VAT considerations for e-commerce
Nehal Radia considers the VAT implications of e-commerce and how taxpayers can take advantage.
According to Forrester Research Inc, US e-commerce spending will increase by 13.4 % to US $262 billion this year, with an expected continuation in growth to $370 billion in 2017. In Western Europe,it is estimated that 2013 e-commerce spending will reach€128 billion ($165.5 billion), up by 14.3 % from last year and with expectations of €191 billion ($247 billion) by 2017. With both double-digit compound growth year on year and the continuing introduction of novel ways of trading across the internet, how can taxation, specifically value-added taxation (VAT), keep up?
To date, many commentators might say it hasn't. Especially in Europe, many consider that the VAT concepts that originated in the late 1970s and 1980s, which were designed to apply to "brick and mortar" sellers, do not sufficiently lend themselves to the way businesses and people buy and sell today, despite efforts to update and modernise the tax regime.
VAT is a tax on transactions and applies to most goods and services. In the context of e-commerce, with the sale of digitised products, there is a greater challenge for both sellers and purchasers in defining what is being sold, who is selling, for what price, and where. We will examine some of the main VAT considerations for e-commerce in the EU and more widely.
VAT is more than a European tax. VAT applies in over 150 countries worldwide, and all the OECD countries except the US have a VAT system. The current average OECD VAT rate is 19 %, and VAT accounted for on average 18.7 % of total tax revenues in OECD countries in 2008. Given the trend to increase VAT rates, the significance of VAT for governments in terms of revenue generation, and correspondingly for businesses to manage, is increasing.
VAT principles apply to supplies of goods and services. For VAT purposes, goods are generally defined as tangible personal property and services are broadly considered to be anything that isn't a supply of goods.
Having defined what is being sold, it is necessary to determine the place of taxation and the rate that applies. Different rules apply to sales to businesses (B2B) and sales to consumers (B2C). For B2B sales, VAT regimes generally provide accounting simplification measures, and the tax is, in principle, recoverable. It is in respect of B2C sales that the VAT is potentially an increase to the sales price or a reduction in profit margin. It is also usually with B2C sales that it is the responsibility for the supplier to collect the tax. These complexities are discussed further below.
E-commerce is defined as the buying and selling of products and services by businesses and consumers through an electronic medium. This includes indirect e-commerce, whereby the internet is effectively a virtual store for the purchase of goods, which are physically delivered. Indirect e-commerce also extends to services such as the purchase of flights, hotels, or services that are physically delivered or performed. In contrast, direct e-commerce covers products and services that are digitally delivered, such as downloaded music, books, and software.
Direct e-commerce poses the greatest challenges for VAT, and that is the primary focus for this article. Supplies sold over the internet are generally considered to be supplies of services for VAT purposes. The definition of so-called 'electronically supplied services' in the EU include products and services which are delivered over the Internet or an electronic network, where their nature renders the supply essentially automated and involving minimal human intervention, and whereby it is impossible to ensure the delivery in the absence of information technology. The definition of these services is broader than an ordinary definition, and includes digitised products and what may be referred to as "intangible goods," such as electronic publications, applications (apps), and software.
There are specific rules covering the EU taxation of electronically supplied services, and currently a distinction is made between a sale through an EU establishment compared to a sale through the US. A US business will need to collect VAT at the rate applicable in each country where its customer is located. Whilst in principle this could require VAT registration in each country where the customer is located, the EU has a simplified regime whereby the US business can register in just one country and collect taxes for all 28 member states. The important distinction is that an EU-established business will charge only the rate applicable in its own country to all customers, regardless of location. However, in 2015, the rules will change and all businesses, whether established in the EU or not, will have to collect VAT at the rate applicable in each country where the customer is located.
Outside the EU, the position varies. Generally, legislatures in some countries – including South Africa, Switzerland, and possibly Japan in 2014 – are becoming increasingly focused on taxation at consumption. However, in the Asia Pacific region and Latin America, the position is somewhat inconsistent, frequently driven by the existence of a local establishment. In such cases, the challenge is how to collect tax at consumption, given that there is no concept of registering just for VAT purposes. A business is generally required to have a local establishment to register for all taxes, and it would be necessary to fundamentally alter the local tax regime to accommodate this. Turkey is currently engaged in this debate, and is considering the possibility for individuals to be responsible for declaring the tax. Based on the ineffectiveness of self-declaration by individuals in other countries, we don't expect this to be the final outcome.
Distortion of Competition?
The current differentiation in treatment in the EU of sales made by non-EU and EU businesses and rates varying in the EU from 3 % to 27 % can have a significantly distortive effect. Many providers set up in low-tax jurisdictions such as Luxembourg to capitalise on this. However, in 2015, the rules will change and all businesses, whether established in the EU or not, will have to collect VAT at the rate applicable in each country where the customer is located.
In the publishing industry, a mere difference in the mode of delivery of the printed product can change the nature of the product, the place of supply, and the rate of taxation. The main difference in VAT treatment between the supply of print versus digital is the applicable VAT rate, with some countries applying a significantly reduced rate to print publications. This rate arbitrage between products and between EU countries is currently the object of significant attention and debate at the European Commission and we expect to see further changes in the rules regarding rates that may level the playing field.
There is also room for distortion of competition outside the EU, where, as mentioned above, it is often advantageous for businesses to sell from outside a country rather than from within. Some countries, including Japan, South Africa, and Turkey, are trying to address such distortion, whereas in other countries, such as Australia, the distortion of competition in e-commerce has not yet been addressed and does not appear to be on the tax authorities' agenda.
The e-commerce environment has given rise to the increased use of aggregators or agents to sell globally. Based on the different rules for businesses with an establishment and those without an established business presence, it is conceivable that different sellers of the same product could be taxing the same product differently. It's important to look carefully at the terms of the arrangement to address questions including: who will account for VAT; are the seller and the aggregator/agent jointly and severally liable for the payment of the tax; who dictates the sales price; how are commissions calculated?
Consolidated product sales
We have been discussing mainly direct e-commerce and the sale of digitised products, but there are additional challenges for businesses that sell both digital and print products, particularly as a bundled offering. This is again, a particular issue for publishers who often sell digital and print versions as a consolidated supply where there is a difference in the rates applicable to print and digital products.
When a business supplies a mixture of digitised and print products, for VAT purposes the supply could be treated as a single supply of either print or digital, with an incidental or ancillary supply of the other. Alternatively, it could be treated as two supplies, one digital and one print. There are no set rules in EU VAT legislation on what determines whether a supply should be treated as a single supply or a mixed supply for VAT purposes. However, this issue has been looked at in numerous VAT cases that have established the principles to help determine the correct VAT position. These principles include examining the core features of the transaction and not artificially splitting a transaction. The existence of a single price is not decisive.
In determining whether a supply is ancillary to the principal supply, one of the key questions to consider is whether the supply can be regarded as 'a means of better enjoying' the principal supply (that is, the ancillary supply is not an aim in itself for the consumer). Outside the EU, similar considerations apply, but there is less prescriptive guidance.
In determining the allocation between two supplies (which can be important when the supplies have different VAT rates) there is relatively less precedent, but tax authorities generally require that a fair and reasonable allocation be applied. Given the subjectivity, the price allocation may be an area in which businesses can gain a competitive advantage but tax authorities, particularly in the EU, are closely scrutinising this allocation, and challenge to aggressive positions can be expected. Common methods of allocation are selling price or cost. Other factors that are likely to be considered include customer perception, usage, and content differentiation.
This is not just an issue for publishers, but all e-commerce providers selling different products. Even if rates don't vary, the way to account for VAT will often vary (goods or service) and the invoicing and compliance associated with such transactions gets complicated.
Compliance and reporting
E-commerce creates VAT compliance and reporting obligations for business that can be challenging and burdensome. In addition to the requirement to maintain VAT registrations, file periodical VAT and other statistical returns, there are a number of other considerations that are particular to the industry.
Because taxation is based on consumption, it is necessary to determine where consumption takes place. The rules vary in different jurisdictions and often the billing address alone will not be sufficient for this assessment. The EU recently issued draft regulations providing specific rules to determine the place of consumption where there is the potential that the customer is established or resides in more than one country.
These guidelines make reference to different presumptions based on the circumstance in which the supply is made. Relevant factors include permanent address, billing address, location of WIFI hotspot, and IP address. Under the new guidelines, two items of evidence are generally required to determine where the customer is established, has its permanent address, or usually resides. It can be challenging for businesses to capture the relevant information and verify it.
Setting up accounting and billing systems, as well as customer interface, can be complicated. It will be necessary, for example, to:
Capture the relevant tax rate information per country for both print and digital products, where applicable.
Differentiate between business and individual customers, if both markets are being served.
Identify relevant information in respect of customers to determine the place of supply – permanent vs. billing address, VAT registration number for businesses, etc.
Apply the correct price and taxability for the products sold, with particular attention to the pricing considerations discussed above with regard to bundled products.
Include relevant information on the customer interface on the website.
Issue appropriate invoices, where necessary.
Fraud is already a significant concern in the VAT arena. According to the OECD, revenue loss from VAT fraud and avoidance is running at 10 % and in some instances, at 30 % of potential VAT revenues. The EU is generally concerned with "Missing Trader Intra-Community" (MTIC) fraud. Missing-trader fraud arises when a business purchases goods or services as part of an intra-community transaction without having to pay VAT to its supplier, collects VAT from its customer on the subsequent domestic supply, and then disappears without having paid the tax to the tax authorities.
MTIC is an indirect e-commerce play, but the virtual market place, with the lack of information required to be provided by supplier and consumer, the ease of payment, and the scale of access to markets provides a fertile ground for fraud to thrive across all areas of e-commerce.
More generally, suppliers can sell on the internet without meeting VAT obligations, resulting in lost VAT revenue and distortion of competition arising from suppliers not collecting VAT where they should. Furthermore, fraudsters could collect VAT but not remit it – a clear loss of VAT revenue to the relevant government. There is also scope for potential 'fraud' by consumers. Given that suppliers have to rely on evidence provided by consumers regarding their location and the place of consumption, there is some potential for VAT-rate shopping through the provision of preferential billing information. This is more likely to result in the misallocation of VAT in the EU rather than nonpayment and lost VAT revenue.
Changes on the horizon?
Given the complexity, the rapidly changing business environment, and the significant variations in rules and rates of taxation, it is difficult for e-commerce businesses to have a clear and consistently applied global approach to VAT.
There is recognition at the EU and OECD levels that something must be done to simplify the rules and level the playing field in terms of rates and rules and there is some progress, but this is slow.
In the meantime, it is important to have an awareness of the key principles and trends involved, and to be mindful of the potential pitfalls of expanding into new countries. More specifically, taxpayers should be aware that although in many countries taxation increasingly focused on the place of consumption, being a virtual seller does not always preclude creating a physical presence for VAT purposes. It's also not always about a down-side. There can be scope for potential tax reductions and with an average OECD VAT rate of 19%, this is particularly relevant for B2C sales, where any changes in the VAT treatment can have a notable impact for businesses on competitive pricing or profit margin.
Senior Manager, Global Indirect (VAT/GST) Services
Deloitte Tax LLP
Tel: +1 212 436 2338
Nehal is a senior manager in our US-based global VAT practice. She has over 15 years' experience in indirect taxes working in both the UK and the US, advising global multinationals on VAT/GST matters. She has practical knowledge of worldwide VAT systems, advising businesses on their expanding international operations principally in Europe, and also in Asia Pacific and Latin America.
Nehal has managed numerous global consulting and compliance engagements assisting companies managing VAT globally, including the efficient set-up of operations and VAT recovery. She has extensive experience in co-ordinating and managing large teams within our organisation, having worked in an in-house role supporting the management and development of Deloitte's Global Indirect Tax network. She also has experience in the area of indirect tax technology with a focus on the enhancement of compliance processes and risk management.
Nehal has a wide range of industry experience, particularly in the technology, media and telecommunications and consumer products industry.
Nehal regularly presents at internal and external seminars and conferences on international VAT/GST matters.
Nehal is a qualified UK solicitor, a chartered tax adviser (ATII) and a member of the UK Chartered Institute of Taxation.