As disruptive technologies and heightened connectivity continue to transform the way people around the world work, play, and interact, the digital economy is increasingly becoming the economy itself. According to a recent study by Cisco, 4.1 billion users – more than half the global population – will connect to the internet by 2020 using some 26.3 billion devices. The digital goods and services they consume are expected to top $4 trillion.
With expanding consumer demands for social media, video streaming, gaming, music and digital services make up a growing portion of the overall market for electronically supplied items. In 2014, the US alone exported almost $400 billion in digital services, which represented 56% of US services exports and 17% of total US goods and services exports.
Those numbers and projections have caught the attention of tax authorities worldwide, who are identifying ways to capture tax revenue from the growing volume of digital purchases and to institute efficient ways to collect the revenue.
The OECD examined the issue of taxation in the digital economy as Action 1 of its 15-point action plan to address base erosion and profit shifting (BEPS), and published its report addressing the tax challenges of the digital economy in October 2015. The resulting recommendations, which include the imposition of a value-added tax (VAT), or equivalent, on cross-border digital services provided by non-resident suppliers to individual consumers, are viewed as the preferred standard for countries designing and implementing tax reform in this area, and these largely follow reforms adopted from January 1 2015, across the 28 EU member states.
This article takes a closer look at digital services taxation efforts in North America and Latin America. The Americas region has an internet penetration rate of 70% (second only to the EU, with 77%) and is thus a market ripe for continued growth in digital services and the resulting tax legislation.
Companies selling digital services in these markets must stay apprised of the (evolving) tax rules and compliance obligations, which is not easy given the size, diversity, and complexity of the region. We will examine the overall trends in the region and provide updates on the latest taxation issues and the progress in the largest countries.
Indirect tax landscape in North America/Latin America
The Americas is a melting pot of regulations and requirements related to indirect tax laws. Only a handful of countries in the region are members of the OECD, and while some, such as Colombia, seek to align themselves with the OECD, and Brazil has just recently requested OECD membership, others such as Argentina show little indication of doing so.
The sheer diversity of the region, with a distinct and complex mix of markets with varying complexities of indirect taxation, results in rules being implemented and enforced at different times and in different ways. Similar patterns can be seen in other regions, particularly Africa and Asia, and there are a number of comparisons that can be drawn between the experience of these regions and the state of play in the Americas. What is perhaps most interesting, as we explore below, is that there are some fundamental challenges associated with implementing indirect taxation on digital services under the existing indirect tax legislation in the Americas. Whilst local tax authorities appear to be recognising this, they are doing so without finding any real solutions.
As a general rule, under local legislation in the Latin Americas region, non-resident businesses often are not able (or even permitted) to register only for VAT/indirect taxes. Instead, tax registration will cover all taxes and, before registration can be carried out, a business will often be required to set up some form of local establishment in the country, be it a branch or a legally incorporated entity. This runs counter to the OECD's recommendation that digital services should be taxed at the place of consumption and that the non-resident supplier should account for the taxes due.
In line with the difficulties experienced elsewhere, before any rules to tax digital services can be effectively implemented in the Americas, broader changes to most local indirect tax legislation will be needed, a step that seems to be at least under discussion in some countries. Not surprisingly, this is proving to be a complex process and time-consuming to implement. As a result, the need to fundamentally rework legislation could mean that, one or two countries aside, introducing a requirement for non-residents to register directly and specifically for indirect taxes never really gains traction. The fact that countries such as Argentina and Brazil have multiple tiers of government, with varying levels of responsibility for taxation, does not help matters here.
As an alternative to amending existing legislation, the tax authorities in the Americas have looked at other ways to collect indirect taxes on supplies of digital services. For example, new legislation that was introduced on January 1 2017 in Colombia aims to bring digital services supplied by non-residents within the scope of Colombian VAT. For business-to-business (B2B) sales – that is, when the service is provided to a business customer in Colombia – the VAT accounting responsibility will fall to the local business customer under the reverse-charge mechanism, which is in line with most countries worldwide other than South Africa, which requires suppliers of digital services to register and account for local VAT if they are supplying digital services to South Africa business customers. In contrast, business-to-consumer (B2C) sales – that is, when the service is provided to a private individual in Colombia – are in theory subject to VAT, but the mechanism for this VAT accounting is a withholding requirement imposed on credit card companies/payment processors that collect the payment for the services.
In principle, this approach eliminates the need for a non-resident digital services provider to register for VAT in Colombia. However, the approach is relatively untested and it raises a number of practical questions, not the least of which is how a bank or payment processor can be sure that what was purchased was in fact a digital service. Argentina wrestled with this very issue after a withholding tax mechanism was introduced in 2014, under which credit card companies were required to withhold turnover tax from payments made by private consumers to non-resident service providers for digital services supplied in Buenos Aires. The government had to postpone implementation of the rules because the credit card companies lacked the systems needed to withhold the correct amount of tax.
Given the potential challenges associated with implementation, the new rules and the associated collection mechanism may not be in force in Colombia until as late as July 2018, so its possible effectiveness is uncertain for the time being. However, if the tax authorities can make the system work, it could serve as a model for other countries developing their own legislation, in the Americas region and elsewhere.
Whether all countries would adopt this approach, or would seek to adopt any other model to tax non-residents, is unclear. However, our experience in some of the Americas countries tells us that not all tax authorities feel the need to change their existing rules.
For example, legislation in Canada, which applies a subjective test of whether a non-resident company is "carrying on a business" in the country before bringing it into the indirect tax net, already captures a number of the largest digital services providers, largely because those providers tend to have set up some form of operations within Canada. The Canadian Revenue Authority had the taxation of digital services on its agenda two or three years ago, but it now appears to be a lower priority, perhaps due to the lack of additional revenue that legislating for and administering such a change could bring if the major players already remit indirect taxes. Chilean authorities have taken a somewhat similar approach, considering that existing domestic withholding tax legislation should result in collection of the appropriate tax. Whether tax is actually collected in this manner is less clear, but these examples raise the question of whether all countries in the region will eventually follow Colombia's approach or choose to remain reliant upon their existing taxation framework.
Summary of practices in various countries
The taxation environment in the Americas region clearly will continue to evolve. As illustrated by the table below, changes are taking place and legislation is being considered in a number of countries. However, the efforts are slow and diverse, and it seems unlikely that any type of uniformity – even that all countries in the region will tax digital services – will exist in the near future.
In 2014, the city of Buenos Aires sought to apply a withholding tax on digital services. However, the tax was suspended the next year to allow the withholding agents – credit card companies – time to adequately modify their systems to collect the tax.
At a federal level, the taxation of digital services is on the tax reform agenda targeted for the end of 2017, but Argentina currently only taxes digital goods (i.e. goods sold into Argentina via web sales), not services. Some provinces, such as Cordoba, have introduced a turnover withholding tax for certain services (including digital services) provided by foreign parties, but the rule is not yet in force.
The VAT Act, introduced in 2015, in principle requires the taxation of digital services provided by persons not domiciled in the Bahamas to persons domiciled in the Bahamas where the benefit or advantage is for persons in the Bahamas. In practice, we understand that while one or two businesses supplying digital services in the Bahamas have registered for VAT, not all have, and to date there has been limited enforcement by the local tax authorities. The efficacy of the tax, therefore, remains relatively untested.
While there currently are no rules in Brazil which require non-resident suppliers to register and account for indirect taxes, legislation has been introduced which requires Brazilian resident business customers to account for local indirect taxes on the purchase of digital services from non-resident suppliers. This could arguably be the first move to tax non-residents on B2C transactions, and the taxation of these services at the municipal level remains a possibility. However, there are still debates in Brazil on the concept of "digital services" and, to date, there is no legislation that would require a foreign supplier, i.e. a supplier without any physical/legal entity presence in Brazil, to charge and collect indirect taxes.
There is currently no specific rule for the indirect taxation of digital services provided by non-residents and Canadian residents. Such suppliers, therefore, fall under the general taxation rules in Canada. While there previously was a consultation on this issue, it is not considered to be high on the Canadian Revenue Authority's list of priorities, potentially because many of the largest non-resident suppliers already seem to be applying indirect tax on sales of digital services into Canada.
Chile operates a territorial-based VAT system, and services provided from outside of Chile typically are not within the scope of Chilean VAT. Chile also operates a direct tax withholding mechanism that should apply to most payments made to non-residents. As such, the provision of services by non-residents to Chilean customers should be subject to such withholding, which theoretically ensures that such services are taxed in Chile.
Legislation that applies as from January 1 2017 taxes both B2B and B2C supplies of intangibles by non-residents. From a B2C perspective, the intention is to collect the tax through banking institutions and payment processors, although limited guidance has been issued to date and an 18-month timeline for implementation is in place. As such, affected banks/payment processors are still in the process of determining the exact impact this has on them.
There is no mechanism in Mexico to collect tax on digital services purchased by residents from a non-resident supplier. Despite being a member of the OECD, the Mexican tax authorities are not understood to be considering the introduction of such rules given that they would require significant changes to the tax code. Given the recent changes in the Mexican VAT law, there is no expectation that the authorities will prioritise the taxation of digital services any time soon.
In the US, indirect taxes levied on the sale of digital services vary widely by state and local jurisdiction. In general, US sales and use tax is imposed only on a retail transaction to the end customer.
The taxation of digital services is increasing, though, with software-as-a-service (SaaS) and the provision of online content being two areas that have been subject to change. However, most of these changes affect US providers of digital services, rather than foreign providers.
Recently drafted regulations aim to tax two or three specific non-resident companies operating in the transportation and leisure industries in Uruguay. These regulations would appear to illustrate a desire to tax such services, but there is little clarity on how this might be accomplished or when actual changes may be introduced.
Staying ahead of cross-border indirect taxation in the Americas
The fast pace of digital technology disruption and the introduction of new digital services is creating considerable complexity, and it is difficult for both the tax authorities and taxpayers to keep up with technological advancements and how such services should be taxed. This is unlikely to change; the complexity in this area from an indirect tax perspective is likely to increase, as more countries likely will require indirect tax to be collected on the supply of digital services going forward.
Although it is unknown which countries will be the first to implement indirect tax changes and new collection mechanisms, one thing is clear: From both a legislative and business standpoint, indirect tax developments in the Americas as they relate to digital services should be monitored closely, and getting in front of the developments is key.
Whether it's keeping up with the local legislative position in countries in which a company does business, managing customer interactions to ensure that sufficient customer data is collected, considering whether pricing models (and hence margins) are impacted, or giving thought to how (and whether) business operations should be restructured, companies should be taking some sort of action. At the very least, keeping a watchful eye on developments, and working with affected functions within the company (e.g. finance and IT) will put businesses in the best place to navigate the inevitable change that will arise in the coming months and years.
|Ronnie Dassen, Jon Tilson and Steve Butler|
Deloitte Tax LLP