In 2015 all European countries will charge VAT on all eservices provided to their residents no matter where the eservice provider will be located (i.e. in Europe, America, Asia or elsewhere). This will be the result of the new B2C VAT rules and the technology which will enable to enforce these new rules. The VAT taxation will lead to increased sales prices of digital products (by as much as 27%) and/or decreased the profit margin for the e-businesses. In addition compliance and admin costs will increase as a result of increased tax compliance and reporting procedures. All this will directly impact the profit line. Alternative is even worse – e-businesses not willing to register and charge VAT will be shut out of the European market.
Yes, I understand – you probably hate VAT and do not wish to hear anything about it. Don’t worry – this is perfectly normal. VAT has its own logic, which is not necessarily logical. But it also has a direct impact on companies’ profits and therefore, please, stay with me. I will explain this as pleasantly as possible.
VAT is something you either already deal with or will have to deal with. It is not pleasant and it will not go away. If you think it is bad now, wait for y2015. It is not your friend – but you can get prepared to face it and deal with it.
Let’s approach this issue step by step – in small doses (you know, the same as for medicine or poison):
Step 1: What is VAT?
Chances are that you have probably heard of or experienced the VAT (Value Added Tax) in practice. This tax system was first introduced in the fifties in France, Europe and has in the meantime become a worldwide phenomena. VAT (or its twin brother “GST”) has been in the mean time introduced in almost all countries around the world (only about 10 remain completely VAT free). It is very efficient and for this reason popular among the tax administrations worldwide (with USA being the biggest exemption – for now). It is being addressed as the new governmental money-making machine.
When VAT was first introduced, it was the most modern tax system up t that date. VAT is a consumption tax and requires from the sellers to collect the tax on behalf of the tax administration from their customers by charging the VAT on top of the sales price.
Most business customers can afterwards recover VAT charged to them by following relatively formalistic and usually complicated accounting and reporting procedures. For them VAT is a neutral tax, although they still have to endure expenses related to admin and compliance.
Some categories of business (such as banks, insurance companies, governmental and non-governmental organizations – the list goes on) and any consumers are not allowed to recover VAT – for the VAT is a final costs as it increases the final sales price for as much as 25% to 27% (e.g. in Sweden, Norway, Iceland, Hungary).
Consumers do not differentiate between net price and VAT – they only see a final sales price. The higher the final price is for them, the less are they able to buy and this decreases sales volume and profits of the sellers.
Step 2: The ugly truth about the VAT
VAT was a great system when it was invented. Its idea was really simple and it was perfect to cover all sorts of sales of goods and services. Then the politic got involved and introduced a bunch of specific rules, which made it really complicated. And then the business reality and real life and technical inventions and change of lifestyle and all sorts of other things came in the way and the VAT system got outdated.
Any changes to the current European VAT system reassemble more an ongoing patching process of outdated software instead or releasing a new generation product. Because of the efficiency of the VAT system for the state budgets and luck of any better alternative and due to political compromises integrated in the current system we probably cannot expect a drastic improvement in a foreseeable future.
Step 3: Why was VAT inefficient when it came to the taxation of eservices
While VAT was a great tax system and is still is a good system when it taxes the sales of goods (at least as long as no more than two countries are involved), it is not perfect when it gets to the supply of services and it fails completely when it gets to the supplies of eservices. The business world has outpaced the political understanding of the reality by several years (some say even decades) – but to be fair, the politicians are slowly catching up.
Until y2003 the EU VAT system did not acknowledge the existence of eservices and was not prepared for them. The politicians have forgotten that eservices know no borders and treated them as any other standard service (e.g. construction work). This means that the e-business established within the EU had to charge Vat on their digital sales, while e-business outside Europe were not required to do so. This meant that a non-EU company started with a 20% (average VAT rate at that time) price advantage over its EU competitors.
The e-businesses have adapted and have started to sell their eservices from outside of the EU- even if that meant that they had to found a special sales company outside the EU. This meant that they were able to charge more for their products or were able to sell them at a more attractive price (e.g. at $500 instead of $600).
Step 4: Why is VAT still inefficient when it comes to the taxation of eservices
The EU has eventually changed the rules – so now all EU e-business have to charge VAT in the country where they are established – i.e. when they sell eservices to EU consumers and no VAT for sales made to non-EU consumers. Further, all non-EU e-businesses are required to register for VAT in EU and charge VAT at the rate of the country where their consumers are living.
Unfortunately for the EU, most of the small and medium non-EU businesses are not aware of these rules or just do not care about them. Either way they don’t charge VAT and the tax authorities have no means to force them to do so. In practice they can only hope that the e-businesses will register for VAT out of good will.
The biggest e-businesses, who had to deal with the reputation issues and corporate government, choose another solution – most of them established a EU based sales company in Luxembourg where the VAT rate is the lowest in the EU – 15% compared to 20%. This just shows how fast and efficient international companies adapt to the tax rules changes.
Current situation is as follows: (i) eservices are not taxed if provided by the vast majority of the smaller e-commerce providers, and (ii) almost all VAT revenue is generated in Luxemburg (or Ireland in some cases).
This created another anomaly: as other EU country make almost no revenue from the taxation of eservices they do not really make any substation efforts to search e-businesses which are selling eservices to their residents. I mean, why they should spend time and effort if the e-business will afterwards open a sales subsidiary in Luxembourg.
Step 5: New B2C EU VAT 2015 rules
A new change of the rules was required. As of 1.1.2015 the sale of eservices will be taxed in the EU country where the consumer lives regardless where the supplier is established.
This will probably motivate all EU countries to search and force all e-businesses to register for VAT in the EU and charge VAT at the appropriate rate (different rate for every EU country – depending where their customer lives).
This makes perfect sense – all countries are in a desperate need for additional revenue sources and the e-commerce is predicted to exceed €130 billion by 2015. This will generate some €30 billion additional tax revenue, most of which will not end in Luxembourg.
Furthermore, the European countries (not just EU countries but also all other European countries) will be finally able to enforce this new VAT legislation by the means of the various agreements for the mutual administrative support and also by other means available to them – I expect that legislation such as ACTA, SOPA, PIPA and national security agencies will open the doors for the technical means necessary to force the e-business to either accept the new VAT reality or to stop selling their eservices to the European consumers.
Step 6: What does this mean for you?
Your company will also have to adapt to the new business reality, accept it role as de facto revenue agent, fill out VAT reports, reliably identify the location of your consumers and charge VAT in 30+ different countries. You will have to deal with several countries claiming that based on their own criteria (different from country to country) the same customers are living more than one country and therefore VAT should be paid to them and not to some other country. At the same time other countries will be claiming exactly the same (i.e. that this same consumer lives in their territory and therefore VAT should be paid to them) based on different set of country specific criteria.
In the end the decision will be simple: will your company be able to deal with the VAT minefield or will it have to stop selling eservices to its European consumers. Either way, your business will not be the same as of 1.1.2015.
There is still sufficient time to plan, budget and implement the necessary changes to your current business model – these are roughly the relevant deadlines to keep in mind: Budgeting should be done in 2012, planning in 2013 and implementation in 2014.
I trust this “short” introduction has answered some of your questions and provided with a not to technical insight behind the new EU VAT rules for B2C sales of eservices.