New VAT Rules in Europe
The new rules will take effect on January 1, 2005, by which time all member countries will be required to have brought into force the necessary national implementing legislation. The new VAT directive will also apply to the Eastern European countries that will become members of the European Union in May 2004. The new VAT directive is supposed to eliminate current issues of double taxation and non-taxation and distortion of competition between traders.
The gas and electricity market in the member countries of the European Union used to be dominated by major electricity generators, transmission system operators, and national and local distribution companies that were almost completely state-owned. The gas and electricity market was mainly a national market limited to trade within each member country’s borders.
Following the establishment of an European-wide internal market, the electricity and gas market in the member countries has been gradually liberalized in order to increase efficiency in this sector. As a result of the liberalization, gas and energy markets are no longer purely national and have started to operate on an international basis. This has led to the arrival of new market players such as power exchanges, independent power producers, brokers and traders. The dominant position of the state-owned companies, such as the large generators, is changing through privatization and mergers.
As a result of new EU and national measures, a considerable change in the operation of these markets is taking place. The liberalization of the gas and electricity market with its increasing cross-border transactions has led to the introduction of specific VAT rules on the place of supply of such goods.
Place of Supply
The “place of supply” determines in which member state the supply is subject to value-added tax.
VAT rates for electricity and gas range from 15% to 25%, depending on the country.
Before the liberalization of the gas and electricity market, the determination of the place of supply of electricity was not much of a problem because cross-border transactions were incidental. Supplies of electricity were mainly restricted to the home member countries, and the electricity or gas was taxed in those member countries. Opening up the gas and electricity market has resulted in an increasing number of cross-border transactions. As a consequence of the nature of these goods, the current rules regarding the place of supply are not adequate.
The current rules in effect under the national VAT legislation in all EU countries establish the “place of supply” as the place where the goods are located at the time when dispatch or transport to the person to whom they are supplied begins. In case the goods are not dispatched or transported, the place of supply is the place where the goods are when the title is transferred.
The nature of gas and electricity makes it difficult to determine the place of supply as the physical flows of these goods are hard to trace. For example, when electricity is generated in and supplied from member state A to member state B, this does not mean that the electricity will actually flow through the transmission grid from member state A to member state B. Furthermore, due to the method of transportation by transmission line or gas pipeline, such transportation cannot be demonstrated by traditional transport documentation that shows goods have departed or arrived. Under the current rules, cross-border supplies will in principle lead to VAT registration of foreign suppliers in the countries where the customers are located. The current rules are difficult to apply when the contractual relationship is not in line with the physical flow of the goods. This happens when the customer requests direct delivery of the goods to his buyer and the latter is located in a third country.
The new rules abandon one of the main principles that VAT is due where the goods are physically located at the moment of title transfer.
The new rules make a distinction between supplies of gas and electricity before and at the final stage of consumption.
For sales before the final stage of consumption, the “place of supply” is determined where the customer has his business premises or has a “permanent establishment” to which the gas or electricity is supplied, or, in the absence of such a place of business or permanent establishment, the place where he has his permanent address or usually resides. For application of this rule, the customer must qualify as a taxable dealer. For this purpose, a “taxable dealer” means a taxable person whose principal activity in respect of purchases of gas or electricity is reselling such products and whose own consumption of these products is negligible.
For sales at the final stage of consumption, or basically when the supply does not qualify as a supply before that final stage, the “place of supply” is determined where the customer has effective use and enjoyment of the goods. Where all or part of the goods are not in fact consumed by this customer, then these non-consumed goods are treated as if used and consumed at the place where he has established his business or has a fixed establishment for which the goods are supplied. In the absence of such a place of business or fixed establishment, he is treated as having used and consumed the goods at the place where he has his permanent address or usually resides.
In addition to the introduction of new rules for the place of supply of electricity and gas, new rules have been introduced regarding liability to pay VAT and imports so that VAT registration of foreign suppliers and double taxation may be avoided.
Liability for VAT
If both the supplier and his customer are located in the same country and the place of supply is in that country, then the supplier will have to charge VAT to the customer. However, if the supplier is located in one country and the customer is identified for VAT purposes in another country, then an obligatory reverse charge mechanism will apply. This means that the foreign supplier will not have to charge VAT as the VAT liability will be shifted to the customer. If the customer is not identified for VAT purposes, then the foreign supplier will in principle have to register in the country of that customer and collect VAT.
Exemption for Imports
The importation of gas through natural gas pipelines, or of electricity from outside the European Union will be exempted from VAT. This way, double taxation is prevented on gas and electricity supplied from non-EU countries.
The following example shows how the new rules will be applied.
A US company supplies electricity to a Dutch customer. If the Dutch customer is a taxable dealer or is identified for VAT purposes in The Netherlands, the supply by the US seller is subject to 19% Dutch VAT. Based on the obligatory reverse charge mechanism — the seller is located outside Holland — the Dutch customer will be liable for the Dutch VAT.
However, if the electricity is actually consumed in Belgium by a “permanent establishment” of the Dutch customer, then the supply is subject to Belgian VAT. VAT will have to be collected by the Belgian permanent establishment — again, because the seller is outside the country where the electricity is consumed.
If the Dutch customer is neither a taxable dealer nor identified for VAT purposes and consumes the goods in The Netherlands, then the place of supply will be treated as The Netherlands. In this situation, the obligatory reverse charge mechanism will not apply, which would mean that the US seller would have to register for VAT purposes in The Netherlands and collect Dutch VAT from the Dutch customer. However, in The Netherlands a general reverse charge mechanism applies whenever a foreign seller supplies goods to a legal person who does not qualify as a VAT taxable person. An example is a mere holding company or a public body. (This general reverse charge mechanism does not apply to natural persons.) However, most European countries have not introduced such broad application of the reverse charge mechanism as The Netherlands has done. Most countries merely apply the obligatory reverse charge mechanisms.
In any of these situations the importation of the electricity from outside the European Union will be exempted from VAT.
Under the introduced new rules, US suppliers of gas and electricity will not be confronted with VAT registration in the EU and will not have to charge EU VAT to buyers, provided two things are true: first, they do not have EU permanent establishments from which the electricity or gas is supplied and second, the buyers are “identified” for VAT purposes. VAT registration is required and VAT will have to be collected if the final consumers are not “identified” for VAT purposes, unless in that situation a general reverse charge mechanism applies.
Therefore, in order to avoid VAT liability, US suppliers should check with their European customers whether or not these customers qualify as taxable dealers and check their VAT identification numbers. If their European customers are not identified for VAT purposes, they should determine whether or not a reverse charge mechanism applies in the specific country where the electricity is being supplied.