INSIGHT: EU Chain Transactions—in a Minefield

A chain transaction is characterized by the successive supply of the same goods between different parties transported directly from the first party to the latter.

When trading goods within the EU the question about which jurisdiction can exert the power to tax each supply with value added tax (“VAT”) becomes relevant.

To prevent double taxation in the EU there are specific provisions that exempt the supplies in the “ship from” locations insofar as the purchase of the goods is taxed in the “ship to” country.

The VAT zero rate on intra-Community supply of goods is conditional upon the fulfillment of four conditions:

• the right to dispose of the goods as owner has been transferred to the purchaser;
• the supplier establishes that those goods have been dispatched or transported to another member state;
• as a result of that dispatch or that transport, the goods have physically left the territory of the member state of delivery;
• the purchaser has communicated to the supplier its VAT identification number issued to that purchaser in the member state of destination.

The crux of the matter lies in deciding which of these transactions deserve to be exempted/zero rated and this is something that depends on the overall assessment of the specific circumstances of each case.

Current Rules

If the customer (B (normally B acts as intermediary on its own name)) informs the supplier (A) that it is planning to sell the goods on to another party (C) located in another EU member state prior to the goods leaving the country from where they are supplied, this turns that initial supply (A–B) into fully taxable, on the basis that the ownership of the goods was transferred to the last party of the chain before the intra-Community transport occurred.

(However, the second supply (B–C) then benefits from the zero rate, although at the cost of the intermediary party having to register itself for VAT in the “ship from” EU country to carry out such zero-rated supply, with the obligation for the last party of the chain (C) to account for the VAT as intra-Community acquisition.)

However, if the transfer of ownership is to be passed after the goods have left the “ship from” country, then the first supply (A–B) is likely to enjoy a zero rate. In addition, B may take advantage of the triangulation simplification in the ”ship to” country, which basically means its subsequent intra-Community acquisition of the goods is regarded as not subject to VAT and the VAT due on the supply to C is self-assessed by this party.

In any case, as soon as the intermediate party (B) is willing to sell the goods to somebody else, and after receiving the order from this last party of the chain (C) places an order to the supplier, the initial supply (A–B) irremediably fails to fulfil the zero rate requirements.

The legal certainty for the first supplier of the goods is shaken by many variables which are at times beyond the reach of the business.

When party B in an A–B–C chain does not inform A about its intentions to resell the products on to C before or after the transport of the goods ends, what does it mean for the first supply between A and B? Is it eligible for a zero rate or is it conditional on the fulfillment of some conditions that A is not aware of?

Apparently, ignorance of those conditions does not protect the parties from facing VAT liabilities in either the dispatching or the receiving countries or both, which creates a compliance burden on every business before accepting any orders from their customers.

In instances when C picks ups the products at A’s premises, that irrevocably translates into the supplies of A to B being taxable in the “ship from” country and only the supply from B to C receiving the zero rate, because such action of collecting the products equates to an automatic transfer of ownership occurring along the chain.

In many situations, B wrongly charges VAT of the “ship to” destination to C and C then tries to claim it back, which leads to an audit where the tax authorities reject the refund on the basis of the incorrect VAT treatment of the underlying supply chain.

Looking Forward

As of January 2020, in chain transactions the intra-Community transport by default is going to be assigned to the first supply (from A to B), which allows for zero rating that transaction with fewer hurdles. In any case, the intermediary may decide to opt out of that simplification by communicating its VAT identification number in the “ship from” member state, which will result in not zero rating that supply made to it.

In 2022, if a new set of rules is finally passed (as is more likely than not) the existing intra-Community VAT will be replaced by the so called “definitive system.”

Under this new regime, suppliers will have to collect the VAT due on their “intra-Union” supplies of goods and either register in each member state of destination or use a one-stop-shop mechanism to remit the VAT centrally in their member state of identification, which will subsequently distribute the VAT funds to the respective member states of destination.

The definitive system appears to over-complicate trade for many businesses that do not have the scale to manage the process of remitting VAT at destination, at the correct rate as applicable in the member state of destination.

What Should Companies Do?

Even if, after 2020 and 2022, the VAT rules on intra-Community trade might be revamped again, companies should not delay the articulation of a VAT-compliant framework around supply chain which evolves according to the upcoming VAT legislation changes.

The situation requires a strategic mindset and the willingness to remove the possibility of threats potentially affecting long and complex supply chains.

Planning Points

Companies must realize that most of their supplies may potentially be reassessed by the tax authorities unless they take some precautions.

Firstly, suppliers dispatching products cross border to a destination different from the “sold to” address provided by their customers have to verify the conditions under which these products are supplied onwards, in order to prevent a VAT liability that can be imposed on them if they did not act with sufficient diligence.

Be aware that there are some Incoterms (internationally recognized terms published by the International Chamber of Commerce) that are problematic, such as “EXW” (Ex Works) or “FCA” (Free Carrier). Avoid them at all cost or prepare for some backlash from the auditors…

Secondly, traders should consider reviewing their contracts with both their vendors and their customers to check if the transfer of ownership is passed in the case of the first supply, in the “ship from” country and in the second leg of the supply chain, in the “ship to” country.

In addition, businesses have to stay vigilant with regard to the information sent upwards to their vendors, because anything they write or say that slightly departs from the wording of their contractual arrangements can spoil the optimal VAT set up of the whole supply chain and financially ruin primarily the first party in the chain.

Gorka Echevarría Zubeldia is a Senior International VAT Manager.
He may be contacted at: gezubeldia@gmail.com