What Does a US Tax Professional Need to Know about VAT 1 COST Canadian Tax Workshop for U.S. Companies October 2nd, 2014 James Freed - KPMG LLP – Chicago Karl Frieden - Council On State Taxation, Washington DC

Agenda Overview of Global VAT VAT Compared to Retail Sales Tax VAT Terminology and Rates – a Recap Global VAT Risk and Management Will the U.S. Continue to be “Tax Exceptional”? 2

Overview of Global VAT 3

Growing Importance of VAT VAT is a concern for companies doing business globally Many governments are shifting the emphasis from taxing earnings and gains to taxing consumption Many governments use VAT as first tool in fiscal policy −Reduce to stimulate consumption −Increase to reduce deficits Almost 160 countries have a VAT regime −U.S. is only OECD country without VAT −In Canada, regime is known as GST/HST −Other countries considering VAT include many in the Middle East EU average VAT rate is above 21.5% (and rising) Trend is towards increasing rates and anti-avoidance measures to defend yields and reduce the “tax gap” 4

VAT Enactments Timeline >160 Countries Countries Countries Countries CountriesCountriesCountriesCountriesCountriesCountries Source: OECD, Consumption Tax Trends 2012; WNT Research

Shift to Indirect Taxation 6 OECD Tax Revenue by Sector as Percentage of Total Source: OECD, Revenue Statistics

Evolution Average Standard VAT Rates in the EU Source: European Commission, VAT Rates in the EU, July 2014

VAT Compared to Retail Sales Tax 8

VAT vs. Sales and Use Tax VAT is imposed at the national government level whereas Sales and Use taxes are generally imposed at the sub- national level −Any U.S. consideration of VAT would necessarily involve issues of coordination with state and local sales taxes −Canada and India (proposed) are examples of multi-level VATs in a federal system −India (current) and Brazil deal with multiple levels largely by dividing (as opposed to sharing) tax bases VAT rates are typically high in comparison to Sales and Use tax rates −Standard VAT rates between 15%-27% vs. average Sales and Use tax rates of around 7.5% −VAT does have reduced rates, super reduced rates for certain categories of products/services and zero rates

VAT vs. Sales and Use Tax (cont.) VAT generally applies to inter-company relationships whereas Sales and Use tax frequently exempts inter- company transactions (as sale for resale or exempt transactions) −VAT grouping in certain countries allows disregarding inter- company transactions for VAT VAT typically applies to a much broader tax base of goods and services whereas Sales & Use tax generally only applies to goods and a limited number of services −When properly designed with full input tax recapture through credits, VAT allows taxation of all transactions without burdening business inputs −Burden of tax falls on final consumption −Avoids “errors” of current sales taxes and the impact on business inputs that have “doomed” efforts to extend sales tax to service transactions

VAT vs. Sales and Use Tax (cont’d) VAT refers to “place of supply rules” to determine where VAT is due, whereas Sales and Use tax generally refers to “nexus” for jurisdictional rules. −Collection obligation under VAT generally determined by turnover or receipts from within a jurisdiction. −There is no “physical presence” limitation placed on the collection of VAT compared with the “Quill” restrictions on sales and use taxes VAT is a multi stage consumption tax whereas Sales and Use tax is typically only levied at point of final consumption −Companies have to manage both output tax and input tax  Collect and remit output tax  Claim refund of input tax (if allowed) −VAT under “management” is on average 30 to 35 percent of a company’s non-US revenues.  For example, a company with $10 billion in non US sales will have approximately $3 billion of VAT under management.

VAT Terminology and Rates – a Recap 12

VAT Terminology Note the focus on movement on goods/services, rather than movement of money VAT charged by businesses on sales made to their customers “Output” meant to reflect outgoing sales Output Tax VAT spent by businesses on qualifying business expenditures “Input” meant to reflect incoming purchasing Input Tax VAT terminology for a “sale” Goods: tangibles; Services: intangibles Supply Payment received in return for the supply of goods or provision of services According to the EU, “everything received in return for the supply of goods and services, …” Consideration Situation in which seller of services (usually foreign) is not liable for VAT, and instead buyer is required to account for VAT; commonly applied on intra-EU transactions Reverse Charge Mechanism 13

VAT Rates EU VAT rates range from 15% to 27%. Average EU VAT rate is above 21.5%—somewhat less in ASPAC and LATAM Standard Any rate lower than the standard rate E.g., basic food stuff, books—usually political decision Reduced No VAT is charged, but seller has a right to credit input tax E.g., exported goods and services Aka “Exempt with credit” Zero-rated No VAT is charged, but the seller has NO right to credit input tax E.g., certain financial, medical and education services Aka “Exempt without credit” Exempt Not within the scope of VAT in the jurisdiction concerned E.g., charities and non-business Outside Scope 14

Global VAT Risk and Management

Impact of Effective VAT Risk Management VAT is a transaction tax – must be considered for every purchase (input VAT) and every sale (output VAT), and even some movements of own goods between some countries and states −The total amount of output and input VAT managed by a company represents the “VAT through-put” Not simply an “in and out” tax, as not all VAT may be recoverable 16

VAT Throughput Example (fully taxable business) In millions, USD: Sales$5,000 Purchases(3,000) Salaries(1,000) Transfer price adjustments(500) Net Income500 Income Tax (30%)150 Total Output VAT (rate 20%)1,000 Total Input VAT (rate 20%)600 Total VAT flow through the business1,600(*) (*) Total VAT represents 28 percent of company gross sales (including price adjustments)

Global Challenges VAT credits vs. refunds Cashflow VAT system Import restrictions Multiple indirect taxes and jurisdictions Difficulties with VAT refunds Importer of record must be owner to recover VAT Proposed reform Current reform Proposed introduction Import valuation issues Various rate changes 18 Reform in 2015 EU – Sourcing changes for 2015

What Happens if You Get it Wrong? Underpaid VAT liability Budget plans inadequate to cover unexpected VAT costs Financial losses e.g., the VAT becomes a real cost if irrecoverable or never paid out by the tax authorities Penalties and interest imposed by authorities can be up to 200% of the tax due, if not mitigated Closer future scrutiny of processes by the tax authorities 19

What Happens if You Get it Wrong? (Cont’d) The impact of material VAT liabilities on financial statements Damage to business relationships −Customers being assessed for incorrectly charged VAT recovered on purchases −Raising VAT-only invoices in attempt to mitigate own liability Cost of correction −System updates/implementations −Evaluation of errors and reporting outputs 20

Will the U.S. Continue to be “Tax Exceptional”? 21

Taxes as a Percent of GDP – 2012 Source: OECD Tax Revenue Statistics, January 17, 2014 *= 2011 Data

Tax Revenue Distribution – 2012 Taxes by Type as Percent of Total Taxes Source: OECD Tax Revenue Statistics, January 17, 2014 The U.S. relies relatively more on income taxes and significantly less on consumption taxes than other OECD countries

Long-Term Budget Outlook is Still a Concern Calculations based on Congressional Budget Office, The 2013 Long-Term Budget Outlook, revised October 2013

Contact Information Karl Frieden Vice President and General Counsel Council On State Taxation James Freed Senior Manager KPMG LLP

Thank You 26