This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.
The EU VAT system is set for a significant upheaval come January 2015, potentially causing suppliers of digital products a major headache.
The change aligns the rules for both EU and non-EU businesses in relation to the supply of "digital services", so that VAT is charged on supplies to individual customers in the jurisdiction in which those customers are located. Internet businesses can therefore no longer save VAT by supplying digital services from EU jurisdictions with a low rate of VAT (such as Luxembourg).
"Digital services" for these purposes will include video and music downloads, online games, e-books and other forms of online content, as well as broadcasting and telecoms services. They do not include, however, the supply of physical goods (such as books) just because the sale takes place over the internet.
|Who is making the supply?
||The current VAT position
||The position from 1 January 2015
|Supply by non-EU business
||VAT is charged where customer is located
||VAT is charged where customer is located
|Suppy by EU business
||VAT is charged where business is located
||VAT is charged where customer is located
Since 2003 non-EU businesses (for example, US internet companies) making supplies of digital services to individual customers within the EU have been treated as making a supply in the jurisdiction in which the customer is located. This is the case even where the supply is made from a country that does not apply VAT or sales tax.
This change was introduced in response to lobbying by EU internet companies. It was designed to overcome a perceived unfair advantage in favour of non-EU internet companies (and in particular US internet companies) who would not have to charge VAT on the supply of digital content to EU customers, whilst EU internet companies would need to do so.
The rules were never changed for EU businesses making B2C supplies, who continue to be required to treat all supplies within the EU as being made in the jurisdiction in which they are established so that they account for VAT in that jurisdiction only.
This difference in treatment has resulted in most large internet companies establishing themselves, for VAT purposes, in jurisdictions with low VAT rates.
This is arguably causing a distortion of competition, with big businesses such as Amazon and Google able to take advantage of Luxembourg's 15% VAT rate, a rate not available to smaller businesses that cannot so easily relocate. This advantage will fall away once the rules are changed in January, following which any supply of digital services will be subject to VAT in the jurisdiction in which the customer is located.
What problems does this cause?
The change will create significant administrative difficulties for many internet businesses. Ironically, for a change targeted at perceived VAT avoidance by big business, it is going to be start-ups who are hit the hardest, given that, regardless of the level of supplies they make in each jurisdiction, they will still be required to apply the same rules as established internet companies.
Where is your customer located?
One real issue will be determining where a customer is located. The starting position is the customer's permanent address. However, businesses will also be expected to apply a complicated set of presumptions to determine their customer's location:
(i) where the customer is connected to the internet via a landline, wi-fi hotspot, internet café, restaurant or hotel lobby, the customer will be treated as located wherever such landline, wi-fi hot spot etc is located;
(ii) where the supply is made through a mobile phone, the customer will be treated as located in the country code of the phone's SIM card;
(iiii) where the service is supplied through a decoder, the customer location will be where the decoder was sent or installed; and
(iv) where the supply is made on board transport between two Member States, the customer location will be the point of departure.
These presumptions create manifest difficulties in practice. For example, a customer who pays a monthly subscription to, say, Spotify may well stream music in different jurisdictions, using different devices (perhaps a mobile phone in one instance or a tablet connected to a hotel wi-fi in another). It cannot be realistic to expect Spotify to verify where its customers are based on a month-by month basis, and alter the VAT treatment accordingly.
Where the presumptions do not apply, a business will be expected to produce two pieces of non-contradictory evidence (such as a billing address or a bank address) to prove the customer's location. This increases the cost for all businesses but is likely to hit start-ups the hardest.
One helpful carve out to these rules is that supplies made via digital marketplaces, such as app-stores, will be treated as being made by the app-store itself, i.e where it is treated as located.
How should I treat my customer for VAT purposes?
Once a business has determined where its customer is based, it then must apply the local VAT rules to determine whether the supply is taxable or exempt in that jurisdiction.
Businesses will need to take VAT advice in each jurisdiction in which they operate, with potentially 28 different VAT treatments (or even more given the special status of Madeira and Gibraltar for VAT purposes) for the supplies they are making, as opposed to one VAT treatment before the change.
This causes acute problems for companies operating in businesses where the VAT rules may vary from Member State to Member State. Online gambling companies, for example, have typically been based in jurisdictions which treat online gambling services as exempt for VAT purposes (such as the UK) but will now have to apply VAT on supplies to customers in jurisdictions which treat gambling as VATable (for example, Germany or Ireland).
What is the MOSS? Will it really help?
The MOSS, or mini one stop shop, allows an EU business (and a non-EU business which chooses to use the non-EU version of the MOSS) to make one VAT registration application under the MOSS scheme in respect of all of the supplies of B2C digital services it makes within the EU.
The business will be required to file one VAT return to the tax authorities for the Member State in which it is registered. It then accounts for all of its VAT to that tax authority (which then effectively distribute such VAT to the relevant taxing authorities in which customers are based).
The MOSS may well have significant advantages in terms of reducing compliance costs for businesses. However, the MOSS will not apply in respect of EU jurisdictions where a business has a business establishment (such as an office). In this case a business will be required to register with the tax authorities and account for VAT in that jurisdiction, in the usual way, and then rely on the MOSS system in respect of other jurisdictions.
Although the MOSS will help remove the compliance burden of filing returns in each jurisdiction, it will not remove the underlying problem of determining where individual customers are based, or what VAT treatment to apply to those customers.
Given the EU-wide drive to incentivise tech start-ups, it is surprising that the rules have not been simplified by introducing a threshold for turnover, above which the new rules would apply, but below which a company could continue accounting for VAT in the jurisdiction that it is established.
This simple change would have been beneficial to tech-start-ups, with a deferral in the additional administrative burden.
The VAT rules place an obligation on businesses to get their VAT treatment right. There is only a limited extent to which businesses can protect their position through their Terms and Conditions. Any confirmation from a customer as to where he or she is located at the time of the contract will not ultimately determine the relevant VAT treatment.
Businesses may find it easier to charge a flat fee for their digital products, inclusive of any VAT, across the EU, and just accept that this will reduce their margin in jurisdictions with higher VAT rates. Charging VAT on top of the net price for the products will tend to make payment processes more complicated.
The difficulties may see businesses refusing to supply at all in less profitable jurisdictions, as the added compliance costs outweigh the return made. This is particularly relevant to gambling companies with tight margins, where the VAT charge may wipe out their profit entirely.
It is hoped that tax authorities recognise these difficulties and will be slow to apply penalties when businesses make innocent mistakes. But given the difficulties referred to above, a better approach must be to urgently reconsider whether, in targeting perceived VAT avoidance by big businesses, the EU is going too far and should now look to introduce a financial threshold for smaller businesses or at least some form of transitional period before the rules begin to apply to them.