Mar
Is VAT really a tariff?
In the last few weeks VAT has been in the headlines due to the president of the United States, Donald Trump, stating VAT is a tariff and countries who apply it treat US companies unfairly. He then went on to promise he would raise tariffs on countries that apply VAT to US companies.
For many people who know how VAT works this statement came as a shock since it is widely known that VAT is not a cost to a business. If a business pays VAT on goods and services used for business purposes, they can recover it. What made the US president say VAT is a tariff and an unfair tax for US businesses? Was it just ignorance or is there a grain of truth in his statement?
What is a tariff?
Tariffs are taxes applied on the import of goods from outside the customs territory of a country. Tariffs have been in use for a long period of human history and were historically used to raise revenue for the country levying them. In the late 19th century and early 20th century some economists and politicians argued that tariffs should be used to help develop the industrial strength of their nation by sheltering their companies from competition in other countries. In the years of the Great Depression (in the 1930’s) it was argued that tariffs should be used to protect local manufacturers and jobs. Tariffs fell out of fashion in the later part of the 20th century as free trade agreements promised to offer consumers better products at cheaper prices.
But how do tariffs actually work? Well, local companies are able to manufacture goods at a certain cost and will sell them to customers in that country and (if possible) to customers in other countries. If two countries manufacture goods of the same type (let’s say country A and B) and there is a free trade agreement between them, the one that can manufacture them at the lower cost (Country A) will usually outcompete the other one (country B).
Sometimes, this is considered a good thing because the consumers in country B benefit from lower prices, although it will be at the cost their local companies losing customers and possibly going bankrupt. However, the government of country B can step in and impose a tariff on the cheaper goods coming from country A, usually for the reasons mentioned above.
The tariff is a tax applied on the import of the goods from country A into country B. Unlike VAT, a tariff usually cannot be recovered or offset, and therefore it becomes a sticking cost and is added to the price of the goods. Local manufacturers do not pay a tariff on their goods, only importers of the goods from country A.
Therefore, if the goods in country A used to cost £8 / item and the goods manufactured in country B cost £10 / item, then the tariff will usually be set to bring the price of the goods from country A in line with or above the £10 / item price of the ones manufactured locally. The local manufacturers are now as competitive or even more competitive than the ones abroad, even though they have higher manufacturing costs.
However, while tariffs can help local manufacturers be more competitive, this is done at the expense of final consumers who end up paying more for the same goods.
Is VAT a tariff?
The simple answer is: No, it is not.
VAT is a consumption tax that is charged by all companies in a supply chain, be they local or foreign businesses. These companies also have the right to recover the VAT charged by their suppliers thereby making the tax neutral and not a cost to them. The end consumer is the one that effectively bears the tax as it cannot recover any VAT charged to it.
VAT is therefore very different to a tariff as both foreign and domestic companies have to charge it (unlike a tariff where only the importer has to pay). Additionally, VAT is not a cost to these businesses as only the final consumer has to effectively bear the tax.
Then why does the US president think VAT is a tariff?
Well, because for some US businesses VAT can end up being a cost for the importer, similar to a tariff. For example, any UK, EU or US companies that import goods into the UK or the EU have to account for import VAT and usually pay it in order to clear the goods for customs. From a VAT perspective there is no discrimination or unfair treatment in this respect as all companies, whether EU or non-EU have to follow the same process. The importer of the goods is entitled to recover the VAT on the import subject to certain conditions being met – the key one being that they are VAT registered. This right of recovery exists regardless of where that company is established.
However, if the importer of record is not VAT registered in the country where the goods are imported into, they cannot recover the VAT. There is also the question of whether they should be registered for VAT as a result of carrying out transactions in that country. A US or EU company acting as importer of record in the UK with a view to selling the goods onwards to a customer in the UK will usually need a VAT registration. Once registered, the import VAT can be offset against the VAT collected on the sales (or if no VAT is due on the sale, it can be refunded). This is processed by filing the VAT return. This is also true when importing goods into many (although not all) EU Member States. If a registration is required, then the import VAT cannot normally be recovered via any other procedure.
Many US companies unfortunately do not proceed with a VAT registration and therefore do not end up recovering the VAT paid on import. While EU companies have the same obligations as the US ones, most EU companies do register and recover the VAT. Based on our experience, we would put this down to US companies not understanding how VAT works and that it is recoverable.
There is also no incentive to make US companies aware of this issue as the UK Tax Authorities (HMRC) have collected the import VAT from them and their UK customer has not paid any UK VAT on the purchase as none was charged. But this also means the US business is stuck with the cost of the import VAT which is not exactly a negligeable amount if the standard rate of VAT was applied.
All of the above is however easy to avoid as all it takes is a VAT registration in the example of UK imports.
In EU countries where VAT cannot be offset or refunded via the VAT return, a special refund mechanism exists to recover the VAT (a 13th Directive Refund claim) but unfortunately, once more, we see many US companies shying away from going through the refund process.
Finally, we also have to be fair to Mr. Trump and mention that there are some rare cases where US companies are outright denied VAT recovery on import VAT. This happens in countries that typically have a so called “reciprocity requirement” in their legislation, such as many Eastern European countries and a few countries in Western Europe.
For example, a US business that imports goods into Romania or Poland and pays import VAT may not be required to register and therefore cannot recover the VAT via a VAT return. Due to the reciprocity requirement, it will also be denied VAT recovery using the 13th Directive refund claim process. Why? The US does not in fact apply VAT or a similar indirect tax on imports therefore does not have an equivalent refund process. The same restriction applies in other countries where even though a registration may be required as a result of the import of goods, a VAT refund can only be granted via a 13th Directive refund process (e.g. Spain).
In cases like this one could argue that import VAT becomes a cost to the US business importing goods and is therefore similar to a tariff. While there is a grain of truth in what Mr. Trump was saying, such cases are quite rare. And there are solutions to avoid turning VAT into costs even in countries like this, but they do require some changes to the commercial terms and conditions, or the supply chain, which should be done before the import takes place, not after.
Conclusions
VAT is not a tariff and is should not become a cost to any importer.
If you are a US business importing goods into the UK or EU, please contact us and make sure the import VAT does not become a cost to you. You might need to register for VAT or apply for a VAT refund, or in rare cases implement some planning but nonetheless, VAT is not a tariff and should not be a cost to you.