Wednesday, 4 September 2019

Chain supplies or not, tax-exempt or not

During product sales the question arises frequently, how it can be recognized, if there are chain supplies for VAT, what are the circumstances based on which it can be defined, that the specific transaction is multi-characteristic, so more than one supplies are performed. The decision of the question is often very complicated and complex for the participating taxpayers.

We talk about chain supplies in the system of the value added tax (VAT), if a product is sold more than once and it will be dispatched or transported directly from the first supplier with the destination to the name of the last purchaser last in the row. In chain supplies there are three participants at least; however, the transportation of the goods happens only once. If the transport interrupts, it is not a chain anymore, at least not in the relation of the first supplier and the last purchaser.

Based on the regulations of the Hungarian VAT Act related to the place of supply of chain transactions, there is only one supply to be fulfilled where the product can be found at the beginning of the transportation. This only sale to which the transportation is allocated might be exempted from VAT as intra-Community supply of goods (under other conditions as well) if the sold product will be transported proven outside Hungary, but to the territory of the Community. The place of supply of goods preceding the mentioned tax exempted supply shall be the place where the transportation starts, while in supplies following the tax exempted supply the place of supply is where the transportation finishes.

The taxable persons should recognize, if they participate in chain transaction, because it affects the invoicing and the VAT-administration and obligations as well. However, not all of the participating parties is known by the first supplier, who is in contact with only one participating partner. There are minimum three parties in a chain transaction, but in certain cases at the same time long chains may incur making the identification of the whole chain even almost impossible.

In the chain supply with three participants presented in our first example, the Hungarian taxable person seller supplies the goods to its German parent company in a manner that the products will be transported directly to the French customers of the German taxable person. The question is how the Hungarian taxable person can make sure that it proceeds correctly, when it issues its invoice either with or without VAT to the parent company.

The incorrect tax treatment can cost much for the taxable person as the amount of the non-paid VAT is considered as tax shortage, for which tax penalty and late payment interest is due.

In order to decide, which supply might be considered as related to the transportation and therefore to be handled as tax exempt, the following documents and information might be decisive
  • contract between the parties,
  • declaration of the business partners,
  • delivery note,
  • the tax-number used by parties, specially the middleman,
  • which party orders the transportation,
  • destination of the products

In the lack of an exhaustive list, further documents might also be considerable, of course, which can help in the decision of the question.

The simplest case, if the transportation is ordered by the first supplier, he signs the contract; he orders the transportation (pursuant to the civil law he shall be considered as master of the case). In this case, his supply shall be considered as tax exempt, because the freight is related to that. If he orders the freight, he is also aware of the final destination of the goods. The first supplier can reasonably think to participate in a chain transaction, if he e.g. notices that the destination does not correspond with the headquarters or site of its direct purchaser.

If the middleman arranges for the transportation, the presumption of the Hungarian VAT Act shall also be considered. According to the main rule of the Hungarian VAT Act, the middleman arranging for the transport in his character of customer, so the supply towards him shall be deemed as tax exempt. However, he has the possibility to prove that the transport – and the tax exempt supply – is linked to his own supply towards the third in the chain. The refusal of the legal presumption is possible only for the taxable person since 2012. For the support of the taxation position of the Hungarian company it is reasonable to let the middleman declare its role in the chain and to request the delivery note upon handover of the goods. It is the most ideal case, when the middleman declares, that he purchases the goods for his further supply and he arranges for the transport in a manner that the goods will be delivered from the first supplier directly to the final customer and informs his partner about this fact. As we have already noted, the middleman proceeds in two roles, because he is simultaneously recipient and supplier of the same product, without physically receiving the goods. Depending on his choice either the first or the second supply can be qualified as supply related to the transportation, so as a tax exempt supply of goods.

For transportation by the final purchaser the exemption from VAT may only be valid for the second supply, because he can transport only in his character of recipient.

We note that the taxable persons do not have to perform the transport under any circumstances with their own means of transportation, they can avail of forwarding companies as well. Upon the definition of the tax exempt supply it is of importance, to which party the transportation might be allocated (order, direct, instruct and contact the forwarding company etc.).

Practical experiences: Upon the identification of the tax exempt supply it is often not enough to prove which party orders the transportation. In case of tax authority inspections we have experienced that the tax exempt supply of the Hungarian seller first in the row was refused by the tax authority with the reasoning that even the transport was ordered by him, the transport costs were directly further recharged to any other party. In this particular case according to the tax authority the supplier (as ordering and arranging person of the transport) cannot be considered as carrying out the tax exempt supply, because according to them he has ordered the transport on behalf of others in his character of mediator, so in reality the transport and the exemption are not related to his supply. Against this tax authority argumentation counter-proving is allowed, of course, and all circumstances of the case shall be considered, who shall be rated as the recipient of the transportation service both legally and economically.

The tax number usage of the middleman has a dominant importance. Based on the Hungarian VAT Act, only the taxable person shall be entitled for the contraprove of the presumption, so the role as middleman character. If he arranges for the transportation by indicating the tax number (which is his decision) he can confirm or contraprove the presumption related to the tax exempt supply, which has a significant influence on the VAT-treatment of the transaction. If he indicates a tax number in country of dispatch for the seller, while the goods will be transported to a destination outside that to another Member State, the first supplier shall be able to recognize, that it is not possible to invoice a tax exempt intra-Community supply and therefore the subsequent supply of the middleman shall be deemed as the tax exempt intra-Community supply in case the products are really transported from the the country.

The first supplier can neither perform a tax exempt supply if the middleman sells the products further for other taxable persons with a destination in the same country. Considering that in this case the place of supply of both sales shall be domestic based on the VAT Act, local VAT shall be charged for both supplies meaning of course that the middleman shall get registered for VAT in that country.

The middleman may also indicate a tax number in the country of destination. If the transportation is performed by the first seller or the middleman in his character of recipient, the first party performs a tax exempt intra-Community supply while in the destination country and the middleman declares an intra-Community acquisition (assuming, that the simplifying rules related to triangle-transactions are not applicable in in the country of destination). The subsequent there shall be taxable, so the taxable person issues the invoice for his customer charging domestic VAT in destination country.

We believe that even this relatively simple example can show the complexity of a chain supply. This complexity may be increased by the number of participants. Irrespective of such, however, the proper classification of the chain and their own role in such transactions is essential for businesses.

As for improper handling, incredible penalty consequences may incur by way of rejection the intra-community exemption of the sale, or even the respective deductibility of input VAT.

On the top of this, in Hungary 50% tax penalties plus late payment interest is also due for such mistake.

You may find more information about the Hungarian VAT legislation on our Hungarian blog

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