Incentive payments to buyers as an object of VAT
Just a few years ago the tax disputes often occurred as the result of the payments of producers/ importers in favor of distributors of goods and retailers aimed at further sale promotion of the goods supplied. The tax authorities did not admit the connection of such payments with the business activity of producers/ importers since the right of ownership to the promoted goods had already been transferred to distributors and retailers.
After a number of high profile court decisions on the issue including the decision of the Supreme Court of Ukraine, the official approach of the tax authorities has been reconsidered. Thus, the Summarizing Tax Consultation, approved by the STS Order No. 123 of February 15, 2012 (hereinafter referred to as “Order No. 123”) confirms the right to deductible expenses in respect of advertising and marketing services including incentive payments made in favor of distributors and retailers. As a result, the question of proving the connection of such payments to business activity is not as urgent for producers/ importers as it has been before.
However, the Order No. 123, clarifying the consequences of incentive payments for the profit tax purposes, did not properly address the issues on VAT application to such payments. Though, it may be concluded from the content of this document that the tax authorities consider any payments of such kind including incentive payments as services. For example, we cite the following provisions of the Order No. 123:
“Incentive payments may include the following: bonus for the early debtor indebtedness repayment, acccomplishing of purchase plan, accuracy of purchase estimates, adherence to the certain range of purchased goods.
Since the incentive payments are aimed at promotion of sales of goods (works, services) such payments may be regarded as the marketing services”.
Let us remind that subpara. b) of para. 185.1 of Article 185 of the Tax Code of Ukraine amongst the objects of VAT mentions the transactions of taxpayers on supplying services within the customs territory of Ukraine.
Therefore, even though the Order No. 123 does not directly addresses the issue on incentive payments VATability, recognition of such payments as marketing services implies that under such payments the VAT object shall arise.
For this reason recently in practice taxpayers often opt for the approach that any incentive payments in favor of distributors/ retailers are the compensation of services and, consequently, the object of VAT.
But the question arises: are there any legal grounds to consider such incentive payments as compensation of services rendered by distributor or retailer to producer or importer?
At first the meaning of the “incentive payments” should be defined in the respective context. This term is not defined by legislation that is why it would be reasonable to follow the understanding from which the authors of the Order No. 123 have proceeded. Thus, following the above mentioned citation “incentive payments” mean bonuses for the purchasers’ adherence to the respective criteria linked to relations under the supply agreement. For instance, for prepayment of goods, for accomplishment of the agreed purchase plan, etc.
As previously mentioned the respective relations are referred to the marketing services by the Order No. 123. However, the analysis of the definition “supply of services” for VAT purposes evidences that this question is not so clear.
The definition of “supply of services” appears in subpara. 14.1.185 of Article 14 of the Tax Code of Ukraine and stipulates the following: “supplying the services is any transaction which is not a supply of goods…”.
This definition is quite broad but it still does not provide grounds for considering any cash transfer among the taxpayers as the compensation for a service. Thus, according to the definition transaction which is not a delivery of goods has to be in place between the parties.
It is important to note, that the mere fact of payment cannot be considered as such transaction. Another approach would bring to the conclusion on application of VAT to such operations as, for instance, provision of financial aid, which is not excluded from the object of taxation in accordance with the Tax Code. At the same time the fact of absence of the object of VAT while the provision of financial aid is admitted by the tax authorities (see, for instance, reply contained in the Unified Database of Tax Knowledge dated February 25, 2011).
Therefore, for recognition of the fact of services supply between the parties, any kind of transaction shall be done in addition to the payment of monetary funds and such transaction shall not be the supply of goods.
Definition of the term “transaction” is provided neither in the Tax Code nor in other laws. However, Article 1 of the Law of Ukraine “On accounting and financial reporting in Ukraine” contains the definition of the term “business transaction”. According to this definition “business transaction – is an action or event that causes change in a structure of assets and liabilities, equity capital of the company”.
Therefore, if we use this definition, the transaction is carried out only if any action or event occurs, in the result of which there are changes in the structure of assets and liabilities, equity capital.
In case upon achieving the criteria set the obligation of the producer/importer to make incentive payment arises as well as countervailing right of a distributor/ retailer to demand such payment, then the achievement of these criteria leads to change in the structure of assets and liabilities of the parties.
Respectively, from the accounting standpoint there are grounds to argue that the fact of accomplishment of the criteria, for which incentive payments are made, is the business transaction. Therefore, if to use the terminology of accounting, there are grounds for the approach about existence of the supply of services and, accordingly, of the object of VAT appears.
Yet, in some cases, known to us, there are no clear criteria, accomplishing of which provides the right to bonus (premium). For instance, it may be established that upon results of certain period, a producer/importer determines the amount of bonus as an agreed percentage of turnover while the deadlines of its payment to a distributor/retailer are not clearly established. In such case we believe that it is difficult to argue about any separate business transaction, due to the absence of the moment when the right for receiving the bonus and the counter obligation on its payment arise.
Besides, the legality of usage of accounting terminology for the purposes of determining the object of VAT may be questionable. The Tax Code directly envisages application of the terms of regulatory legal acts in the sphere of accounting for income tax purposes only (subpara. 14.1.84).
At the same time the legal analysis of contractual relations indicates rather on the absence of separate relations on rendering of services in this case.
Thus, from the point of view of civil law the relations concerning the provision of services arise in case of reciprocal rights and obligations between the parties, which might be the subject of the agreement, separate from the actual sale and purchase agreement. In addition to that in case of incentive payments, producer/ importer is obliged to make such payment under the condition that the distributer/retailer fulfills particular requirements. But the counter obligations of the distributer or retailer, which are necessary for performing the respective requirements, are limited by the actions carried out within the subject of the sale and purchase agreement (placing an order, payment for goods, etc.).
In this case from the point of view of the civil law, there are grounds for conclusion that separate legal relations of providing services in case of similar incentive payments, do not arise.
This approach to the interpretation of the incentive payments found its recognition by our neighbors. Thus, in the Russian Federation the tax authorities took the position that such payments are related to the services, provided by customers for suppliers of goods, and, consequently, the object of VAT appears. However, in the beginning of the last year the dispute on this issue was finished – the Presidium of the Higher Administrative Court of the Russian Federation made the decision in the dispute between Lerua Marlen, LLC and Inter-District Inspectorate of the Russian Federation (February 7, 2012), according to which no object of VAT during the payment of premium (bonus) to the customers/ buyers arises. Thus, in the decisions of the courts on this issue, inter alia, the following is mentioned:
“…the courts have concluded that the Company has no obligation to include the amounts of bonuses to the tax base on the value added tax by reason of the absence of the object of taxation –supply to the supplier of services since the monetary funds received by the Company in the form of bonuses are not related to performing any specific actions in the interests of the suppliers”.
Summarizing the above, the legislation does not provide for a clear and unambiguous answer to the question whether any incentive payments of the producer/importer in favor of distributors and retailers should be considered as compensation for marketing services. Thus in many cases there are grounds both for an approach on application of VAT and for approach according to which the object of VAT does not arise. In every particular case respective analysis shall be made for identifying whether there are grounds to talk about making some transaction separate from the actual transaction on the supply of goods.
It shall be noted that in the Unified Tax Database there is the answer (dated 14.02.2012) to the question “ Is the remuneration (bonus), received by the buyer from the supplier, the object of VAT, due to achievement of the necessary volume of purchase of goods from such supplier? However instead of the answer, the information and reference department of the State Tax Service provided recommendations to appeal to the local authorities of the State Tax Service at the place of registration with the provision of copies of primary documents on such transaction. This may confirm that the tax authorities also do not take categorical position that all similar payments are the compensation for services and result in object of VAT.
What kind of practical consequences do the aforementioned conclusions bring to the taxpayers?
The producers/ importers must pay serious attention in respect of documentation of incentive payments considering the possibility of ambiguous interpretation of respective relations for the purposes of VAT.
In practice there are situations when the respective documents, under which the bonus is paid, for example, for the quantity of goods or assortment (without ascertainment of clear criteria or duties of recipient), but the transfer-acceptance act is drawn and VAT is charged.
In such cases the risks arise, since the tax authorities may take an approach that this transaction is not the payment for the services and on this basis they may refuse to acknowledge the tax credit, which was formed on such transactions. One shall also bear in mind that in the Order No.123 the right on expenses is confirmed for incentive payments referred to marketing services. If the tax authorities do not see the services in the bonus payments, then they might not see the right on expenses. Although it is possible to argue regarding non-recognition of expenses, but in the current conditions one shall not rely on favorable treatment from the tax authorities.
Therefore, if the decision to consider the incentive payments as compensation of services with application of VAT has been made, we recommend working the documents properly. In particular, it shall be clear from the respective documents that distributor/ retailer performs certain actions, which do not directly follow from sale-purchase agreement and which are paid for. For instance, the respective functions of the buyer may be presented in the agreement as the elaboration of estimates of purchasing goods on the basis of analysis of the customer demand; informing the supplier about such estimates with the purpose to elaborate the plan of deliveries; realization of actions for encouragement of sale goods (informing consumers about the advantages of goods, etc.) and achievement of certain sales volumes as a result of such actions.
Recommendation to pay attention to documenting of the respective payments is fair also for the opposite situations, namely when the taxpayer does not consider the motivational payment as an object of VAT. In this case, it is important to elaborate the documents in such a way that there were no grounds for conclusion that the distributor/ retailer renders services, and one shall be ready to defend the right on expenses, which will be much more difficult with such structuring.
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.