Following changes to EU VAT law and Social Security regulations, companies need to revise the way they account for expatriate contracts. This task is especially urgent, because many companies are still applying accounting methods more appropriate for long-term postings than for the currently more usual short-term assignments. A failure to act now will steadily increase the financial risk of disputes with tax authorities in areas such as transfer pricing.
For tax and transfer pricing purposes, not all expats are equal. Imagine a multinational company sending an employee from a ‘home country’ to a ‘host country’ for a three year posting as sales manager. In this case, the expatriate is likely to be under the direction and control of the host company. Hence, the assignment will generally be considered a ‘supply of staff’ transaction from a VAT perspective. If, however, an expert from the home country is flown in for a mere three weeks to resolve a specific IT problem in the host country, this is considered a ‘supply of service’, as control over the employee remains firmly with the company in the home country.
Under current EU law, the home country should not charge the host country any VAT on its invoice for supply of staff, as the host country itself must account for VAT on the value of the transaction under the ‘reverse charge’ principle, i.e., it self-assesses for the VAT due. Such a clear, general rule is absent from EU law for expat assignments that are regarded as a supply of service. In this case, individual member states have had, up until now, the discretion to decide whether VAT was due in the home country or – via reverse charge – in the host country.
This discretion, however, is about to disappear. Under new VAT rules effective from January 1st 2010, virtually all services supplied cross-border within the EU will be subject to reverse charge VAT in the host country. Home country companies in EU member states that have been adding VAT to their invoices when billing for international assignments must therefore cease doing so, zero rating the invoice instead. The practical application of these new VAT rules will have significant impact on accounting and financial systems, invoice processing and business accounting planning.
This is a major change, because ‘supply of service’ expats are rapidly crowding out their ‘supply of staff’ colleagues. In our current cost-conscious business environment, many companies prefer short term or even commuter assignments to the traditional long term expat posting with its historically high level of assignment-related benefits.
This shift from long term to short term is also important for transfer pricing purposes. As an expat assignment almost by definition involves a transaction between two related parties, ‘arm’s length pricing’ should rule the contract between home and host country. But what is the appropriate methodology to establish an arm’s length price? In the case of a long term ‘supply of staff’ posting, a ‘cost plus’ calculation is often most appropriate: the gross salary of the expatriate with a mark up for additional expenses. In the case of a short-term assignment, however, a ‘market price’ is more often than not the most suitable method, i.e., the home country should recharge the host country at the same rate an external consultant would charge.
The relevant decisions regarding VAT and transfer pricing on expat contracts can be complicated. The following factors all play a role: duration of the assignment; control over the employee; location of the employee’s supervisor; other services rendered in conjunction with the assignment; and location of the company that ultimately bears the cost. Each case is unique. Unfortunately, the VAT cross-over point from ‘supply of staff’ to ‘supply of service’ does not always coincide with the transfer pricing border between ‘cost plus’ and ‘market price’.
To complicate matters further, the way a company accounts for an expat posting from VAT and transfer pricing perspectives should be in line with its description of the assignment to obtain the ‘Certificate of Coverage’ for social security purposes. As of May 1st, 2010, Regulation 883/2004 will harmonize and modify some criteria of this E101 certificate.
Because of the changes in VAT law, the introduction of Regulation 883/2004 and the increasing importance of short-term assignments now is the time for companies to have a fresh look at how they account for international assignments. Descriptions of the assignments for VAT, transfer pricing and social security purposes should be compatible with each other. VAT and transfer pricing accounting for the transactions should be reasonable and well-documented.
National tax authorities are exchanging ever more information and are rapidly becoming more sophisticated and assertive in areas such as transfer pricing. What’s more, in the current environment of enormous fiscal deficits, tax authorities will probably focus on areas such as transfer pricing to increase revenues. Companies therefore ignore the issue of how to account for international assignments at their own peril.
Peter Ferrigno, Partner at Ernst & Young, Head of EMEIA Human Capital (Europe, Middle East, India and Africa)
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