Recovering foreign value-added tax (VAT) and goods and services tax (GST) and reducing excess foreign VAT/GST credits are crucial parts of an effective indirect tax strategy. VAT/GST recovery by nonresident businesses is difficult or even impossible in many countries. Even where refunds apply, long delays are common. As a result, unclaimed or irrecoverable foreign VAT/GST is a common cause of excess indirect tax credits, leading to negative cash flow and absolute costs.
Why is foreign VAT/GST a common cost of business?
- VAT/GST applies worldwide
VAT/GST applies worldwide: most countries now impose a VAT/GST or similar sales tax. As business has become increasingly international, more businesses are paying foreign VAT/GST charges in their everyday activities by having executives travel, by attending or hosting international meetings and conferences, and by engaging in global trade.
Most global businesses incur VAT in countries where they are not established – for example, on trade fairs and conferences, filming on location, meals and accommodations, travel, transportation and fuel, business entertainment, marketing and advertising, professional services, telecommunications, printed materials and stationery, and training.
- Input tax recovery by VAT/GST taxpayers is a crucial feature of all classic VAT/GST systems
Input tax recovery by VAT/GST taxpayers is a crucial feature of all classic VAT/GST systems: VAT/GST taxpayers have the right to recover input tax paid on legitimate business expenses and receive refunds or credits for excess input tax. That way, VAT/GST “flows” through the system, and the burden of taxation falls on final consumers, not on businesses within the supply chain. This offset system usually works well for domestic taxpayers but not so effectively for nonresident businesses. In many cases, foreign VAT/GST is not recovered, and it becomes a cost of doing business.
- Sticking tax
Sticking tax: irrecoverable VAT/GST is often referred to as “sticking tax” because it becomes part of the cost of goods and services within the supply chain. Common reasons for “sticking tax” include:
- Countries do not refund VAT/GST to nonresidents.
- Businesses do not track and identify foreign VAT/GST.
- Businesses do not claim foreign VAT/GST refunds.
- Expenses are not supported by suitable detail and documentation.
- Expenditures do not qualify for input tax recovery.
- Refund claims are rejected for formal reasons.
- Refund claims fail local tax audits. Read more in Managing indirect tax controversy: dealing with audits and disputes
- Tax administrations
Tax administrations: because the tax is collected and remitted by businesses, the VAT/GST system can be vulnerable to fraud and manipulation by dishonest traders. Tax administrations may be concerned about their ability to verify and audit nonresidents’ refund claims effectively. Some countries may also be concerned about the costs and resources associated with establishing and administering refund schemes. In most cases, these concerns have been overcome only where there are clear mutual refund protocols (such as those in the EU).
- Can this situation continue?
Can this situation continue? As business becomes increasingly global, more taxpayers are likely to incur VAT/GST costs in foreign jurisdictions. The issue of “stuck” foreign VAT/GST resulting from difficult administrative procedures and a lack of mutual refunds may become a higher priority for global businesses, and they may seek to influence tax policy in this area.
The Organisation for Economic Co-operation and Development (OECD), for example, has already indicated in its International VAT/GST Guidelines that countries should take steps to keep nonresidents from incurring input tax costs. Tax administrations may also be willing to change their stance as the increased use of technology, data analytics and e-audit techniques improves administrative processes and eases their concerns about the costs and risks associated with granting refunds to nonresidents.
Common expenses that may attract foreign VAT/GST
- Hotel, restaurant and entertainment costs
- Meeting rooms, equipment hire, catering costs and business support services for conferences and events
- Advertising and promotion in the territory
- Technology purchases
- Car hire, gasoline and vehicle maintenance
- Legal and professional services
- Transportation, warehousing and processing of goods
- Goods for resale or onward supply
- Setup costs for a local office, shop or warehouse