With our earlier Transfer Pricing webinar having placed a focus on all things transfer pricing, we are taking the opportunity to shine a light on the often overlooked interaction between transfer pricing and VAT. These are two areas of tax not often considered together and yet the possible VAT implications of transfer pricing adjustments is a topic discussed by the VAT Expert Group at an European Commission level.
Transfer pricing is a direct tax aimed at ensuring proper allocation of income between parties. VAT, on the other hand, is an indirect consumption tax. While conceptually different, there may be VAT implications arising out of transfer pricing adjustments. Unfortunately the approach to those VAT implications varies across different Member States and there is little specific guidance or case law to assist companies in determining the correct treatment. Non-binding recommendations as to the treatment have been put forward at an EU level and these can offer some level of direction to businesses navigating this area.
What are the potential VAT implications of Transfer Pricing adjustments?
When looking at whether a transfer pricing adjustment has VAT implications, we need to understand what constitutes a taxable transaction for VAT purposes, and how the transfer pricing adjustments may be linked to such taxable transactions and the associated taxable amount.
For a taxable transaction to exist for VAT purposes, there must be a supply of goods or services for consideration by a taxable person acting as such. For VAT purposes, transfer pricing adjustments may potentially be treated as:
- a pricing adjustment to a previous taxable transaction,
- as consideration for a separate taxable transaction, or
- alternatively the transfer pricing adjustment is outside the scope of VAT.
As a starting point, the key elements to identify are the specific supply, specific consideration and importantly whether there is a direct link between that supply and the consideration received. The ‘link’ when analysing transfer pricing adjustments looks to whether the adjustment can be split so as to directly connect the Transfer Pricing adjustment (or part of the adjustment) to a specific underlying supply of a good or service. Where this link is present, the adjustment may be viewed as a taxable transaction for VAT purposes and amendments to the relevant VAT amounts required. Contracts in place may specifically define transfer pricing adjustments and provide sufficient detail to clearly identify the type of adjustment being made, and subsequently the VAT treatment that follows.
The types of adjustments where a direct link is generally not identifiable may be adjustments to achieve a guaranteed profit margin, or a profit split adjustment. In these circumstances, the adjustments are not taxable transactions and so tend to fall outside the scope of VAT. In other words, they are ignored for VAT purposes and no further action is required to be taken from a VAT perspective.
The EU VAT Expert Group has put forward a recommended approach whereby, unless otherwise contractually agreed, all types of transfer pricing adjustments be treated as outside the scope of VAT where it relates to B2B transactions and the parties involved have full VAT recoverability. It remains to be seen whether this is an approach that will be universally accepted across EU tax authorities.
Impact on VAT Compliance
Where an adjustment falls to be outside the scope of VAT, there should be no corresponding impact on the VAT compliance requirements. However, where it has been determined that an adjustment has given rise to a VAT impact, debit or credit notes may be required and any resulting VAT liability/deduction should be captured in the relevant VAT and statistical returns.
Invoicing – Word of Caution
While a transfer pricing adjustment may fall outside the scope of VAT, documents to evidence the adjustment may be required by the parties. There is a risk that where such ‘invoices’ are described as such, the tax authorities may assume that VAT is due on such adjustments. It may therefore be beneficial to ensure any such transfer pricing adjustment documents refer to alternative wording rather than ‘Invoice’ or ‘VAT invoice’. A description such as ‘Transfer Pricing Adjustment’ or ‘Transfer Pricing Payment Request’ may be more suitable and avoid any potential confusion with the tax authorities.
VAT Recovery on Intra Group Charges
Another area in which the VAT implications of transfer pricing needs to be very carefully considered is where the recipient does not have full VAT recovery. Where intergroup supplies/recharges take place, there is still a supply for VAT services with a requirement to charge VAT. This can be overlooked. Whilst it is possible to put a VAT group in place to eliminate VAT on intra-group supplies between Irish entities, it is not possible to include a non-Irish entity in a VAT group.
In cross border situations, VAT is often accounted for on a reverse charge basis. Where the recipient does not have full VAT recovery they are technically required to account to their Revenue authorities for the VAT on the supply. An example of where this can arise is in the context of financial services groups where a head office may consider charging costs to overseas subsidiaries. When determining a transfer pricing strategy, consideration needs to be given on whether the strategy creates any VAT cost. This is an area that Revenue authorities tend to look at closely in Revenue audits.
As shown, there are numerous considerations to be borne in mind when assessing the potential VAT implications of transfer pricing adjustments. It should also be noted that transfer pricing adjustments could have consequences for customs valuations. In a post-Brexit world, this could be an area of ever-increasing significance.
Due to the lack of clarity and guidance regarding the interaction between transfer pricing and VAT, we would advise that the VAT treatment of any transfer pricing adjustments undertaken be checked on a case-by-case basis.
To discuss the above in further detail, please contact our team on (01) 6440100 / (090) 6480600:
- Lorraine Morrison, VAT Director
- Ronan McGivern, International Tax & Business Advisory Partner
- Jackie Masterson, Head of Tax, Partner
While every effort has been made to ensure the accuracy of information within this publication is correct at the time of going to print, RBK do not accept any responsibility for any errors, omissions or misinformation whatsoever in this publication and shall have no liability whatsoever. The information contained in this publication is not intended to be an advice on any particular matter. No reader should act on the basis of any matter contained in this publication without appropriate professional advice.