should be eliminated. Similarly, some countries currently impose penalties in the event of an incorrect accounting for the reverse charge by fully taxable businesses or issue assessments without crediting the VAT that may be recovered. It is important that the Commission work to prevent such inequities.

TEI also believes that exclusions to the general rule must be limited. Before such exclusions are adopted, the Commission should evaluate each proposal and articulate why Article 9(2)(e) treatment should not be allowed. Exclusions may be more important for B2C transactions, where the VAT charged is not recovered by the customer and hence forms part of the tax revenue of the country. This is not, however, the case in B2B transactions (except where recovery of VAT is specifically blocked on the supply or the customer is not fully taxable); insufficient VAT is involved in such B2B supplies to justify the added complexity of exclusions to the general rule. Adopting the Article 9(2)(e) rule will yield a more accurate VAT recovery for customers that are not fully taxable because restrictions on VAT recovery are more uniformly applied to VAT-registered businesses than under the Eighth or Thirteenth VAT Directive.

If exclusions are deemed necessary, they should be focused on specific problems. In addition, the European Commission should clearly state the circumstances in which the exclusions should apply. In addition, clear guidance on how to determine whether a customer is in business should be provided. In doing so, the Commission may wish to revisit the requirement for a customer simply to be "in business" for a supply to fall under Article 9(2)(e). There is a need to redefine this condition because of the increased use of this rule and hence the increased tax loss where the "business" customer is not registered for VAT.

Proposed Treatment for Specific Types of Services

TEI agrees with the Consultation Paper that to provide certainty of treatment, the supply of management services should be subject to the general Article 9(2)(e) place-of-supply rule.

If the European Commission concludes that an exclusion from the general rule is required in respect of services connected with immoveable property, the scope of the exclusion should be limited. The term "connected with" immoveable property currently used in Article 9(2)(a) is too broad and results in unnecessary VAT registration obligations for experts whose services would otherwise fall within Article 9(2)(e). Only services closely connected with immoveable property and grants, assignments, and surrenders of rights in or over land should be taxed where the immoveable property is situated.

To the extent that VAT will continue to be incurred by business customers in countries where they are not registered, the Commission should enhance the operation of the Eighth and Thirteenth VAT Directives to ensure such VAT is repaid in a timely manner. TEI also recommends that the Commission consider replacing the Eighth Directive entirely with a provision for businesses to recover such VAT via their domestic VAT returns. The VAT will then be redistributed to the Member States in the same way that VAT on sales of e-commerce services will be redistributed under the special regime outlined in the Directive on electronically supplied services (2002/38/EC).

TEI agrees that problems currently exist with the provision of training services (both in terms of VAT registration obligations for suppliers and submission of Eighth Directive Refund claims by customers) and that these services should be treated as falling within the general rule of Article 9(2)(e).

TEI agrees that a simplification of rules relating to work on tangible moveable property is required. The provision of such services should fall within Article 9(2)(e); there are no compelling reasons why an origin rule should be applied to this type of service. The application of Article 9(2)(e) should result in taxation in the country of consumption in B2B transactions.

TEI recognises the difficulties inherent in using the default rule for the supply of certain services failing under Article 9(2)(c) and "tangible services." These difficulties arise, however, not from the place of consumption, but rather from the problems in differentiating between B2B and B2C supplies. Because these supplies will be subject to VAT in the country of consumption, the Eighth and Thirteenth Directives should be amended to facilitate recovery and the rules for recovering VAT in the Member States should be harmonised to ensure consistent treatment.

Paragraph 4.2: Extension of VIES to Article 9(2)(e) Services

The VAT Information Exchange System (VIES) was established in 1993 to enable Member States to control exempt intra-EU acquisitions of goods by taxable persons because there was no longer any documentary control of imports and exports across borders. In the Consultation Paper, the Commission asks whether VIES should be extended to services. TEI says no. VIES merely replaced one reporting requirement with a similar requirement in a different form; the proposal to extend VIES to supplies of services, however, is an added requirement to those currently in place.

If a general destination rule is introduced, TEI believes that the VIES system should not be extended to services. First, VIES only captures data on services supplied by taxable persons in Member States and supplied to taxable persons in other Member States. Significant elements of data on services imported from outside the EU by taxable persons will be omitted from such a system. Such data therefore have limited use.

More important, the extension of VIES will impose significant administrative burdens on taxable persons in the EU. The experience of EU business in introducing systems to collate data for EC Sales Lists illustrates the significant costs in developing compliance systems. In addition, such a system will effectively impose policing responsibilities on EU taxable persons. Because the tax authorities have the power to control cross-border transactions, this proposal seems unnecessary. Tax authorities already have the ability to verify that an Article 9(2)(e) service supplied by a supplier in Member State A to a taxable person in Member State B has been subject to a reverse charge in Member State B. These control mechanisms should ensure VAT compliance.

TEI also has concerns about the ability of a VIES system and EU businesses to provide the data at the same time when both taxpayers and governments are dealing with the information requirements resulting from the addition of 10 countries to the EU.

Article 9(3): Use and Enjoyment

a. In General. With respect to the supply of services under Article 9(2)(e) and the hiring out of moveable tangible property, Article 9(3) provides the Member States with discretion to consider:

(a) the place of supply of services, which under this Article would be situated within the territory of the country, as being situated outside the Community where the effective use and enjoyment of the services take place outside the Community; and

(b) the place of supply of services, which under this Article would be situated outside the Community, as being within the territory of the country where the effective use and enjoyment of the services take place within the territory of the country.

When a Member State elects to apply Article 9(3), under existing rules an EU business is responsible for determining whether its non-EU B2B customer "uses and enjoys" a service within a Member State because the supplier is required to register in the state where "use and enjoyment" occurs and charge that country's VAT. This is simply not practical, and unless the non-EU B2B customer is an exempt financial institution, the application of Article 9(3) to B2B transactions does not result in net VAT revenues to the Member State. TEI therefore recommends that the Article 9(3) election be available to Member States only when Article 9(2)(e) supplies are made to non-taxable persons.

The Sixth Directive provides no definition of "use and enjoyment" and little practical guidance on the term has been published. While it may be difficult to define the term, the proposal to change the place of supply rules increases the need for clarification. Failure to do so will ultimately result in uncertainty, further references to the ECJ, and significant costs to the affected businesses.

b. B2B Transactions. The place of supply for services is determined in accordance with Article 9 and Article 28b(C), (D), (E), and (F). This generally leads to taxation somewhere in the EU for services consumed within the EU. Articles 9(3) and 9(4) recognize, however, that there are circumstances where the application of Article 9(2)(e) can result in double taxation, non-taxation, or distortion of competition. The main areas where this has an effect relate to private consumers--a subject that is outside the scope of this review--and businesses that are not fully taxable, i.e., those that are unable to fully recover the input VAT. Specific comments on issues relating to businesses that are not fully taxable are made below. First, however, we will make some general observations that apply to supplies of services to both businesses able to fully recover VAT and those that are not.

"Use and enjoyment" should not refer to the physical location of employees or the location of physical assets, where the presence of these "human" or "technical" resources does not, of themselves, give rise to a fixed establishment (FE) of the business. It is important not to confuse the location of an employee with the location of the business. In other words, the "use and enjoyment" of the supply may not always rest with the "recipient" of the supply.

In the case of a non-EU recipient with a branch, TEI agrees that the use and enjoyment rules should apply where a local EU branch of the non-EU recipient genuinely uses the service (because the business has an FE that makes use of the service in the EU). In this instance, the tax authorities should not seek to treat any charge or allocation from the non-EU establishment to the EU branch as a supply for VAT purposes (subject to the reverse charge). Instead, they can rely on "use and enjoyment" to argue that the location of the recipient of the service is in the EU. The EU recipient will either incur local VAT or account for VAT through the reverse charge.

If an EU service provider has taken reasonable steps (e.g., in contracts and negotiations) to confirm that its customer does not have an EU branch to which the services could be supplied--and it later transpires that such a branch did, in fact, exist--the supplier should not incur penalties as a result of its customer's failures. In these circumstances, the European Commission should ensure that Member States utilise a standardised test to evaluate whether the supplier can be relieved of any penalties for failure to account for tax if it has fulfilled certain criteria.

In certain circumstances, the normal application of the Article 9(2)(e) rules may result in services not being taxed within the EU. For example, consider an EU business that provides an Article 9(2)(e) service to a non-EU customer located outside of the EU. The service is treated as supplied where received, i.e., outside the EU, and is therefore free of VAT.

Where the recipient of the service has an EU affiliate or branch that is not fully taxable, tax authorities may assume that because the services are supplied VAT-free, a distortion may arise. In TEI's view, however, tax authorities must respect the contracting arrangements. Specifically, the European Commission should acknowledge that it is increasingly common for a non-EU legal entity to contract with an EU Article 9(2)(e) service provider. Also, many non-EU entities will contract for such services on a global basis. In these circumstances, TEI believes it is in appropriate for tax authorities to second-guess the actions of the non-EU customer, thereby forcing the EU supplier or an affiliate of the non-EU customer to "tax" a proportion of the services supplied. If the tax authorities have any questions on the nature of the treatment applied by the supplier, they should address these with both the supplier and its non-EU customer. In other words, the tax authorities should not see a "distortion" simply because the VAT has been accounted for via the reverse charge mechanism (if the charge has flowed through the supply chain), rather than being charged by the local supplier.

The non-taxation of services does not always produce an illogical result. For example, an Article 9(2)(e) service purchased by a non-EU recipient may represent a "corporate stewardship" cost, properly consumed in the non-EU territory. Or, where the non-EU recipient of the service makes a recharge to its EU affiliate (e.g., because the non-EU recipient determines that this is necessary for direct taxation reasons) and the EU affiliate is the ultimate consumer of the service, the EU subsidiary is then required to apply the reverse charge and restrict VAT recovery in accordance with its normal procedures.

If Article 9(2)(e) services are supplied to a non-EU recipient, there may be concern that the service may be incorrectly described when recharged, resulting in non-taxation (e.g., if it is incorrectly described as an Article 9(1) service). Internal corporate controls should prevent this avoidance. In any case, the ability to avoid the reverse charge will be further limited under the revised place of supply rules proposed by the Commission.

While it is theoretically possible that the non-EU recipient will bear the cost of the Article 9(2)(e) service and not make a recharge to avoid a reverse charge in the EU affiliate, direct tax rules in the non-EU country make this unlikely unless the service is indeed genuinely purchased for the non-EU purchaser. In addition, from a commercial perspective business units are unlikely to absorb the costs of another business unit. For this reason, bearing the cost is not a viable proposition.

Identifying the Establishment From Which Services Are Supplied

The Commission should provide a clear and detailed set of rules to enable a taxpayer to determine from which establishment it makes a supply of services. Furthermore, if the general Article 9(2)(e) rule is adopted, the significance of determining which establishment of a taxable person is making a supply of services is decreased. TEI believes that the European Commission should emphasise that Member States should respect established ECJ case law to ensure certainty of treatment within the EU. In particular, the Commission should ensure that where Article 9(2)(e) services are supplied by a non-EU establishment of a supplier (which has a branch or affiliate in the same country as its EU customer), tax authorities do not try to force local VAT to be charged to the customer.

Identifying The Establishment To Which Services Are Supplied

The Commission should also provide a clear and detailed set of rules to enable a taxpayer to determine to which establishment it makes a supply of services when its customer has more than one establishment. If a general Article 9(2)(e) rule is introduced, this is a critical area for the efficacy of such a place of supply rule.

III. Conclusion

Tax Executives Institute appreciates this opportunity to present our views on the Consultation Paper relating to the place of supply for services rules. These comments were prepared under the aegis of TEI's International Tax Committee, with guidance from TEI's European Chapter. If you have any questions about the Institute's views or need additional information, please contact the chair of the European Chapter's Indirect Taxes Committee, Fabio DeAngelis at 41.21.924.2501 ([e-mail]), its vice chair Mark Keogan at 44.11.321.54908 ([e-mail]), or Fred F. Murray or Mary L. Fahey of the Institute's legal staff at 1.202.638.5601 ([e-mail] or [e-mail]).

(1) Given the focus of the consultation document on B2B transactions, TEI will address only those transactions. The Institute has not adopted a position in respect of B2C transactions.

(2) Although some commentators have expressed concern that the use of a reverse charge mechanism may be prone to fraud, TEI suggests that fraud is more likely to arise where tax is purportedly charged by one taxable person and recovered by the second taxable person, without the tax being paid by the first person.