Value-added taxes (VATs), which have gained wide acceptance throughout the world, have many complexities for U.S. businesses that may be unfamiliar with this type of levy. Understanding key aspects of the tax can help to boost the bottom line and mitigate or eliminate potential liabilities.
Nearly all countries outside the United States impose a VAT, sometimes also called a goods and services tax or a consumption tax. The United States is the only industrialized and Organisation for Economic Co-operation and Development member country without a VAT system. As a side note, the U.S. consumer products industry, which is the largest business lobbying group in the United States, strongly opposes a VAT in the United States because it is projected to adversely impact that industry. It is considered a regressive tax, which means it is imposed at an equal rate on everyone irrespective of their income level, like a sales tax. Primarily for these reasons, the United States has rejected implementing a VAT.
Even traditionally tax-friendly Gulf Cooperation Council (GCC) countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates – have embraced VATs. The United Arab Emirates and Saudi Arabia were the first to introduce a VAT in 2018 with a rate of 5% (though Saudi Arabia has since tripled that rate to 15%). Bahrain implemented a 5% VAT in 2019, Oman is scheduled to implement a VAT effective April 16, and Kuwait and Qatar are in the process of enacting VAT legislation.
VATs are transactional taxes levied on practically all goods and services. “Goods” generally refers to tangibles and “services” to intangibles, or more broadly anything that is not deemed to be goods. VATs are imposed throughout the supply chain on both business-to-business and business-to-consumer transactions, including the importation of goods and services and intercompany supplies. A physical presence in a VAT jurisdiction is generally not a condition to be liable to VAT. However, for most businesses, VATs incurred on purchases, whether for resale or internal use, are potentially refundable.
Like the U.S. single-stage sales tax, the aim of a VAT is for the tax to be borne by the final customer or consumer. However, the advantage for local governments of the multistage VAT is that tax revenue is collected earlier because it is imposed throughout the supply chain, based on the value added in each phase of the supply chain.
Consumer prices are usually quoted inclusive of VAT. This means that the price quoted on an invoice or on the shelf includes the VAT, unless otherwise indicated. Though the GCC countries introduced their VATs at a modest 5% rate, most countries have VAT rates exceeding 10%, and some European countries have VAT rates of 25%. VATs tend to raise a lot of tax revenue in a manner that is fairly easy to administer, too. For example, a 5% VAT introduced in the United States would raise about $350 billion in tax revenue annually. To put this into perspective, the U.S. federal corporate income tax revenue collected annually from U.S. corporations is roughly $210 billion.
For U.S. businesses, this means that every activity with a non-U.S. element should be analyzed from a VAT perspective. Active management of VATs is critical for businesses to minimize exposure for collection obligations and to pursue opportunities for refund claims on purchases. Care should be exercised to ensure contracts include VAT clauses and, where relevant, details on shipping terms and title transfer.
The South Dakota v. Wayfair Inc. Supreme Court case in the United States, which adopted an economic nexus by means of sales thresholds without the requirement of physical establishment for state sales taxes, has highlighted what many countries with VATs already apply – rules simply deeming a particular transaction to take place in their jurisdiction, irrespective of a physical presence.
In an effort to secure taxation in the jurisdiction of consumption, the European Union was the first in 2003 to require nonresident providers of electronically supplied services or digital services to register and account for VAT on sales to consumers in those countries. Subsequently, an increasing number of countries around the world have enacted similar rules imposing an obligation to collect VAT on businesses that lack a physical presence within their borders. Business customers generally self-assess VAT on these purchases. However, the obligation to register and account for VAT arises from sales to consumers, though there are countries that apply the same rules to sales to business customers.
Note that VATs should not be confused with a digital services tax (DST), which is a corporate-type tax on revenue generated from certain digital services and is separate from VATs. The United States has opposed DSTs and has levied or threatened increased tariffs on countries that implement DSTs as a way to encourage countries to remove those DSTs. In addition, the U.S. Treasury Department and the IRS have recently issued new regulations indicating that DSTs are not a creditable foreign income tax for purposes of claiming a foreign income tax credit.
Countries are expanding VATs to tangible products (i.e., goods and so-called low-value consignments) that are purchased from a different jurisdiction and may go untaxed due to tax-free import thresholds. Countries are seeking to reduce or abolish these tax-free thresholds on the importation of tangible goods and at the same time impose a VAT collection obligation on nonresident businesses. Such an obligation may arise irrespective of shipping terms and the selling business not being the designated importer into the country of the consumer.
Scrutiny by local tax authorities across the world has intensified over the years, which has included monitoring internet traffic to identify nonresident businesses selling to consumers in their jurisdiction. The COVID-19 pandemic has caused a surge in online consumer purchases, and governments are seeking to increase VAT revenue to replace decreasing corporate income taxes and to finance COVID-19 relief measures. In addition, the implementation of new customs borders as a result of the United Kingdom’s departure from the EU as part of Brexit could create VAT compliance issues for firms doing business in the United Kingdom.
For U.S. businesses, it is important to understand how VATs are administered across jurisdictions. Failure to collect a VAT when required can create significant penalty exposure. Although the principles of VAT are similar across jurisdictions, numerous complexities can arise in different countries. Businesses need to be mindful of these complexities, including various exceptions and rates, differing levels of published guidance, and the frequency of required VAT return filings to minimize the administrative burden and avoid penalties. Exposure to VATs may be minimized or eliminated by means of a carefully drafted contract.
Andrew M. Bernard Jr., CPA, is managing director for Andersen in Philadelphia and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.
Benno Tamminga is managing director for Andersen in New York. He can be reached at email@example.com.