Luxembourg’s new VAT grouping regime has plenty of downsides

Luxembourg hopes the new VAT grouping regime will help the financial sector get over the loss of IGP

Luxembourg's VAT grouping regime will help soften the blow of losing the independent group of persons (IGP) option for some financial companies, but one VAT manager at a financial services company says the new rules are useless.

VAT groups allow all companies within one jurisdiction to be treated as a single entity for VAT purposes, reducing the administrative burden and providing a number of tax advantages.

But VAT groups have become less advantageous for the financial sector in the EU since the 2014 Skandia ruling. But Luxembourg needed to introduce an alternative to its IGP regime after the European Court of Justice (ECJ) ruled in September 2017 that the old IGP system contravened the EU VAT Directive.

Companies, however, are weighing up whether to use Luxembourg's regime or not.

"Some might be afraid of the initial investment in the project, such as the mapping exercise, or the certification required. In the financial sector, the potential impact of Skandia might also be a reason not to go for a VAT group," said Erwan Loquet, partner at BDO Luxembourg. "But taxpayers with significant inter-companies between Luxembourg entities will certainly consider implementing the regime."

"We've looked at it quite closely but after a cost-benefit analysis it doesn't seem likely that we will be using it," said a source from a financial company. "The issue is the strict territorial and strict Skandia and reverse-Skandia interpretation which would be unhelpful for us."

Despite the issues, advisers told International Tax Review that there is plenty of interest in the new regime from sectors such as banking and insurance but, unlike with the IGP regime, also in the wider economy. Where advisers disagreed was how often clients' cost benefit analyses will see them elect to use the VAT grouping provisions.

"A lot are still analysing/preparing," said Loquet. "The regime entered into force [during] not necessarily the most favourable period of the year to consider implementing such a project. In addition, the regime implies the VAT deregistration of the entities entering a VAT group and the submission of the outstanding VAT returns within a two-month delay."

Loquet expects more companies to take up the regime from January 1, which is a more convenient date from a Luxembourg VAT perspective. The regime first entered into force on July 31.

But Bruno Gasparotto, partner at Arendt & Medernach, feels the regime has, compared with the IGP regime, many holes in it to be useful for a large number of taxpayers.

"They are curious, but when you explain exactly what it is all about [the level of interest] is decreasing," he told ITR. "This is because of the downside of it: the administrative burden and all types of obstacles, so they find it more complicated and more difficult than the past, which was very simple to implement."

"The VAT group is not as easy to implement – it needs some effort and time and cost, and that's the reason why people and companies are a bit surprised. In many cases I'm wondering whether they would like to decide to go for it or not."

Indirect tax is a crucial field of tax competition within the EU. Many member states strive to make their regimes as business-friendly as possible to attract companies, particularly those in the lucrative financial sector.

Luxembourg played this game well with its application of the IGP exemption in the VAT Directive, which exempted from VAT supplies by an 'independent group of persons' to its members, when the members were involved in VAT-exempt activities such as insurance and banking. Luxembourg's VAT law allowed, among other things, a particularly advantageous input tax deduction for supplies to IGP group members and various VAT exemptions.

Once the ECJ ruled against its IGP regime, many people predicted Luxembourg would come up with a VAT grouping regime to compensate. As such, the new regime allows groups of companies to have intra-group supplies exempt from VAT, which provides a crucial cash flow advantage. This should lessen the blow of losing the IGP exemptions.

In addition, the VAT grouping regime can potentially benefit more industries than just the financial services sector.

"With the grouping regime, we have talked to companies in various industries, including some with commercial activities, and full input VAT recovery rights," said Loquet. "The main drivers for such companies are the simplification in their VAT compliance process and the cash-flow advantage on the intra-group recharges."

Despite this, the regime is not as helpful to businesses in the financial sector as the IGP regime was.

The implications of the 2014 ECJ ruling in Skandia make Luxembourg's new regime very difficult to use for banks with branch structures. All companies wishing to use Luxembourg's VAT grouping regime should include Skandia in their analysis when weighing up the positives and negatives, advisers have said.

In Skandia, the ECJ ruled that the supply of IT services by US company Skandia America Corporation to its Swedish branch, Skandia Sverige, which was part of a Swedish VAT group, could not be exempt from VAT. This was despite Skandia America Corporation having no fixed establishment in the EU.

While financial institutions initially feared the ruling would cause widespread changes to all VAT regimes, some countries including the Netherlands and the UK ultimately made only minor changes. However, Luxembourg's new regime takes Skandia into account.

Laurance Lhote, head of indirect tax at KPMG Luxembourg, said Skandia could put taxpayers off the new regime, "especially if you are under a branch structure instead of having subsidiaries. In that case you should analyse carefully what would be the consequence if you go then to the VAT group."

In addition to Skandia, parts of the new grouping regime are administratively onerous. It is also far less flexible than the old IGP system: all members of a VAT group will be jointly liable for paying any VAT due.

Additionally, there is no 'cherry picking' – that is to say, taxpayers must use the regime for all of their Luxembourg entities, or not use it at all. In some groups, this could force entities, which are pure holding companies, for example, into a VAT group, making them taxable persons rather than non-taxable persons.

"As in some other member states, the companies which meet the conditions have to be in the group, with minor exceptions," confirmed Yannick Zeippen, partner at EY. "It is not possible to select only some of the companies and exclude others."

"This has consequences in terms of the cost side of these entities because if you are a holding company paying fees to a US entity, for example, before joining the group there is no VAT leakage," said Gasparotto. "But when part of a VAT group in Luxembourg, this type of management fee would then attract VAT. In that kind of example it creates tension."

Antonio Merino, tax manager at Baker McKenzie, added: "The new regime requires the fulfilment of administrative obligations, [such as] appointment of a group representative [and] reporting to the VAT authorities about transactions between members, and should be maintained for at least two calendar years."

Another requirement is for a certified accountant to give 'certification' that all the conditions necessary for the VAT group are met. Businesses must renew this certification each year. Big 4 firms can easily provide the certification themselves – perhaps explaining advisers' more positive slant on the VAT grouping regime – but in any case, this is a new cost for companies.

"This creates a cost for the group which in some cases may represent a very complicated exercise," said Gasparotto. "The certification, this verification of the financial integration which is based on the majority of the voting rights… it's maybe quite a heavy exercise."

"It's just an opinion on something very simple; you need to check the whole structure for this financial integration for voting rights," he added. "That's a condition in the law that is not so friendly, I would say."

In addition, VAT groups must appoint a representative to make a VAT return. This return must be very detailed.

"In terms of the time to be spent on the preparation of this 'global' VAT return, it's quite a heavy exercise," said Gasparotto.

He also fears that entering into the VAT group regime is a difficult decision to reverse.

"Even if you need to file an introduction request to the VAT authorities for gaining and obtaining a VAT number for the group, that does not mean that the VAT authorities fully agree with how the VAT group has been built among the members," said Gasparotto. "That means that in two or three years' time the VAT authorities might come back, have another interpretation of a part of your business, and reject the VAT group in the worst case scenario."

It's unlikely that the Luxembourg tax authorities would strictly enforce such a nuclear option, but it goes without saying that all intra-group flows unexpectedly becoming taxable would be disastrous.

As with many new tax regimes, there are differences in opinion, but advisers who spoke to ITR agreed that it was important that Luxembourg came up with an idea to replace the IGP.

"Luxembourg is just implementing a provision of the VAT Directive that is already adopted by many other EU countries for many years," said Loquet. "This is a very positive step towards more modern VAT legislation."

That said, the downsides to the regime indicate that fewer companies in the financial sector will elect to use it than the IGP regime.

"We don't have too many entities in Luxembourg so it does not really make too much sense [to use this regime]," said a source.

Equally, companies with many entities may be put off by the lack of 'cherry picking'.

Gasparotto does not expect many companies to take up the regime, "except in very necessary situations, where they have no choice but to find an alternative to the IGP. But this is not the case for the majority of entities".

The alternative, he says, is for companies to restructure slightly to change the way they provide services intra-group.

It's natural for companies to be hesitant when looking at a new tax regime, particularly one with a high level of complexity that creates more administration. Nevertheless, there are certainly savings to be made for companies with several entities in Luxembourg. Once a few major taxpayers have taken the plunge, others may follow.