A session report from the IBA’s 24th Annual US and Europe Tax Practice Trends Conference in Munich

Friday 12 April 2024

Co-Chairs

J Brian Davis, BakerHostetler, Washington, DC

Markus Müller, KMLZ, Düsseldorf

Speakers

Catarina Belim, Belim Castilho, Lisbon

Mariana Eguiarte-Morett, Sánchez Devanny, Mexico City

Lars Gläser, Glaeser Law, Vienna

David López Pombo, Uria Menéndez, Madrid

Reporter

Maximilien De Ridder, Lenz & Staehelin, Geneva

Introduction

The panel discussed the main hurdles faced by a non-EU based company importing and selling goods in the European Union (EU) via a traditional buy-and-sell or a limited-risk distribution model.

The panellists opted for a pragmatic approach, illustrating the challenges faced by the non-EU based company with a hypothetical example involving the following jurisdictions: Mexico, Germany, Mexico, Romania, Spain and the United States. Consequently, this session report focuses on these five jurisdictions by highlighting the challenges surrounding direct and indirect taxes, with particular emphasis on the latter.

To make this session report easier to understand, a diagram of the example is depicted below.

General framework

Lars Gläser and J Brian Davis began by describing the general framework in which the US parent company operates and the choices it faces when organising the transformation of raw materials into semi-finished goods in Mexico and shipping them to the Spanish distributor, with a pit stop in a German warehouse and final processing in Romania.

Davis first discussed whether the Spanish distributor operates as: (1) a full-fledged buy-and-sell entity or (2) a low-risk distributor (LRD). The effective allocation of functions/risks within the structure is key to determining the share of profit allocated to each entity.

Gläser highlighted the fact that the operating model chosen has an impact on the type of corporate income tax risks that need to be monitored, namely the suitability of the transfer pricing model, the unintentional creation of a permanent establishment in each country where the goods are produced, transit, processed or sold, and any applicable anti-profit shifting rules (eg, those applicable to controlled foreign corporations (CFCs)).

Irrespective of the operating model chosen, indirect taxes (value-added tax (VAT), customs) are usually not correctly taken into account in this type of scheme. This is because, as Gläser points out, it is simplistically assumed that indirect taxes are always borne by the end consumer and have no impact on the profit margin.

Step one: US/Mexico – conversion of the raw materials into goods

The first step for the US parent company is to give instructions to its Mexican counterpart, the manufacturer, for the conversion of the raw materials into semi-finished goods.

Mariana Eguiarte-Morett explained the benefits of the maquiladora tax regime for the US parent company and the Mexican manufacturer. This tax regime allows the manufacturer to import raw materials under a specific import regime to avoid customs duties and other indirect taxes.

For corporate income tax purposes, the companies operating under such a regime are not considered to have a permanent establishment in Mexico – here the US parent – even though the US parent owns the inventory, in addition to monitoring/evaluating the production process.

Eguiarte-Morett concluded her comments on the maquiladora regime by pointing out that the marginal corporate tax rate is 30 per cent in Mexico, whereas it is only 21 per cent in the US. This is an important factor to consider when allocating functions between the US and Mexico.

Step two: Mexico to Germany – entering the EU

In the second step, the Mexican manufacturer exports the semi-finished goods to a German warehouse, while the US parent is still the sole owner of the goods.

Catarina Belim reminds us that a non-EU company, like the US parent, must find a customs representative or another importer of record to act on behalf of the US parent. These two options entail major administrative formalities in terms of representation, insurance, guaranties and documentation.

Belim concluded with the fact that the valuation carried out by customs officers at the time of import does not take into account any subsequent transfer pricing adjustments (upwards or downwards) on the value of the imported goods. If we consider a potential adjustment in transfer pricing, customs duties of between two and six per cent and import VAT of between 17 and 21 per cent may apply, which is sometimes difficult to recover, can unexpectedly jeopardise the profit margin of the entities involved in the scheme.

Step three: Germany to Romania – further processing

Markus Müller began by pointing out that, for corporate tax purposes, warehousing goods in Germany and processing them in Romania do not constitute a permanent establishment in those countries for the US parent.

He went on to say that although the semi-finished products are now definitively imported into the EU, potential problems may still arise, as each EU Member State applies its own interpretation of the European VAT Directive (Council Directive 2006/112/EC).

Romania was not chosen by chance for the purposes of this hypothetical case, as the Romanian tax authorities have taken the position that local toll manufacturing arrangements may result in a foreign principal having a fixed establishment for VAT purposes. Consequently, the Romanian toll manufacturer will be liable for Romanian VAT on the manufacturing services provided to the foreign principal, resulting in the assessment of additional historic VAT liabilities and significant penalties imposed by the Romanian tax authorities.

Finally, notwithstanding the position of the Romanian authorities, VAT compliance in each EU country is relatively complex and easily costs €1,000 to €2,000 per year, which is not negligible if multiplied by 27 possible EU Member States.

Step four: Romania to Iberia – from processing to distribution and sale

The final stage is the import of the goods from Romania to Spain by the distributor and their sale to the end customer.

David López Pombo described the long-standing practice of the Spanish tax authorities, upheld by the courts, of qualifying a foreign company as having a permanent establishment in the premises of its Spanish subsidiary and highlights the key criteria examined: exclusivity, instructions, use of the premises, etc. While these risks were virtually non-existent in Germany and Romania in this hypothetical case, they become material in Spain, depending on the chosen distribution model.

López Pombo finally indicated that specific taxes levied by some EU Member States should not be overlooked and provided, as an example, the fact that Spain levies €0.45 per kilogram of non-recycled plastic imported into Spain, even from other EU Member States.

Conclusion

Davis concluded this hypothetical case by stating that even if the scheme is manageable from a corporate income tax and/or transfer pricing perspective, indirect taxes are often neglected in the setup of the scheme, as well as in regard to the associated formalities (the appointment of customs representatives, VAT registration, etc).

Although it is often assumed that these costs only impact the end consumer, this is not always the case, and such costs can have a decisive impact on the profitability of a scheme.