Do not Fall Into a VAT Trap: Manufacturing or Toll Manufacturing Makes a Huge Difference

Analysis

Dr. Gellért Menczel-Kiss, Partner, Tax advisor, LeitnerLeitner

Hungary is often mentioned as a country of manufacturers, but there is a significant difference from a tax point of view between manufacturing independently or on demand, when a foreign customer engages a Hungarian firm to make products using the customer’s raw materials. And it can be expensive to make a mistake in evaluating the nature of the transaction!

Producing goods from the raw materials of the principal is regarded as a service, but it changes the situation if the manufacturer adds its own goods to the finished product. Investigating the volume of the goods from the manufacturer and the exact scope of the engagement is crucial to see whether you can stay within the terms of toll manufacturing and providing a service.

As long as the added goods do not have a significant volume, it is clear that the nature of the transaction is unchanged, and the manufacturer never performs a sales transaction but instead remains within the framework of service supply. But there are no black-or-white answers; transactions should be reviewed on a case-by-case basis, considering the above factors and the intention of the parties.

Namely, it must not be ignored while defining the transaction if the principal is interested in the activity and service of the manufacturer (as in producing goods from its materials or installing and manufacturing the goods of the customer) or rather in the purchase of finished goods which are the products of the manufacturer. A wrong interpretation and treatment might bear significant VAT risks for both parties.

Toll manufacturing as a service is regarded as a general B2B service in terms of VAT, meaning that the place of supply is where the recipient has established its business. Assuming that the customer is a foreign taxable person without a seat or fixed establishment in Hungary for VAT purposes, the place of supply is outside of Hungary, so the manufacturer issues an invoice without VAT with a reverse-charge reference.

Does the manufacturer have any additional obligations in this relation? It is easy to say no, while it is responsible purely for processing and is not involved in delivering either the raw materials or the finished goods. Nevertheless, even if the manufacturer is not engaged in the transportation of the goods (since it has been concluded that the manufacturer is providing a service), in some cases, it might be faced with a connecting liability.

If goods are delivered by the principal from its premises to the manufacturer for processing, and later these are returned to the principal, that creates no VAT liability in Hungary that would require a tax ID number. The delivery of goods does not require registration either, as those shipments are out of the scope of VAT. Nevertheless, if the products are subject to EKAER reporting in Hungary, in the absence of registration and the tax ID number of the principal, the manufacturer is required to register the deliveries in the EKAER system. Even if the scope of products subject to EKAER reporting has been significantly limited, it is worth checking both the Hungarian VAT status of the principal and the connecting liabilities of the manufacturer; further, within the contractual provisions, those questions should be outlined with task allocations.

Even toll manufacturing may not create a VAT liability for the principal in Hungary under the above-referred circumstances, as, from practice, we know this is not always so. Suppose the client orders goods from external suppliers to be delivered directly to the manufacturer. In that case, the exemption and possibility of non-registration are no longer available since VAT liability immediately arises. This is also true when the finished goods are not returned to the principal but sold directly to the customer from Hungary.

Thus, as always, such cases require the utmost care and precise administration from all parties. Moreover, in doubtful situations, seeking confirmation from an external party, such as a tax advisor, is recommended.

LeitnerLeitner is one of the most influential tax consulting companies in Central Europe. You may rely on our specialized full-scope VAT package: advice for cross-border VAT issues, optimization of chain and triangular transactions, assistance with audits, and representation before tax authorities.

This article was first published in the Budapest Business Journal print issue of March 24, 2023.

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