22 May 2015 International Trade & Customs Bulletin Trade controls and M&A: how to preserve the value of your transaction? The substantial risk associated with the expansion and enhanced enforcement of trade controls has a direct impact on due diligence in cross-border M&A transactions. The failure of the buyer to focus his due diligence on potential violations of international trade laws and regulations by the target, may have a serious adverse impact on the value of the transaction. Read more Testing economic conditions for producing biofuel under outward processing: what is understood by the term, community processor? The Dutch High Court (decision 19-12-2014, nr. 13/05584) referred preliminary questions to the ECJ in a case where the Tax inspector, after consulting the European Commission, had refused to issue an outward processing license for the production of bio-fuel (by mixing community (light) petrol with non-community bio-ethanol) outside the EU territory (in international waters), on the grounds that the economic conditions for the use of the customs procedure of outward processing, had not been met. The High Court asked if the term community processors as mentioned in article 148, letter c, of the CCC only refers to businesses established in the community, able to execute the same production activities, or if it also includes community businesses producing similar end products (i.e. bio-fuel). Read more
Trade controls on cryptography products: how shall we deal with the Mass Market Exemption? The EU Dual-Use Regulation (EC) No 428/2009 ( Dual Use Regulation ) sets out the framework of EU dual-use controls and the list of controlled goods. If listed, a license will, in principle, be needed to export such items outside the EU. Controls do not apply to shipments between EU Member States (with limited exceptions for certain highly sensitive items), but the supplier is obliged to make a reference on the commercial documentation, (i.e.an invoice), indicating that it concerns a dual use item. A particular group of products that falls within the scope of the Dual Use Regulation are cryptography items (Category 5, Part 2 of annex I) such as, for example, routers. EU dual-use export controls apply to these encryption products, but include an exemption for exports of mass market items under the Cryptography Note included in the Dual-Use Regulation (note 3 of Category 5, Part 2). Read more The never-ending talks on the classification of alcoholic beverages: how will it taste the ECJ? In the landmark Siebrand ruling (F&B sector), the ECJ decided that certain alcohol-based beverages, which previously were classified under heading 2206 of the CN (Combined Nomenclature), must now be classified under heading 2208 (attracting a higher excise duty rate). The criteria put forward in Siebrand seemed to open the door to operators classifying their products. The new preliminary questions in the Toorank Productions case (ECJ Toorank, C-532-14 & C-533-14) indicate, however, that there are still some uncertainties. Read more E-commerce and VAT: How do you prefer your book: hard- or soft copy? The ECJ delivered its long awaited judgments on the infringements procedures against France and Luxemburg, concerning their application of reduced VAT rates to e-books. The court held that e-books qualify as electronically supplied services, and, as such, reduced VAT rates cannot be applied. Therefore, the VAT treatment of printed books (or more precisely, books on physical means, according to the VAT Directive), which are taxable at the reduced VAT rate in most EU countries, cannot be extended to e-books. The only way of having the reduced VAT rate applied to e-books as well, would be to change the EU VAT Directive, which will be a long process. Read more 2
Trade controls and M&A: how to preserve the value of your transaction? The substantial risk associated with the expansion and enhanced enforcement of trade controls has a direct impact on due diligence in cross-border M&A transactions. The failure of the buyer to focus his due diligence on potential violations of international trade laws and regulations by the target, may have a serious adverse impact on the value of the transaction. Governments enforce laws and regulations to promote their national security, foreign policy, and economic interests, including those related to exports, imports, and trade sanctions, but also to combat bribery and corruption. US and EU trade regulations and sanctions are a case in point. Companies, therefore, find themselves increasingly exposed to multiple trade control regulations. The US in particular, tends to see these regulations as a common mosaic that calls for integrated enforcement. As a result, companies also face a growing multiplicity of penalties applied by different national regulations. International trade due diligence aims to minimize these risks. First, it is critical in controlling the risk of successor liability. A buyer can be held liable for the violation of trade laws and regulations committed by the target. Only if the buyer is able to adequately establish the vendors violations, can it take appropriate remedial action to cover the potential costs. Secondly, a trade-focused due diligence helps to ensure that the acquisition is valued correctly. Apart from being exposed to liability for past actions of the target, inadequate trade due diligence also puts the buyer at risk for other reasons. These include - but are by no means limited to: the loss of revenue streams from countries subject to trade sanctions; the termination of key employees, agents, business partners or contracts as a result of corruption; the loss of governmental exporting or contracting privileges; and potential delays with the transition of licenses and authorizations What does this mean for business? Buyers in cross-border M&A transactions should be aware of the substantial risk involved in the violation of trade regulatory matters by the target. They should conduct a trade-focused due diligence that includes specific requests with respect to export and import controls, trade sanctions, and anti-corruption and anti-boycott regulations. In addition, buyers should demand general information from targets about their compliance processes and procedures, their implementation of those processes and procedures, as well as about past disclosures, investigations and penalties regarding trade regulatory matters. 3
Testing economic conditions for producing biofuel under outward processing: what is understood by the term, community processor? The Dutch High Court (decision 19-12-2014, nr. 13/05584) referred preliminary questions to the ECJ in a case where the Tax inspector, after consulting the European Commission, had refused to issue an outward processing license for the production of bio-fuel (by mixing community (light) petrol with non-community bio-ethanol) outside the EU territory (in international waters), on the grounds that the economic conditions for the use of the customs procedure of outward processing, had not been met. The High Court asked if the term community processors as mentioned in article 148, letter c, of the CCC only refers to businesses established in the community, able to execute the same production activities, or if it also includes community businesses producing similar end products (i.e. bio-fuel). In the case at hand, a license for outward processing was requested for the following activity: a ship would be loaded in a Dutch port with two products (separated by a bulkhead): community (light) petrol non-community bio-ethanol After sailing to international waters, the bulkhead would be removed, allowing both components to mix. Further mixing would be achieved by the action of wave movement on the ship. The resulting product (called E85 or bio-fuel) would be customs cleared upon arrival (CN 3824.90 duty rate 6.5%), less the import duties that would be due for the import of the community (light) petrol (2008 tariff of 4.7%). The Tax inspector (on the basis of article 503 CCCIP) asked the European Commission to investigate if, in this case, the economic conditions for outward processing were met. The Commission argued that imported bio-fuel (E85) is in direct competition with domestic bio-ethanol, since bio-ethanol is the fundamental component of E85 (approx. 85%). At the time of investigation (2008) almost half of the EU s industrial ethanol capacity was not being used. The Commission concluded that the economic conditions were not met. On the basis of this opinion, the inspector rejected the license application. The court of first instance ruled that the economic conditions did not justify assessing the interest of community producers against that of the non-community components (bio-ethanol producers), only an assessment against the interest of community processors (producers of E85 bio-fuel). The Supreme Court (hearing with the appeal of the State Secretary of Finance) questioned the opinion of the court of first instance in view of the opinion of the European Commission (expressed at the request of the tax inspector). Apparently, the term, community processors, (as mentioned in article 148, letter c CCC) also includes producers of one of the components or intermediate products of the relevant finished product. In its consideration, the Supreme Court referred to the ECJ case, Friesland Coberco (C-11/05, ECLI:EU:C:206:312) where a similar conclusion was drawn. As the Friesland Coberco case concerned Inward Processing, the Supreme Court questioned if the conclusion also applies to outward processing (taking into account the fact that the goals of the two customs procedures are different). 4
The preliminary question requested confirmation of whether the term community processors (in article 148, letter c) of the CCC, also includes community producers of components or intermediate products equal to the (non-community) ones used in the processing operation. What can this mean for business? If the ECJ agrees with the (broader) interpretation of the term community processors, applications for outward processing licenses (and possibly also for other customs regimes) could be subjected to more scrutiny when testing the validity of the economic conditions of the procedure. On the other hand it would also broaden the possibilities for challenging licenses if they compete with community production of components or intermediate products. 5
Trade controls on cryptography products: how shall we deal with the Mass Market Exemption? The EU Dual-Use Regulation (EC) No 428/2009 ( Dual Use Regulation ) sets out the framework of EU dual-use controls and the list of controlled goods. If listed, a license will, in principle, be needed to export such items outside the EU. Controls do not apply to shipments between EU Member States (with limited exceptions for certain highly sensitive items), but the supplier is obliged to make a reference on the commercial documentation, (i.e.an invoice), indicating that it concerns a dual use item. A particular group of products that falls within the scope of the Dual Use Regulation are cryptography items (Category 5, Part 2 of annex I) such as, for example, routers. EU dual-use export controls apply to these encryption products, but include an exemption for exports of mass market items under the Cryptography Note included in the Dual-Use Regulation (note 3 of Category 5, Part 2). Under the Cryptography Note, the export controls set out in 5A002 and 5D002 of the EU control list, do not apply to exports of goods or software that meet all of the following: a) Generally available to the public by being sold, without restriction, from stock at retail selling points by means of any of the following: 1. Over-the-counter transactions; 2. Mail order transactions; 3. Electronic transactions; or 4. Telephone call transactions; b) The cryptographic function cannot easily be changed by the user; c) Designed for installation by the user without further substantial support by the supplier; and d) When necessary, details of the goods are accessible and will be provided, upon request to the competent authorities of the Member State in which the exporter is established, in order to ascertain compliance with conditions described in paragraphs a. to c. above. Unfortunately there is only limited guidance available with respect to the interpretation of this mass market exemption. An additional complication is that each EU Member State has its own national regulator (or in the case of Belgium even three regional regulators) which are responsible for overseeing the licensing and enforcement in that jurisdiction. Needless to say that this can result in differences in interpretation between the Member states. This obliges exporters, in practice, to check the exact interpretation of a particular exemption in the EU Member State where it operates. Another layer of complexity can be found in the fact that export control authorities outside the EU have sometimes broader exemptions, which can lead to situations where foreign companies that operate in the EU wrongly assume that because an export license for a particular item is not required in their home jurisdiction, an EU license is not required either. That could, for example, be the case for products that come under the ECCN-code 5A992 or EAR99 classification in the US (e.g. waived from a license requirement for example because the item is considered mass market ), but for which no equivalent classification exists in the EU. This can, in practice, easily lead to compliance gaps within a company s trade control compliance programme. It is, therefore, strongly recommended to check whether a decontrolled item in the US (or any other non-eu jurisdiction) will be similarly treated in the EU, and vice versa. 6
Lastly, it is important to note that US export control law, contrary to EU legislation, also applies to re-exports of US-origin goods from the EU, and that US economic sanctions and trade embargoes can also apply to conduct in the EU (particularly where US companies and individuals are involved). What can this mean for business? Companies that export goods from the EU should ensure that their export compliance procedures are updated to take account of EU export controls and any other controls that can impact their trade (for example US controls). Furthermore, each EU Member State has its own regulator(s) and the interpretation of the EU Dual Use Regulation and the practical procedures can thus differ slightly. Especially for cryptographic products one should always carefully review whether their export requires a license or not. 7
The never-ending talks on the classification of alcoholic beverages: how will it taste the ECJ? In the landmark Siebrand ruling (F&B sector), the ECJ decided that certain alcohol-based beverages, which previously were classified under heading 2206 of the CN (Combined Nomenclature), must now be classified under heading 2208 (attracting a higher excise duty rate). The criteria put forward in Siebrand seemed to open the door to operators classifying their products. The new preliminary questions in the Toorank Productions case (ECJ Toorank, C-532-14 & C-533-14) indicate, however, that there are still some uncertainties. The Siebrand judgement contained three practical guidelines for the classification of certain alcohol products (see 35 to 38 of the judgement). The guidelines are as follows: i) it has to be established which kind of alcohol (fermented or distilled) contributes more to the total alcohol content (alcoholic strength by volume) of the product, eventually contributing even more to the total volume by weight of the product. This criterion must not be regarded as a single demarcation line but as a starting point for further investigation into the objective characteristics and properties of the product ii) it has also to be established whether the particular organoleptic (i.e. taste, sight, smell) characteristics of the products correspond to those of products classified in CN code 2208. The taste can constitute an objective characteristic or property of a product. If the addition of water and other substances (such as syrup, various aromas and colourings, and, in some cases, a cream base), results in a loss of taste, smell and appearance of a beverage produced from a particular fruit or natural product, (that is to say a fermented beverage of CN code 2206), then the classification falls into the CN code 2208 category, and the product falls within the spirits category for the purposes of excise duty. iii) the final consideration is that of the intended use of a product which may constitute an objective criterion for classification if it is inherent to the product. That inherent character must be capable of being assessed on the basis of the product s objective characteristics and properties including the form, colour and name under which it is marketed. If they correspond to those of a spirituous beverage, classification in CN code 2208 takes place as well. The Dutch Supreme Court has again referred preliminary questions to the European Court of Justice (ECJ) with regard to the classification of the below products itemized below: beverages that are based on fermented alcohol to which distilled alcohol is added (C-532/14) beverages that are based on fermented alcohol to which no distilled alcohol is added (C-533/14) and beverages based on fermented alcohol, to which no distilled alcohol is added and to which sugar has been added (C-533/14). ECJ case C-532/14 ECJ case C-532/14 concerns the excise tariff rate that is to be applied to alcoholic beverages that are based on fermented alcohol, known as Ferm fruit, to which distilled alcohol, sugar (syrup), milk, fats and various aromas are added. The alcohol percentage is in total 13.4%. At least 51% of the alcohol consists of fermented alcohol. The fermented alcohol is cleared by means of ultrafiltration and has therefore a neutral taste, color and smell. The Tax Court considered the beverage as a liqueur, to be classified under CN code 2208 7010, upon which the high excise rate of distilled alcohol is due. 8
Procedure before the Supreme Court The Supreme Court refers to the Siebrand case (C-150/08 of 7 May 2009) where the ECJ ruled that, in order to determine the essential character of a beverage, not only the specific organoleptic characteristics of the product and its inherent destination, but also the amount of distilled alcohol in comparison to fermented alcohol must be taken into account. The question now, is how to explain the findings of the ECJ in order to determine whether a beverage satisfies the essential character of a beverage that is classified in CN heading 2208. The Supreme Court decided to refer the following questions to the ECJ for a preliminary ruling: Should heading 2206 of the CN be interpreted as meaning that a beverage with an alcoholic strength by volume of 13.4% vol., obtained by mixing a purified, alcoholic beverage (base) known as Ferm Fruit, obtained by fermentation from apple concentrate, with sugar, aromatic substances, colouring and flavouring agents, thickening agents, preservatives and distilled alcohol - in the sense that that alcohol does not exceed, either in volume or in percentage, 49 per cent of the alcohol occurring in the beverage, whereas 51 per cent thereof consists of alcohol obtained by fermentation - should be classified under that heading? If not, should subheading 2208 70 of the CN be interpreted as meaning that a beverage such as that should be classified as liqueur under that subheading? ECJ case C-533/14 ECJ case C-533/14 concerns a beverage called Ferm Fruit (the base drink) with an alcohol percentage of 16%. This beverage is prepared with sugar syrup, demineralized water, apple concentrate, minerals and vitamins. After mixing, pasteurization takes place and wine yeast is added, as a result of which, the product becomes an alcoholic product. The alcoholic product is cleared by means of, among other things, ultrafiltration and has, therefore, a neutral taste, color and smell. It does not contain distilled alcohol. This alcoholic beverage is suitable for human consumption and not destined only for the preparation of consumer products. The Tax Court considered the base drink (Ferm Fruit) as a beverage which is prepared by means of fermentation and that must be classified in CN heading 2206, as a result of which the (lower) excise rate of mediate products applies. Other products that are subject of the procedure, are manufactured on the basis of the above mentioned Ferm Fruit product. These products have an alcohol percentage of 14%. They are prepared by adding sugar, aromas, colorings, flavors, thickeners, preservatives and a cream (base) to the Ferm Fruit product. No distilled alcohol is added. The Tax Court considered the drinks,manufactured from the base drink, to be alcoholic beverages under CN heading 2208, as a result of which the high excise rate of distilled alcohol was due. 9
Procedure before the Supreme Court The Supreme Court refers to ECJ s Siebrand case, and asks why the CN heading 2206 was designated for the classification of a fermented beverage that does not have the taste, smell, colour and appearance of a beverage and that is manufactured out of a certain fruit or natural products. The only CN heading that seems suitable for the classification is 2208, but the product is not a distilled beverage and does not contain any distilled alcohol. The wordings of CN heading 2208 [ spirits, liqueurs and other spirituous beverages ] suggest that CN heading 2208 applies only to beverages, including liqueurs, that contain distilled alcohol. Further the Supreme Court considers beverages with a relative low percentage (14) of alcohol, that contain sugar but no distilled alcohol, to be a mismatch with liqueurs or other distilled beverages that in general contain a relatively high percentage alcohol content. The Supreme Court, therefore, decided refer the following questions to the ECJ: Should heading 2206 of the CN be interpreted as meaning that a beverage known as Ferm Fruit, obtained by fermentation from apple concentrate, which is also used as a beverage base for the production of a variety of other beverages, which has an alcoholic strength by volume of 16% vol, which, as a result of purification (including ultrafiltration) is neutral with regard to colour, smell and taste, and to which no distilled alcohol has been added, must be classified under that heading? If not, should heading 2208 of the CN be interpreted as meaning that such a beverage must be classified under that heading? Should heading 2206 of the CN be interpreted as meaning that a beverage with an alcoholic strength by volume of 14% vol, obtained by mixing the beverage (base) described in question 1 above with sugar, aromatic substances, colouring and flavouring agents, thickening agents and preservatives, and which does not contain any distilled alcohol, must be classified under that heading? If not, should heading 2208 of the CN be interpreted as meaning that such a beverage must be classified under that heading? What can this mean for business? After the ECJ Siebrand case, it seemed generally accepted that products could be classified on basis of their content. The abovementioned Toorank Productions cases, however indicate that there remain uncertainties with the classification of alcoholic beverages. Manufacturers of similar products who currently classify their products in CN heading 2208 (and consequently pay the high excise duty rate) should be alert to this issue and take steps to safeguard their legal rights. 10
E-commerce and VAT: How do you prefer your book: hard- or soft copy? The ECJ delivered its long awaited judgments on the infringements procedures against France and Luxemburg, concerning their application of reduced VAT rates to e-books. The court held that e-books qualify as electronically supplied services, and, as such, reduced VAT rates cannot be applied. Therefore, the VAT treatment of printed books (or more precisely, books on physical means, according to the VAT Directive), which are taxable at the reduced VAT rate in most EU countries, cannot be extended to e-books. The only way of having the reduced VAT rate applied to e-books as well, would be to change the EU VAT Directive, which will be a long process. E-book publishers in France and Luxemburg (and presumably also Italy that only recently announced that it intends to apply a reduced rate for e-books) must change their respective national legislations and apply the standard VAT rate to the sale of e-books. Luxembourg has confirmed that it will apply the standard VAT rate of 17% as of 1 May 2015. What does it mean for business? Companies involved in the sale of e-books, in the jurisdictions mentioned above, will have to re-consider their pricing (i.e. a price increase or margin reduction) and implement the new VAT rates. Disclaimer Although this publication has been compiled with great care, Loyens & Loeff N.V. and all other entities, partnerships, persons and practices trading under the name Loyens & Loeff, cannot accept any liability for the consequences of making use of this issue without their cooperation. The information provided is intended as general information and cannot be regarded as advice. www.loyensloeff.com