GLOBAL TAX WEEKLY ISSUE 234 | MAY 4, 2017 a closer look

SUBJECTS TRANSFER PRICING INTELLECTUAL PROPERTY VAT, GST AND SALES TAX CORPORATE TAXATION INDIVIDUAL TAXATION REAL ESTATE AND PROPERTY TAXES INTERNATIONAL FISCAL GOVERNANCE BUDGETS COMPLIANCE OFFSHORE SECTORS MANUFACTURING RETAIL/WHOLESALE INSURANCE BANKS/FINANCIAL INSTITUTIONS RESTAURANTS/FOOD SERVICE CONSTRUCTION AEROSPACE ENERGY AUTOMOTIVE MINING AND MINERALS ENTERTAINMENT AND MEDIA OIL AND GAS

COUNTRIES AND REGIONS AUSTRIA BELGIUM BULGARIA CYPRUS CZECH REPUBLIC DENMARK ESTONIA FINLAND FRANCE GERMANY GREECE HUNGARY IRELAND ITALY LATVIA LITHUANIA LUXEMBOURG MALTA NETHERLANDS POLAND PORTUGAL ROMANIA SLOVAKIA SLOVENIA SPAIN SWEDEN SWITZERLAND UNITED KINGDOM EMERGING MARKETS ARGENTINA BRAZIL CHILE CHINA ISRAEL MEXICO RUSSIA SOUTH AFRICA SOUTH KOREA TAIWAN CENTRAL AND EASTERN EUROPE ARMENIA AZERBAIJAN BOSNIA CROATIA FAROE ISLANDS GEORGIA KAZAKHSTAN MONTENEGRO NORWAY SERBIA TURKEY UKRAINE UZBEKISTAN ASIA-PAC AUSTRALIA BANGLADESH BRUNEI HONG KONG INDONESIA JAPAN MALAYSIA NEW ZEALAND PAKISTAN PHILIPPINES SINGAPORE THAILAND AMERICAS BOLIVIA CANADA COLOMBIA COSTA RICA ECUADOR EL SALVADOR GUATEMALA PANAMA PERU PUERTO RICO URUGUAY VENEZUELA MIDDLE EAST ALGERIA BAHRAIN BOTSWANA DUBAI EGYPT ETHIOPIA EQUATORIAL GUINEA IRAQ KUWAIT MOROCCO NIGERIA OMAN QATAR SAUDI ARABIA TUNISIA LOW-TAX JURISDICTIONS ANDORRA ARUBA BAHAMAS BARBADOS BELIZE BERMUDA BRITISH VIRGIN ISLANDS CAYMAN ISLANDS COOK ISLANDS CURACAO GIBRALTAR GUERNSEY ISLE OF MAN JERSEY LABUAN LIECHTENSTEIN MAURITIUS MONACO TURKS AND CAICOS ISLANDS VANUATU GLOBAL TAX WEEKLY ISSUE 234 | MAY 4, 2017 a closer look CONTENTS

FEATURED ARTICLES Tax Compliance And Planning Issues For NRAs Topical News Briefi ng: US Tax Reform – With Ties To Th e United States: Part Two A Movable Feast Stephen Flott, Joseph Siegmann, Brittany Oravec Th e Global Tax Weekly Editorial Team 31 and Gina Lee, Flott & Co. 5 Mexico: Digital Strategy For Tax Obligations – UK Tax Policy And Th e 2017 Finance Bill – New Developments All Change Please! Gustavo Gomez, Jaime Campos, Luis Beltrán Stuart Gray, Senior Editor, Global Tax Weekly 14 and Alberto López, Tax Partners, EY Mexico 33 Th e Value-Added Tax And Border Adjustment Topical News Briefi ng: Tax Debate: Enough Is Enough Hard Brexit Bargaining Awaits Paul Tadros, Schwartz International 23 Th e Global Tax Weekly Editorial Team 38 Danish Authorities Set To Reduce Fines Section 956 In Th e Partnership World: In Cases With Missing Or Incomplete An Aggregate Tour de Force With Some TP Documentation Bumps In Th e Road Anders Oreby, Bech-Bruun Taxand 27 Mitchell B. Weiss and Josh Fieldstone, Deloitte Tax LLP 40 NEWS ROUND-UP

US Tax Reform 66 BEPS 68 US Tax Reform Proposals Announced Asia-Pacifi c Firms Value Tax Certainty Most: Survey

Tax Foundation: US Tax Reform Plan Would Leave No One-Size-Fits-All Solution For Developing Nations' Revenue Gap Tax Regimes: UN

Ireland's Ibec Unfazed By US Tax Reform Plans IRS Releases Model Agreements To Exchange CbC Reports

EU Parliament Agrees Broader Hybrid Mismatch Fix FEATURED ARTICLES ISSUE 234 | MAY 4, 2017

The Value-Added Tax And Border Adjustment Tax Debate: Enough Is Enough by Paul Tadros, Schwartz International

Introduction Th e purpose of this article is to explain, in layperson's terms, the operation of a val- ue-added tax system ("VAT") and dispel the notion that a tariff / border adjustment tax ("BAT") / "reciprocal" tax (whatever that means) is similar to a typical VAT system.

Th e notion that the proposed BAT and VAT are similar and the intent is to level the "playing fi eld" is, bluntly, utter nonsense. Furthermore, what's disturbing is an apparent lack of under- standing of some of the fundamentals, and there must be a more informed and logical dialogue about the key issues.

Let's get one thing clear: Th e VAT is a consumption tax and the income generated by all sales (ex- port and domestic) is still subject to income tax in the country of residence of the seller.1

Th e other nonsensical notion is that a US-based seller exporting its goods (or services) to a coun- try with a VAT system is the one who is subject to the VAT and, therefore, being treated unfairly. (As an aside, if the exporter is paying the VAT and not recovering it, it needs to get better advice very quickly.)

For the purposes of this article, we refer to a foreign-based manufacturer as FCo and a US-based exporter as USCo.

VAT System: Introduction Assumption: Purchases/sales of raw materials and fi nished products are not exempt from VAT.

Th e basic premise of a VAT system is that the ultimate burden is borne by the last person in the supply chain, i.e. , the fi nal consumer.

23 Example: FCo purchases materials to be used in the manufacturing of product X. Whether the input materials are imported or not, FCo will pay the VAT (if imported, the VAT is paid at the port-of-entry to Customs; if locally, seller charges the VAT and remits to the government). FCo must maintain records of VAT it paid and VAT col- lected from its customers.

On the sale of product X to, say, a local retailer, FCo charges VAT on the selling price; nets the VAT collected against the VAT it paid (referred to as "input credits"); and re- mits the net amount to the government. On the sale of product X by the local retailer to the consumer, the consumer is charged VAT on the selling price. Th e retailer goes through the same process as FCo vis-à-vis record keeping and remitting to the govern- ment. Again FCo has the administrative headache of dealing with the VAT, but is not a net VAT taxpayer.2

Th is can be further illustrated by the following numerical examples:

VAT Example: Rate of 20 percent 1. FCo purchases materials for 100 2. FCo sells to wholesaler fi nished product for 150 3. Wholesaler sells to retailer for 170 4. Retailer sells to consumer for 200 The total VAT will be 40 (20 percent of 200) totally borne by the consumer

FCo Wholesaler Retailer Consumer Purchases 100 150 170 200 VAT on initial purchase of materials by FCo 20 VAT on value added through the supply chain: FCo to Wholesaler 10 [20 percent of (150 – 100)] Wholesaler to Retailer 4 [20 percent of (170 – 150)] Retailer to Consumer 6 [20 percent of (200 – 170)] VAT paid by Consumer 40 [20 percent of 200]

VAT System: Imports Into A Country Imposing A VAT Generally, when USCo sells to a customer ("A") in, say, Germany and A is the importer of record, it's A which will pay any import duties and the VAT, not USCo. If A buys from another German company, the only item it will not pay is the import duty – it still has to pay the VAT. Th erefore, if USCo is competing with another seller, the VAT part is totally irrelevant.

24 ( Note: Absent any free trade agreement, the import duty on the same product purchased will be the same irrespective of the country of the seller. Obviously if A, in our example, sources locally there won't be an import nor a potential duty.)

On USCo's sales, title often passes outside the US to ensure foreign source income, and that is why USCo will generally not need to handle VAT. However, alternative situations exist. How about USCo selling via amazon.co.uk where USCo owns consumibles stored in UK warehouses? USCo generally is the importer of record and subject to VAT upon import. As a VAT taxpayer, USCo should register for VAT, collect VAT on the sale (likely via amazon.co.uk) and, again, does not bear the VAT's economic burden.3

VAT System: Exports From A Country Imposing A VAT Where FCo exports product X, the sale is often classifi ed as a "zero-rated" transaction for the purposes of determining the net amount of the VAT it is obligated to collect and remit to the government. Two important points to note:

1. FCo is still subject to local income tax on the income from the export sales; and 2. FCo's government forgoes VAT on the sale (based on the premise that consumption occurs elsewhere).

Th e country of export cedes the right to apply VAT (not the right to tax the income) to the coun- try in which the purchaser resides. For example, a Germany-based entity sells to a customer in Canada, which also imposes a goods and services tax ("GST", which functions in the same way as a VAT), Germany cedes the right to the VAT to Canada. Th e fact that Canada's GST rate may be lower than Germany's VAT rate is irrelevant. Th e ceding of the consumption tax, via the zero-rate mechanism, is not dependent on whether the importing country imposes a VAT or not.

Conclusion If there is a "disadvantage" to a US-based exporter, it defi nitely does not arise from the VAT. Th e disadvantage will arise from the following:

1. Th e strength of the US dollar vis-à-vis a non-US competitor's currency in relation to the purchaser's currency; 2. Th e import duty to the extent USCo's duty is higher than its competitor, perhaps due to a free trade agreement; and

25 3. Of course, the pre-tax price of the product (for example, USCo's price is USD1,200 while the competitor's price is USD1,000).

While some may posit, as justifi cation for the BAT, that VAT is subject to abuse (or in some cases, fraud), such a position/argument deviates from the debate. Th e BAT provides an income tax ex- emption for export sales and disallows a deduction (again, for income tax purposes) for imports.

States within the US exempt export sales from sales/use tax. If a tangible good is sold by FCo to a buyer in, say, California on which sales/use tax is imposed, should FCo's country contend that this is an unfair practice?

So let's get the facts straight and have an informed debate.

E NDNOTES 1 While there may be some jurisdictions providing an income tax exemption for specifi c activities, this article focuses on the general rules and it is doubtful such exemptions will be found in developed countries given that they will be in violation of WTO rules. 2 We realize there are specifi c circumstances where FCo might be a net payer, but those are generally the exception, such as when certain items might be subject to a 0 percent VAT versus being VAT- exempt. Such details are beyond the scope of this article. 3 Yes, we understand there could be a time value of money argument on the cash fl ow, but let's keep the big picture in perspective. Here are two quick e-commerce-related items – Non-US sellers on amazon.com, Shopify and other US e-commerce companies where goods are stored in the US have a frustrating time because many need to register for state sales tax, even though there might not be a US trade or business or Permanent Establishment at the federal level or income tax nexus at the state level. Flip the situation for a moment where USCo sells via amazon.co.uk and doesn't understand that the sales price a buyer sees includes VAT, meaning that price is not USCo's revenue but the VAT plus revenue. USCo blames the VAT for its losses, but the real problem might simply be poor pricing and/or ineffi ciency. We call that "user error" by not hiring the right advisors in the fi rst place.

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