Taxing Exports. Position Paper on Proposal for a Council Directive amending the Taxation of Travel Products

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1 Taxing Exports Position Paper on Proposal for a Council Directive amending the Taxation of Travel Products COM (2002) 64 Final. Council Directive amending 77/388/EEC with a view to simplify, modernise and harmonise the application of the special scheme for travel agents. 1

2 Introduction The European Tour Operators Association (ETOA) represents companies who sell European vacations in long-haul origin markets. This paper sets out the views of the inbound industry on the impact that the 2003 draft to amend the directive would have had on this industry. These operators bring tourists to Europe and as such are exporters: their clients spend foreign currency in hotels, shops, restaurants, visitor attractions and theatres. As these clients lack experience, they shop for European services on price. Products do not sell if there is a 1% price differential. Agents switch sell for a ¼% premium in commission. Any European taking a holiday outside Europe pays no EU VAT: nothing on the hotel, nothing on the tour operator. But, should anyone come from outside Europe and take a vacation here, VAT is due not only on all the services they consume, but also on the organisation of the trip. Europe taxes its exports, and grants tax-free status to its imports. A European-based tour operator faces a further penalty: they have to pay a tax on any work done to organise a European package. A tour operator based outside the European Union does not have to pay this tax. The more an operator works (the more they add value ), the less competitive they become. This regime differs from treatment of other export industries. It is also counterproductive: very little revenue is derived from this tax on exports. All it has done is drive business off shore. We call on the Council of Ministers: a) to create a level playing field between EU and non-eu operators by making sales to customers abroad exempt from VAT (already recommended by the European Parliament); and b) to retain the ability of businesses to opt out of paying VAT on their margin when selling to other businesses. If these provisions are not made, then those countries that still retain incoming tour operators must use their veto to block this directive. 2

3 Background The Tour Operators Margin Scheme (TOMS) was introduced to tax tours that run through several countries. It enabled operators to pay a VAT inclusive price on their tour components, and to have VAT levied on their margin. Tax was left paid where the clients enjoyed their services. Operators avoided having to register for VAT in several countries, and completed a simple return in the country where they were registered. It had it has one major drawback. As VAT is a sales tax, it cannot be collected if the operator is based outside the EU. It is thus effectively an optional tax: a tour operator can choose not to have the tax levied by basing himself outside the EU; a client can choose to purchase a product sold by a tour operator outside the EU. There are three main types of incoming tour operator that are affected by this problem. 1) Tour operators acting in principal These market their product to clients with whom they aim to build lasting relationships. They invest heavily in establishing brands and continue to print brochures. They still tend to distribute through travel agents. This category of inbound tour operator has been driven offshore by taxation. Their margin has to be large enough to support an extensive marketing structure. The VAT on this margin is commercially catastrophic: it is more than twice the net operating margin. This is explained in Appendix I. Most of the tour operators acting in principal and who sell Europe to non- Europeans are based in countries outside the EU. 2) Wholesale tour operators who sell only to other businesses Wholesalers organise tours for foreign operators, group leaders or associations. It is a specialised business that involves a deep understanding of the destination to be visited and knowledge of the needs of the client. But as they sell at net rates to other businesses, wholesalers can survive on a lower gross margin. They are also able to opt out of TOMS. This reduces their exposure to VAT. 3) Online tour operators This is the fastest growing sector in the travel industry and now dominates the industry. Two broad business models are being adopted. Some online distributors act as agents : they make commission from those whose products they sell, such as plane tickets, hotels and car rentals. 3

4 Others act in principal, and have a taxable margin on the services they provide. These face exactly the same problems as the tour operators acting in principal. Internet clients can compare prices with even greater ease. It is inconceivable that a company that can provide cost savings to their clients will fail to do so. They can do so by closing down their European operations and move offshore. Companies constantly review the cost implication of their choice of base. They can be located anywhere. We have already seen the transfer of a number of travel-related internet jobs to India. If it were impossible to sell to non-eu customers from a European base, Europe s future as a dotcom centre would be endangered. The proposals We understand that the discussions among the working group will be based on the draft VAT directive that was placed in front of the Council of Finance Ministers (ECOFIN) on 7 October That document was not prepared in consultation with the industry, and it contains proposals that differ substantially from previous proposed legislation that has been prepared in consultation with the industry. It aimed to simplify, modernise and harmonise the taxation of travel products by eradicating some VAT anomalies within Europe. In principle, this was a much-needed move as there are many anomalies in the way in which TOMS is applied within Europe. But it also penalised export tourism companies (see Appendix 1). Moreover, the amended directive ignored the problems associated with the original scheme and contained measures that were disastrous. Had it been implemented, it would have lead to a catastrophic loss of competitiveness. There were two measures of great concern, one glaring omission and one absurdity. 1) In paragraph 2(b), it obliged operators to apply TOMS in every case, including business-to-business transactions and transactions where a taxable company is the end user. The consequence of this would have been to force companies operating in the wholesale, internet and incentive markets to close or relocate offshore. 1 Proposal for a Council Directive amending Directive 77/388/EEC as regards the special scheme for travel agents /03 4

5 2) Paragraph 3 declared that all supplies of goods or services effected by a provider of travel services, in respect of a journey shall be treated as a single service. This ended the ability of those operators who do not own their own means of transport to apportion a lower rate of VAT on the transport component. This would have caused price rises throughout the European package industry. These rises would have been disproportionate, causing small operators to suffer. Furthermore, it would have prevented tour operators (and their clients) from benefiting from the reduced rates of VAT that national governments applied to tourist services. 3) Nowhere in the directive is there any reference to the parliamentary amendment that proposed for inclusion the clause: Where travel services are supplied to a customer permanently resident outside the Community, those supplies may be exempted. 2 VAT does not and should not apply to exports. But under the current legislation it does. This has the effect of disproportionately penalising European-based operators from promoting Europe as a destination. Exempting VAT for the supply to customers outside the EU is essential to create the long-sought level playing field between EU-based operators and non-eu-based operators. 4) The only area where there was an attempt to create a level playing field is where non-eu companies were selling services to EU citizens. A non-eu company can register for VAT in one member state and then pay TOMS according to the residency of their client. There are deeply complex problems to be resolved in this area. When operating at low margins, differential pricing according to country of residence will be inescapable. Cruise companies will find it difficult to account for the sale of one excursion to a ship consisting of passengers from many member states. However, the basic principle was fair. It also enabled non-eu companies to avoid TOMS when selling to non-eu citizens. This measure should be extended to EU-based companies. 2 2 Report on the proposal for a Council Directive amending Directive 77/388/EEC as regards the special scheme for travel agents. Committee on Economic and Monetary Affairs. Rapporteur: Helena Torres Marques. PE NOT+XML+V0//EN 5

6 Impact of proposed reforms It should be clear from the former sections that the ramifications of this directive were immense, and not restricted to the incoming sector. Smaller specialist inter-european operators will come under intense price pressure and unfair competition from large integrated groups who are able to post margins on their transport provision. Conference and incentive operators will find themselves wholly compromised because when tax retrieval takes place by their customers (if it can), both their profit margin and their net rates will be exposed. The impact on wholesale incoming tour operators will be straightforward closure and/or relocation abroad VAT 800 Margin 600 Transport 400 Componant costs Wholesaler non EU Wholesaler EU If they were selling a European tour to a Japanese group leader, an operator might have component costs of 600 for the hotels and the attractions, 150 for transportation, and a margin of 200. Under the new scheme, both the transport and the margin would become taxable under TOMS. This would render any operator based in the EU 5% more expensive even when supplying identical services. Both operators are paying VAT on the services that their clients consume. The new tax is imposed on a margin that can be added anywhere in the world. It will be added anywhere in the world other than the EU, as clients switch suppliers for a 1% variation in cost. 6

7 The impact for the online distributors is identical to the wholesalers. Their margins may be smaller, but their price sensitivity is even more acute. It is important to understand that no tax revenue will be gained through this. Rather these proposals present a multimillion Euro incentive to relocate outside the EU. 7

8 Appendix I EU versus non-eu tour operation in principal The above graph compares a European holiday sold to an American by a non-eu tour operator with one based within the EU. If a non-eu operator markets a tour for $1,000, it is likely to consist of $600 of tour components (hotels, restaurants, transportation etc), $160 of sales and marketing costs, $200 of agency commission and a net margin of $40. If an EU-based operator provides the same service, then he would bear the same costs, but with an additional $74 tax and $18 commission. An agent will expect commission of 20%: you pay extra for paying VAT. It is important to note that both operators are paying VAT on their tour components in the countries in which the services are consumed. The disparity is that an EU operator has to pay VAT on the difference between their gross margin and the price to the consumer. The non-eu based operator does not. For an American consumer, this is an optional tax. It is not collected if the operator is based outside the European Union. It is not possible to collect a tax on a sale made on a third country to a non-eu citizen. The result of this scheme is that an identical tour sold by a European tour operator is over 12% more expensive. The tax levied on this export is over twice the net operating margin. 8

9 Appendix II The European Parliament s proposed amendment 27 August 2002 REPORT on the proposal for a Council directive amending Directive 77/388/EEC as regards the special scheme for travel agents (COM(2002) 64 C5-0112/ /0041(CNS)) Committee on Economic and Monetary Affairs Rapporteur: Helena Torres Marques Where travel services are supplied to a customer permanently resident outside the Community, those supplies may be exempted. Amendment 2 Article 26.5, subparagraph b (new) Justification This amendment seeks to create a level playing field between the tour operators based in the EU, and those based in third countries. Under the new regime, as proposed by the Commission, EU tour operators would be at a disadvantage when supplying packages to tourists from third countries. An EU operator would have to levy up to 25% VAT on the profit margin, which, considering the often slender margins in this sector, would make it impossible to compete with a company based outside the EU which would not have to levy VAT. Although your rapporteur supports a high degree of harmonisation of the VAT system, and thus the phasing out of derogations, she nonetheless considers that they sometimes are necessary. It should be noted that it is only the actual supply that is exempted, the operator would still have to pay VAT on the constituent goods and services without any right of deduction (Article 26.6). Thus, the services actually enjoyed in the EC such as meals and accommodation would still be taxed, in the country of consumption, thus broadly respecting the general principles of the VAT system. It is proposed to leave it up to the Member States to decide whether to grant such an exemption or not. 9