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Defense Acquisition University
Defense Acquisition Magazine
VAT Is Where It’s At
Written by: Stephen Speciale
December 18, 2018
On military support purchases abroad, should the Department of Defense (DoD) or its industry partners pay extra money that provides no value to the United States? U.S. taxpayers ultimately spend lots of money in foreign countries on products and services that support international acquisition efforts, perhaps including costs that they could save or avoid.
Value added tax (VAT), a consumption-based tax charged by foreign countries on purchases, could represent a major cost element for such acquisitions. Opportunities exist for DoD and its industry partners to receive VAT exemption. DoD’s acquisition workforce members in program management, financial management, contracting, logistics and engineering can execute sound VAT exemption activities that support international acquisition efforts. The most effective application of VAT exemption includes applying a team-based approach while sharing information, pursuing VAT exemption approval prior to purchases, streamlining processes with defined areas of responsibility and maintaining documentation.
DoD’s current strategy largely centers around strong alliances and partnerships with foreign nations. Specifically, the 2018 National Defense Strategy (NDS), published in November 2017, stated that “Mutually beneficial alliances and partnerships are crucial to our strategy, providing a durable, asymmetric strategic advantage that no competitor or rival can match. We will strengthen and evolve our alliances and partnerships into an extended network capable of deterring or decisively acting to meet the shared challenges of our time.” Therefore, it is highly likely that the United States will continue and expand its acquisitions abroad with allies to accomplish the NDS objectives.
While supporting multiple DoD major missile defense projects in Eastern European countries from 2015 to 2018, I encountered process inefficiencies that prevented consistent application and maximum cost savings or avoidances. I created and implemented streamlined business processes affecting many stakeholders that produced successful operations. This article provides information and lessons learned from actual experiences with VAT exemption on international acquisitions for increased understanding and application.
As the United States carries out international acquisition efforts, it is imperative that we seek VAT exemption from foreign countries in order to save or avoid unnecessary costs. For the purposes of this article, international acquisition efforts include international deployments, international cooperative efforts, foreign military sales (FMS) and any other major effort where the DoD could spend abundant resources within a foreign country.
VAT in Brief
VAT rates are determined by the country where a customer makes purchases, and vary per country and type of good or service. For instance, the standard VAT rate for Finland is 24 percent, while the standard VAT rate in Japan is 8 percent. Table 1 provides the current standard VAT rates for certain countries around the world.
VAT exemption explained. Such an exemption is a customer’s ability to complete purchases without paying VAT. Exemption can take place at the time of purchase or allow the customer to recoup VAT through reimbursement after the purchase. Authorization for VAT exemption is required from a foreign country’s government. DoD typically receives VAT exemption authority through a Status of Forces Agreement (SOFA) or FMS case. A SOFA is a high-level agreement between governments outlining a major effort where DoD will operate in or with a foreign country. SOFAs are a responsibility of the Department of State (DoS) and are an integral part of DoD’s international efforts that define the legal status of U.S. personnel, property and activities outside the United States. On the other hand, all FMS cases are required to include a provision that prohibits taxation (including VAT) by foreign countries on purchases supporting U.S. assistance efforts. The Defense Security Cooperation Agency (DSCA) released guidance in 2004 specific to tax prohibition on FMS cases.
Applicability of VAT exemption. The exemption applies to purchases made by the DoD or industry partners so long as appropriate authority and documentation support them. Common purchases include, but are not limited to, materials, equipment, services (construction, engineering, base operations support, utilities, communications, administrative, rental vehicles, leases) and fuel.
Methods for receiving VAT exemption. There typically are two methods of receiving a VAT exemption: time of sale or reimbursement.
The time-of-sale method allows a customer to receive VAT exemption at the point of purchase. For this method, the customer has exemption approval prior to purchase and does not pay the VAT for the purchase amount.
The reimbursement method results in a customer completing a purchases (including VAT), but recapturing VAT through reimbursement after purchase.
In addition, a foreign country may allow VAT exemption on entire contracts that support an effort covered by a SOFA or FMS case. VAT exemption for entire contracts can apply to both fixed-price and cost-plus type contracts. This option allows DoD and its industry partners to complete VAT-exempt purchases in a foreign country without required foreign country approval for each purchase.
VAT exemption is important. It can produce significant cost savings or avoidances for the DoD on international acquisition efforts and reduce the overall cost of deployments, weapon systems, facilities, etc. It also can provide the means to use taxpayer funds for other needs. For example, if the DoD has an international deployment that will require purchases totaling $100 million in Hungary, the DoD could save up to $27 million (based on a standard VAT rate of 27 percent) if VAT exemption is authorized and properly completed by the stakeholders executing purchases for that international deployment. Table 2 provides another example of potential cost savings from a $500,000 VAT-exempt purchase within three countries and the resulting final purchase amount.
Although Bahrain does not charge a VAT, Finland and Japan do. DAU has an online job support tool (Value Added Tax Exemption Calculation Tool) that can help users evaluate VAT exemption on purchases or contracts within specific countries and potential cost savings or avoidances. Given the latest NDS, the VAT exemption is important now more than ever when DoD teams formulate acquisition strategies and conduct operations overseas.
Major stakeholders involved. Many stakeholders perform various functions within and between countries in support of VAT exemption activities. The major U.S. stakeholders include the DoS, Combatant Commands (COCOMs), DoD acquisition teams, DSCA and industry partners. A foreign country’s major stakeholders include the country’s DoS equivalent (such as its Foreign Ministry), DoD equivalent (such as its Ministry of Defense), tax office, and vendors selling goods and services. Table 3 provides a synopsis of key responsibilities per major stakeholder.
Best Practices and Lessons Learned
The following are some examples of best practices and lessons learned from actual experiences that can assist the DoD and other U.S. personnel with current or future international acquisition efforts where VAT exemption applies. The italicized sections detail my real-world experiences when supporting Missile Defense projects in Eastern Europe.
Apply “Team” Approach and Share Information
Two sayings relate to VAT exemption activities: “If you fail to plan, you are planning to fail” and “knowledge is power.” As seen in Table 3, stakeholders and responsibilities are widespread. Since initial planning between countries can begin well in advance of an effort beginning, it is a best practice to maintain a “team” approach throughout the effort and regularly share information with necessary stakeholders. These actions can enable all stakeholders to overcome the barriers (language, time zones or cultural) that may arise on international acquisitions.
After inheriting VAT exemption duties in the middle of an international deployment, it was immediately apparent that a “team” approach did not exist and that crucial information was not appropriately shared among stakeholders. DoD entities ineffectively coordinated with one another, their industry partners and the foreign country’s various entities. As a result, DoD entities and industry partners applied inconsistent VAT exemption processes that were noncompliant with foreign country requirements. This resulted in strained business relations with the foreign country and untimely processed VAT exemption requests.
Applying an alternative approach to a new and separate international deployment produced much different outcomes. Consistent coordination and information sharing among DoD entities, their industry partners, and the foreign country’s various entities created a highly effective environment. Initiatives included interacting with stakeholders, sharing procedural documents and required VAT forms, and providing regular training. This resulted in successful business relations and timely processing of VAT exemption requests.
The benefits of a team approach and information sharing cannot be overstated. These efforts must be applied to ensure successful VAT exemption activities.
Pursue VAT Exemption Approval Prior to Purchases
The time-of-sale method is the preferred method to receive VAT exemption since the customer never pays VAT on purchases and it places the majority of the administrative responsibilities on the foreign country vendor. The reimbursement method is not preferred since it places the majority of administrative responsibilities on the DoD or industry partner and can take significant time for that entity to receive reimbursement from the foreign country’s tax office. Also, pursuing VAT exemption for entire contracts is a best practice, when applicable, since it eliminates the need for the foreign country to approve each purchase for VAT exemption.
While working multiple international deployments, some industry partners did not pursue the VAT time-of-sale exemption method on purchases nor seek VAT exemption approval for their entire contract (even though the foreign country was willing to approve an exemption). Rather, the industry partners completed purchases including VAT, with plans to pursue VAT exemption later. As a result, the industry partners struggled to submit timely and compliant VAT reimbursement documentation per the foreign country’s requirements and did not receive reimbursement until more than a year after the original purchase date. In one instance, the foreign country’s tax office affirmed it could not provide VAT reimbursement to the industry partner since the country lacked sufficient resources to do so. In another case, an industry partner spent months circulating VAT exemption documents back and forth to the foreign country’s tax office without correct forms and required information. Such situations created financial hardships for the industry partners and difficult relations between the various stakeholders. The entities that pursued VAT exemption through the time-of-sale method and approval for their entire contracts experienced more favorable operations than those that pursued VAT exemption through the reimbursement method.
The DoD and its industry partners should default to using the time-of-sale method and seek VAT exemption approval for entire contracts associated with international acquisitions (if the foreign country is willing to approve). If they default to the reimbursement method for VAT exemption, the process will not be as efficient since that could impose additional administrative burdens and result in an untimely recapture of VAT.
Streamline Processes and Define Areas of Responsibility
It is highly likely that VAT exemption processes and responsibilities will differ for each international acquisition simply because each international acquisition with a foreign country is unique. However, since VAT exemption activities are similar in nature to other administrative activities, processes and responsibilities should be documented and available to involved stakeholders. Procedural documents, such as standard operating procedures, should include input from individuals of the foreign country and industry partners on that specific international acquisition. This will support the creation of streamlined processes that are efficient, simple to complete, and understood by all.
During an international deployment, there were no VAT exemption-related resources available that identified general processes, stakeholders involved in the process, or areas of responsibility. Current and new personnel on the deployment could not easily identify nor complete VAT exemption efforts. It was also evident that the DoD and its industry partners had different understandings of the VAT exemption process than that of the foreign country. This caused inconsistent and inefficient processes for all stakeholders. During another international deployment, processes were created and documented with involvement from major stakeholders (including the foreign country) involved in the VAT exemption process. This resulted in processes being documented, consistent and efficient.
VAT exemption success directly ties back to the established processes. Streamlined processes and defined responsibilities are critical as they define who, what, when, where and why.
Maintain Documentation and Report Often
Documentation applies to more than processes or procedures, as numerous parts of VAT exemption activities should be documented. This includes VAT exemption requests, VAT exemption approvals, contract documents, and vendor quotes or invoices. The documentation responsibilities apply to both DoD entities and industry partners. Documents are critical as the majority are translated into multiple languages, to meet each country’s requirements, and have signatures from designated authorities. It is a best practice to maintain documentation if it supports VAT-exempt purchases or contracts. In addition, it is recommended that the DoD entity managing VAT activities for a specific program or site maintain records to document VAT exemption metrics and report as needed.
During an international deployment, no DoD entity assumed responsibility to maintain documentation supporting the VAT exemption activity. As a result, critical supporting documents, including reference materials and reports relative to VAT exemption activity, were unavailable. This caused significant problems when industry partners and the foreign country’s tax office requested specific VAT exemption information. It also caused problems when the DoD entities could not provide VAT exemption metrics (such as total cost savings) to senior DoD officials. During another international deployment, a DoD entity created an electronic filing system to maintain supporting documents for all DoD and industry partner VAT exemption activities. Furthermore, the same DoD entity maintained a report that generated timely VAT exemption data and metrics upon request.
Documents supporting VAT exemption activities are incredibly important to DoD entities, industry partners and foreign country entities. Implementing a document and reporting system can only strengthen the overall VAT exemption process.
The DoD will likely continue and expand its international acquisition efforts in conjunction with allied nations to maintain its competitive advantage. As such, it is imperative that we pursue VAT exemption authorization, to the greatest extent possible, from foreign nations on all international acquisitions. VAT exemption can yield significant cost savings or avoidances for U.S. taxpayers and eliminate unnecessary administrative burdens during operations for the DoD and their industry partners. Successful VAT exemption efforts require a team approach, information sharing, streamlined processes, defined responsibilities and appropriate documentation. DAU is able to assist DoD acquisition teams with VAT exemption efforts on international acquisition efforts.
Speciale, currently a professor of Financial Management at the Defense Acquisition University’s South Region in Huntsville, Alabama, worked at the Missile Defense Agency and performed financial management and program management functions supporting NATO’s European Phased Adaptive Approach in Romania and Poland. Speciale implemented and managed value added tax (VAT) exemption activities among multiple Department of Defense entities, industry partners and foreign government entities. His efforts produced significant cost savings for the U.S. Government and process efficiencies to be utilized for other international acquisitions.
The author can be contacted at
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