From January 1 2015, new VAT rules coming into force meant that European buyers of certain digital services are required to pay tax according to the VAT regime in the country where they live, rather than where the supplier of the services is based.
Affected by the change are broadcasting, telecommunications and electronic (BTE) services including films, e-books and music downloads as well as paid-for software and some training courses.
The change in regulations is the EU’s attempt to provide an even playing field for all firms offering digital services – thereby preventing companies located in low-rate countries from undercutting firms based in higher-rate countries.
However, in practice the changes present sizeable challenges to any business selling digital content to individual customers (as opposed to business customers) across the EU. These challenges include not only applying the 28 member states’ 75 or more different VAT rates to invoices, but also submitting VAT returns to each of the various member states’ tax authorities.
In order to make it easier for small companies, the EU has introduced the VAT Mini One-Stop Shop (VAT MOSS), a system which allows businesses to register simultaneously for VAT in all of the 28 member states. Every member state runs its own MOSS portal.
As far as UK businesses are concerned, they do not need to register for VAT and charge the tax on their customers if their annual turnover is less than £81,000 (US$120,000). However, in order to take advantage of the VAT MOSS arrangement it is necessary for these lower turnover businesses to register for VAT. Until December last year, this meant that all business which registered would have to charge all their customers VAT – adding a hefty 20% to domestic invoices as well.
Bowing to pressure from the UK’s small and medium-sized enterprises (SME) business community and the media, Her Majesty’s Revenue & Customs (HMRC) has now changed the rules. A spokesperson for HMRC said: “Businesses below the current VAT registration threshold that can separate their sales to UK customers from sales to EU customers can voluntarily register the cross border element of their business, and then use that registration number to register for MOSS. This means that their domestic sales will remain VAT free.”
Roelof Hoving, vice-president corporate tax for Wolters Kluwer, one of the world’s biggest providers of tax information, acknowledges that for companies primarily selling business-to-business (B2B), or local-to-local (L2L), the impact of the changes will be slight.
“For large cross-border business-to-consumer companies selling online, it will have a major impact,” he says. “The biggest challenge will be for companies who sell cross-border to private individuals; they will need to verify in which EU country the client is located and charge them the local VAT rate. This means the company’s administrative systems will need to integrate up to 28 different VAT rates.”
The Location Challenge
Johnathan C Davies, director at PwC, says that the identification of customer location and the implementation of that in clients’ systems presents a major challenge. “For most supplies affected by the changes, the law requires the supplier to use two pieces of non-contradictory information to verify the location of the customer,” he explains.
“The EU law implementing the changes gives a range of options as to potential evidence of customer location that can be used in the determination – including information that can be provided by the customer, along with other indicia that are more ‘independent’ such as the internet protocol (IP) address.” He adds: “All of the options are seeking to give a proxy for customer residence – there is an acceptance that it is not an exact science.”
Having established in which country the customer resides, the supplier will then be liable to auditing from the tax authority of that country – although the audit will, in many cases, be coordinated by the supplier’s own tax authority.
Davies says that applying the correct VAT, once the member state of the customer has been identified, should be fairly straightforward – providing that which is being supplied is typically a standard rated product.
“However, there are issues for some businesses in determining whether their products or services are subject to the standard rate, a reduced rate, or exempt from VAT in the member state of the customer,” he says. “The European Commission [EC] has published a spreadsheet that seeks to assist in this determination, but we have seen clients needing to take country specific advice in respect of their products and services to gain clarity in respect of this.”
He points out that invoicing is likely to be a different issue, with some EU states requiring VAT invoices to be issued to private consumers and others not. “Businesses first have to understand whether sales to customers in particular territories require an invoice, then if they do, what the particular requirements are,” he says. “In general, these requirements are broadly similar but there are country specific requirements that businesses need to understand in order to be 100% compliant. It is not easy to achieve this without seeking professional advice.”
Impact of Varying Rates
Lastly, there is the impact on pricing and profit margins of different VAT rates across Europe. Here, Davies says there are only two possible outcomes.
The first is variable pricing for customers across the Member States, the second is flat pricing but a variable profit margin for businesses, depending on the location of the customer. The former is more difficult to implement from a systems perspective as businesses would need to have a view on where the customer was located – often before those customers have actually provided any information.
“We have seen a mix across our clients of how they are going to deal with this, some maintaining current flat pricing, with a ‘wait and see’ approach, some maintaining flat pricing but increasing pricing across the board to reflect predicted margin impact, and some moving to a variable pricing model,” Davies reports.
Although it is not yet clear how the changes will play out in the coming months, Wolters Kluwer’s Hoving sees it having a major effect on pricing and/or profit margins for large business-to-consumer (B2C) companies selling cross-border online. “Many of these have established their invoicing hubs in places with low VAT, like Luxembourg,” he says. “That has given them a tax advantage under the old system, but now they will have to charge VAT at the local rate of the person buying. Companies affected like this will probably have to adjust their pricing model.”
Hoving concludes: “In today’s virtual and digital world, it is not always easy to establish exactly where a customer is. We will see how it works out in practice, but in my view tax legislation has yet to get to grips with the digital economy.”
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