VAT changes in the digital (download) world
VAT Changes in the digital world
From 1 January 2015, businesses involved with electronically supplied services (digital services) to private individuals face more changes to the VAT ‘place of supply’ rules. Currently these changes are being made in the EU and South Africa to apply VAT on supplies of e-services made by non-resident suppliers to local customers. There are many practical issues that digital companies face in dealing with the shifting tax landscape. Although still a long way off, affected businesses need to start planning now. This means tax teams need to be engaging with commercial teams to reduce the compliance and commercial costs associated with these trend.
The EU: the 2015 VAT changes
These changes will apply VAT to all Business to Consumer (B2C) supplies of “e-services” made in the EU in the EU country where the customer is resident, however this does not apply to business-to-business transactions (B2B). Therefore the rate of VAT charged on a digital service will depend on the country where the customer resides, not where the supplier is based. As such, this change is creating a number of practical issues for EU suppliers. These issues are substantial for digital businesses and taxing jurisdictions around the world because, the 2015 changes are not straightforward to implement, with the European Commission working hard over a number of years to guarantee a consistent approach and clarity within the legislation for businesses and tax authorities alike. Data storage and data protection issues may also arise as businesses may be required to keep customer data for more than 10 years under the 2015 VAT changes.
However, even with half a year to go until these changes become effective, many suppliers are still struggling with the implications for their businesses, especially those in lower VAT countries, including the impact on customer contracts, prices, website design and reporting. For example, for some businesses, the VAT on their supplies will increase from 15% to 27% as a result of the 2015 VAT changes. What impact will that have? How does VAT apply for subscriptions that span the changeover date? Can that increase be passed onto consumers? These are all important concerns. Of equal concern, a number of EU Member states are not yet ready for the changes and may not be so by 1 January next year. Businesses are rightly concerned about what may happen in countries that do not have clear rules and practices in place.
South African VAT changes
South Africa has taken a similar approach to taxing non-resident suppliers making digital supplies into the country. However, unlike the EU, South Africa is looking to tax supplies of business-to-business (B2B) e-services as well as supplies to private consumers. This difference is likely to mean that many non-resident businesses will be impacted by these changes, which will be mostly negative for companies in countries with a higher VAT rate, even those that do not consider themselves to be typical digital businesses. For example, companies may be caught because they are selling some digital services as part of a wider package of B2B supplies.
These rules have not been easy to implement, and as a result the South African tax authorities have had to push back their implementation date from 1 April 2014 to 1 June 2014, not least because the difficulties with implementation arise from how to define the scope of “e-services” for these purposes.
As a result of the absence of available precedents and the lack of clarity in this area, many businesses are looking to obtain a ruling from the South African tax authorities as the only means of obtaining certainty on the tax treatment of their activities in this new world of taxation.
Fixed establishment risk
Businesses that do not trade in countries planning to or have introduced changes on taxing e-services may believe that they will not be affected. This is not the case. As businesses of all types negotiate the commercial impact of this move to online delivery, their tax teams need to keep a keen eye on the shifting VAT rules and be conscious of the general tax trends in this area. Tax teams also need to be engaging with commercial teams from early on to reduce the compliance and commercial costs associated with the changes. Tax authorities may look to ensure collection of local tax on digital services by raising a challenge on the basis that the business has a local establishment from which it makes supplies.
There have been a number of cases within the EU addressing the point of what constitutes a supply made from a fixed establishment for VAT purposes. Due to these recent decisions, the definition of a fixed establishment for VAT purposes may be broadened, and thereby businesses (particularly multinational companies with operations in multiple countries) could find that they have local fixed establishments where they did not previously consider there to be a risk. This making it increasingly complex for businesses to comprehend what exactly creates a fixed establishment. At the same time, it seems to be getting easier, and more common, for tax authorities to challenge a business on the basis that it has a local fixed establishment that should be accounting for local VAT. With many countries also increasing their VAT rates by up 2% this could have a significant impact on digital businesses.
A global trend?
The 2015 EU VAT changes and the South African VAT changes, represent a universal trend by governments toward taxation on non-resident businesses making digital sales into their country. Other countries are also looking at this area, including the Bahamas and Turkey, with many prepared to act swiftly. Further, although up until now these measures have generally impacted B2C sales, South Africa may serve as a warning that other countries could look to widen the VAT registration net to catch B2B deliveries as well. Furthermore, experience shows that, in practice, the rules are rarely introduced smoothly. Meaning many issues are likely to arise, including how to register overseas businesses, establishing an agreed-upon definition of e-services covered by the rules, and how they can collect and report VAT charged and paid in each country. Digital businesses expand rapidly into new markets. Therefore they must adapt quickly not only to unfamiliar tax jurisdictions but also to rapid changes in the tax rules that affect their activities. While traditional digital businesses are border-less in terms of trading, we also see that other traditionally non-digital businesses are offering more online products.
To minimize cost and risk, companies that provide e-services will need to be well prepared for these changes and act quickly to fully understand the implications for their business. So what should taxpayers be doing now do to prepare for these changes? In the table below, we have identified five key areas to focus on:
Five key areas
- Pricing– understand the potential impact of VAT changes on your pricing.
- Systems– ensure your customer acceptance, accounting and reporting systems are set up in good time for VAT accounting, and any changes in the VAT rules. Consider how you can future-proof system capabilities to deal with new VAT systems as and when they are introduced.
- Contracts– ensure you understand who has responsibility for accounting for VAT.
- Compliance– understand the detail behind compliance (e.g. invoicing rules, exchange rates, audit procedures, storage of data).
- Customer experience– ensure that the changes won’t impact how customers experience your site or service. Consider aspects such as the need to collect personal information about where the customer belongs and storing customer data for long periods of time.
Five key areas
1. Pricing– understand the potential impact of VAT changes on your pricing.
2. Systems– ensure your customer acceptance, accounting and reporting systems are set up in good time for VAT accounting, and any changes in the VAT rules. Consider how you can future-proof system capabilities to deal with new VAT systems as and when they are introduced.
3. Contracts– ensure you understand who has responsibility for accounting for VAT.
4. Compliance– understand the detail behind compliance (e.g. invoicing rules, exchange rates, audit procedures, storage of data).
5. Customer experience– ensure that the changes won’t impact how customers experience your site or service. Consider aspects such as the need to collect personal information about where the customer belongs and storing customer data for long periods of time.