Stuck with the bill: the need for cross-border VAT refunds

A value-added tax (VAT) is recoverable, and the burden of paying it and reclaiming it should not rest on businesses. An effective VAT refund system is therefore crucial to fulfilling the rights of business taxpayers to be relieved of that burden. Generally, most countries operate under an input-output VAT model, which means that VAT-registered businesses may credit paid VAT against their supplies or obtain VAT refund.

A VAT refund system usually works well for domestic taxpayers, Doing Business finds. However, for firms that incur a VAT in a country in which they do not have a business presence, recovering the tax is not always possible. This type of irrecoverable VAT is referred to as a “sticking VAT.”

As discussed in Doing Business 2020, 174 economies have a VAT system and more are introducing one, including member states of the Gulf Cooperation Council (GCC). Globally, the average time to comply with and obtain a VAT refund has decreased slightly over the past five years (figure 1).

_{Source: Doing Business}

As such, VAT systems continue to evolve around the world. The expansion of International trade and the increasingly globalized economy is one such change VAT systems are adapting to.

As companies become increasingly global, the “sticking VAT” has become a cost of business for many companies and is taking on greater importance. 

In 2015, The Organisation for Economic Co-operation and Development (OECD) launched a project to develop international VAT guidelines¹. The OECD guidelines were clear on a recommendation of neutrality: “foreign businesses should not be disadvantaged or advantaged compared to domestic businesses. This means that foreign businesses should not incur irrecoverable VAT when this would constitute an unjustified discrimination compared to domestic businesses.”

The most effective way for businesses to avoid the “sticking VAT” would be if foreign businesses were eligible for direct refunds. Other approaches include refunds through a domestic registration procedure or making supplies VAT-free. However, both approaches would require businesses to register in the source country, posing an additional administrative burden.

The direct refund of cross-border VAT surplus has become an important tool for governments to help businesses maintain liquidity following the COVID-19 outbreak. Businesses are given the option to postpone VAT payments and tax authorities have accelerated VAT refund payments.For example, Belgium made it possible for businesses that normally qualify for quarterly refunds to obtain a monthly refund of their VAT credit balance.

Currently, entities that are registered in the European Union are eligible for a direct refund. A business that incurs VAT in an EU member state where it is not established may recover that VAT directly from that member state.  Refunds are also granted to non-EU companies if the VAT is charged and paid in the European Union.

Generally, however, few countries outside the European Union refund VAT directly to foreign businesses, although the situation has been changing in recent years. For example, the United Arab Emirates, Bahrain and Saudi Arabia introduced a VAT legal framework that allows recovery of VAT by foreign businesses.² Kuwait, Oman and Qatar are expected to follow the same path in the near future. Georgia recently launched a direct refund to EU entities.

The implementation of a cross-border VAT refund system would require substantial resources and funds for a country to administer such a refund scheme. There would also be a risk that the foreign VAT refund would be vulnerable to more fraud and manipulation. However, with the increased use of technology, data analytics and e-audit, countries are better equipped to deal with the risks associated with granting refunds to foreign businesses.

^{1 Guideline 2.4; OECD (2017), International VAT/GST Guidelines, OECD Publishing, Paris, https://doi.org/10.1787/9789264271401-en.}

^{2 Worldwide VAT, GST and Sales Tax Guide; Ernst and Young; 2019}