Contract manufacturing occurs when a company (the client) entrusts another company (the contract manufacturer) with a specific task involving goods that remain the property of the client.
The company carrying out the work does not acquire the goods, but provides a manufacturing service. The remuneration received therefore relates exclusively to the work carried out and not to the sale of the product.
Typical examples of contract manufacturing include:
- mechanical processing
- assembly of components
- painting and surface treatments
- processing or modification of materials on goods owned by the client
VAT treatment
Contract manufacturing between Italian businesses
When both the client and the service provider are established in Italy, the contract manufacturing normally constitutes a supply of services subject to Italian VAT.
The invoice always relates solely to the processing service and not to the supply of the processed goods.
Contract manufacturing with foreign clients or suppliers
In dealings with foreign parties, it is necessary to check the VAT rules on territoriality to determine in which country the service is subject to tax. For the supply of services between businesses (B2B – Business to Business), the general rule is that the service is deemed to take place in the country where the client is established. This rule is set out in Article 7-ter of Presidential Decree 633/1972.
1) An Italian company carrying out contract manufacturing for a foreign client
If an Italian company carries out processing work for a foreign company, for example a German or Austrian one, the invoice is normally issued:
- without Italian VAT
- stating that Italian VAT does not apply pursuant to Article 7-ter of Presidential Decree 633/1972
The foreign client will, where applicable, apply its own national VAT rules.
2) Italian company receiving contract work from abroad
If an Italian company receives an invoice from a foreign supplier for contract work carried out on its goods, the
reverse charge mechanism normally applies.
This means that VAT is not charged by the foreign supplier, but is paid directly by the Italian customer in accordance with the procedures laid down by Italian legislation.
The main reference is Article 17, paragraph 2, of Presidential Decree 633/1972.
Documentation required to avoid tax risks
Proper document management is essential to demonstrate that the transaction is indeed a contract processing operation and not a supply of goods.
It is advisable to draw up a contract or a processing order setting out the details of the assignment.
It is of fundamental importance to document the movement of goods using:
- a transport document (DDT) for delivery and return, stating the reason, for example: “Dispatch/return of goods owned by the customer for contract manufacturing”
- a specific register of goods received and dispatched for contract manufacturing
- CMR (international consignment note) (for contract manufacturing with EU countries)
- customs declaration for temporary export (for processing operations with non-EU countries)
Intrastat reporting
The processing of goods within the EU requires the completion of Intrastat forms relating to goods, to monitor the movement of incoming and outgoing goods, and Intrastat forms relating to services, to report the value of processing services received or provided.
For certain transactions, there are thresholds exempting operators from the obligation to submit Intrastat forms. However, services provided to EU entities (invoices issued) must always be reported, regardless of the volume of transactions.
Be aware of the difference between processing and sale
If the party carrying out the activity uses mainly its own materials and delivers a finished product, the transaction may be classified as a supply of goods rather than a supply of services.
This distinction is particularly important in international transactions as it can completely alter the VAT treatment and customs obligations.