The European Union (EU) consists of 28 member states comprising 500 million consumers. The economy is worth €14 trillion ($15.5 trillion), 24 million companies operate within it, and there are 300 million online shoppers. It’s a huge marketplace offering massive opportunities for companies from outside the EU to sell their products and services.
But what exactly is the EU and who’s in it? What’s the difference between the EU, the Single Market, and the Customs Union? What are the tax and duty implications of importing products into the EU? What are the appropriate legal structures to consider when deciding whether to do business in the EU? And, most importantly, how do you serve this market in a manner which balances customer service, cost, and complexity?
Over my 30+ year career, I’ve been CFO of multinational companies operating across the entire European market and lived in the UK, Belgium, Germany, and Hungary. During my time with GE, as corporate controller for Europe, I had responsibility for all of the statutory and income tax and VAT returns across Europe. This involved ensuring compliant filing for almost 2,000 statutory and income tax returns and in excess of 10,000 VAT returns. Even for a company the size of GE, it was a constant battle to make sure that internal finance and external audit resources were aligned to ensure compliant filings, and invariably, some returns were late.
There are some common misunderstandings and headaches that businesses need to be aware of, for which I’ll prescribe the solutions that I’ve found most useful.
What Is the European Union?
The EU is an economic and political union between 28 countries (see map below) that, together, cover much of the continent. The predecessor to the EU was the European Economic Community (EEC), created in 1958, focused on increasing economic cooperation between six countries: Belgium, Germany, France, Italy, Luxembourg, and the Netherlands.
Since then, a further 22 nations have joined (although the UK is currently involved in a long-running process to leave, which I will address later). In 1999, a single European currency, the euro, was launched and is currently used by 19 of the 28 countries.
The EU has the power to make its own laws, and treaties exist between members that promise common action in fields like human rights, agriculture, the environment, and foreign and security policy.
The EU’s main economic engine, however, is the Single Market.
Is the Single Market the Same as the EU?
Not quite - you can be in the EU’s Single Market but not the EU. The 28 EU countries - plus Norway, Iceland, and Liechtenstein - are part of the Single Market, also known as the European Economic Area (EEA).
Single Market rules require the free movement from one member country to another of goods, people, services, and capital (the so-called “four freedoms”).
Those rules take two forms. First, they remove barriers to trade. Second, they harmonize, or unify, national rules at EU level. These take the form of minimum standards for things like packaging, safety, and standards.
Membership of the Single Market also normally involves making annual payments toward the EU’s budget and accepting the jurisdiction of the European Court of Justice.
What About the Customs Union?
A customs union means that the countries involved apply the same tariffs to goods imported into their territory from the rest of the world and apply no tariffs internally. In the case of the EU, this means that there are no customs duties to be paid when goods are transported from one member state to another. For imports from the rest of the world, all Customs Union members charge the same set of tariffs – known as a common external tariff. The EU, for example, has a common 10% tariff on cars imported into it.
Once goods have cleared customs in one country, they can be shipped to others in the Union without further tariffs being imposed.
All EU members are part of the Customs Union. Turkey is also a member of the Customs Union (but not the Single Market), and conversely, Norway, Lichtenstein, and Iceland are not members of the Customs Union (despite being part of the Single Market).
If a country has no agreement with the EU, tariffs apply. If a country has a free trade agreement with the EU, tariffs can be reduced or removed.
Brexit and the EU
After winning the UK election on 12 December 2019, the Conservative Party has committed to leaving the EU by 31 January 2020—although, in practice, that is when a transition period will start during which time the UK and the EU will negotiate their future relationship. This transition period lasts until the end of December 2020, and until then, the UK will continue to trade with the EU in the same way it does now, abide by EU rules, and pay into the EU budget. While there are many points to be negotiated, what is known for sure is that the UK will leave the EU, the Customs Union, and the Single Market.
The current political declaration that was agreed back in October 2019 says that both sides will work toward a Free Trade Agreement (FTA), and a high-level meeting will happen in June 2020 to see how that work is going. The text also contains a paragraph on the so-called “level playing field” - the degree to which the UK will agree to stick closely to EU regulations in the future. It says that both sides will keep the same high standards on state aid, competition, social and employment standards, the environment, climate change, and “relevant tax matters.”
These are political declarations and not legally binding, so there is much work to be done between now and the end of 2020.
Tax and Duty Implications
Having established that importing goods from the US (or anywhere else) into the EU involves complying with the rules of the Customs Union, what are the regulatory requirements that must be adhered to?
- Tariff Codes are a means of classifying products for the purposes of collecting information on duty rates, applicable protective measures (e.g., anti-dumping), and external trade statistics.
- Import Duties are payable taking into consideration the value of the goods, the customs tariff to be applied, and the origin of the goods.
- Rules of Origin require importers to prove how and where their goods were made including where all the constituent components come from. They need to prove the “economic nationality” of their products. That means working out the total value and where that value was added along the way.
- Value Added Tax (VAT) is a consumption tax (the equivalent of US sales tax) charged on most goods and services sold in the EU. The VAT structure is harmonized within the EU. The basic legislation on the common system of VAT focuses on the harmonization of the EU countries’ internal legislation and establishes a common VAT structure, a uniform basis of assessment, and the minimum rates to be established by EU countries. VAT is levied on the importing of goods and usually charged when customs clearance procedures take place in order to be released for circulation. However, when the goods are imported into one EU country but are intended for use or consumption in another, they can be placed under a VAT suspensive arrangement. Under this arrangement, VAT will be charged in the EU country of destination and not in the EU country of entrance in the EU.
VAT is calculated on the “taxable amount,” which includes the value of the product plus import duties plus any other expenses incurred up to the place of destination.
How Should I Set Myself Up to Do Business in the EU?
Having established that the EU is an attractive market for your product, what is the best way of accessing the market? That will depend, to a certain extent, on what the most important factor for the exporter is: maximizing customer satisfaction through short delivery times and a wide product range, keeping costs low in order to keep selling prices low, minimizing the administrative burden and reporting requirements, or a combination of all of these. I’ll look at some of the different options below.
Selling Direct to Customers
By far, the easiest method for the supplier is to sell directly to the customer. However, this transfers the administrative burden of importing to the customer. In addition, duty and import VAT will need to be paid by the customer, thus increasing significantly the advertised selling price and not necessarily providing the best customer experience.
If the product is unique with strong customer demand, then the customer may be willing to put up with the additional complexity, but it may put the supplier at a competitive disadvantage. Amazon, for example, provides the option to customers of paying duty and VAT at the time of purchase, and Amazon does all the rest.
To provide a better customer experience, the supplier can register for VAT in each of the EU countries. If you are VAT-registered, you will account for the VAT. You charge the customer the VAT when they buy the goods from you so there are no unpleasant surprises for them on delivery. This is paid over to the tax authority on the VAT return. The import VAT charged is refunded to you via the VAT return.
Once registered, you will have to submit VAT returns to the tax authority in the language, at the frequency, and on the deadline specific to that country. Other reporting requirements such as Intrastat declarations and EC sales lists, which monitor sales between different EU countries, may also need to be filed. Previously, these reporting obligations would have necessitated employing experts in each country, but nowadays, companies such as SimplyVAT and Taxually offer a one-stop-shop service across the whole of the EU.
Agents and Distributors
Of course, selling direct to customers in the EU can be a low-cost option for the supplier. However, sales growth may be slow. Even though a single market exists, marketing challenges exist because of the many different languages spoken and the cultural nuances within the EU.
Agents and distributors offer a relatively low-risk, cost-effective means of expansion into new markets, such as the EU, since they can be a mutually beneficial means of subcontracting elements of the commercial function of a business. They offer a specialized knowledge of local markets, and fresh sales and marketing channels can be exploited without the costs and difficulties associated with setting up a new sales office or overseas business.
Often, the terms agent and distributor are used interchangeably, although there are distinct legal differences between the two arrangements. Both structures can be on a “sole,” “exclusive” or “non-exclusive” basis.
Advantages and Drawbacks of Direct vs. Distributor
A key advantage of the distribution model is that the supplier passes a significant degree of risk to the distributor, who is responsible for customer debts and contractual liabilities to those customers. The supplier deals just with the distributor and not the end customers, thus administrative costs are reduced and the need to have an established place of business in the distributor’s territory is removed.
In a distribution arrangement, however, the supplier will have significantly less control over the activities of a distributor (who may even have other conflicting commitments) than over those of an agent. There is no direct relationship with the customer and the supplier. Credit risk in a particular territory will be concentrated in perhaps only one distributor, rather than in multiple customers. In addition, there are potential competition law implications of certain distribution agreements, which are less of a problem in an agency relationship.
The agency model is particularly beneficial where the supplier wishes to retain a higher degree of control over product sales, allowing the supplier to fix sales prices, which is usually unlawful in a distribution arrangement, and maintain closer control over brand image. The supplier can cultivate direct relationships with customers, particularly vital where the products are supplied on a bespoke basis or where specialized after-sales services are required.
Typically, the commission paid to an agent is lower than the margin which a distributor will earn (since the distributor is taking a greater financial risk and investing in more operational resources). Appointing an agent will, therefore, in general terms, probably cost the business less than a distributor.
A key drawback of an agency arrangement, however, is that the agent may have the statutory right to a lump sum payment on termination of an agency agreement. This arises in many countries—including the UK under the Commercial Agents (Council Directive) Regulations 1993—and in most of the EU, even if the agreement is terminated lawfully. There are complex provisions for “indemnity” or “compensation” payments in this context.
Legal Entity vs. Branch
Once exports to the EU reach a certain level, the brand is well-established, and there is a need to put physical assets on the ground locally to support further growth, it may be necessary to consider opening up a legal entity in a country.
Firstly, what is the main difference between a European Branch and a European Subsidiary?
A branch is a more independent entity that conducts business in its own name but still acts on behalf of the parent company. A branch is not legally separate from the foreign parent company and so is also subject to the local laws governing the foreign parent company. Despite not being autonomous, the branch conducts business independently and so must be listed in the commercial register of the country it resides in.
A subsidiary is an incorporated entity created in the host EU country in accordance with one of the national business legal forms. The capital of the subsidiary is either fully owned by the foreign parent company (making it a single member company recognized in all EU countries) or controlled by a company in collaboration with minority local partners (therefore, making it a joint subsidiary). Depending on the chosen legal structure for the subsidiary, the relevant statutory provisions must be observed, such as entry in the commercial register, rules on minimum capital, and business registration. The subsidiary is the more popular structure to incorporate in Europe. It is much easier to conduct businesses through an independent legal entity, and a subsidiary or a limited liability company usually gives a business more credibility with third parties such as banks, service providers, and partners.
Advantages and Disadvantages of Branch vs. Subsidiary
A branch is easier to wind up if the experiment proves unsuccessful, as it is automatically closed when the trade of the branch ceases. In contrast, closing a subsidiary requires a formal procedure (winding up, striking off, or the appointment of a liquidator).
An overseas parent may prefer the relative anonymity of a subsidiary. For example, in the UK, a branch is required to file the financial statements of the overseas parent at Companies House. Where the parent company is not already required to prepare and disclose financial statements, then it will have to prepare accounts for submission to Companies House. In contrast, a UK subsidiary is only required to file its own financial statements.
However, ultimately, the choice between a branch and a subsidiary will depend on the parent company’s position. Regulatory requirements may dictate that a branch is used—for example, certain financial activities require a minimum level of capital, which is easier to maintain where the parent company capital is taken into account, instead of having to adequately capitalize a subsidiary.
The requirements for setting up a subsidiary or a branch vary depending on the country. The EU encourages all countries to meet certain targets for helping to set up new companies, including: setting up in no more than three working days, costing less than EUR 100, completing all procedures through a single administrative body, and completing all registration formalities online.
Balancing Customer Experience and Practical Application
When considering the best option for selling into the EU, it is clear companies will want to ensure the best experience for their customers but they also need to consider the regulatory and administrative burdens of their choice.
Understanding the basics
Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Italy, Ireland, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Spain, Slovakia, Slovenia, Sweden, and the United Kingdom (UK).
The EU is an economic and political union between 28 countries that together cover much of the continent. In 1999, a single European currency, the euro, was launched. The EU has the power to make its own laws, and treaties exist between members that promise common action in certain fields.
There are 28 EU member states.