Author: Rupert Moyle
Partner and Head of VAT and Duty at Kreston Reeves, Chair of the Global Indirect Tax Group at Kreston Global
Rupert has over 30 years of experience as a VAT specialist and has been Head of VAT at Kreston Global member firm Kreston Reeves since 2015, becoming a partner in 2017. His work focuses on owner-managed businesses and international groups, and he has extensive experience advising businesses on the consequences of trade between the UK and EU post-Brexit.
The exposure to indirect taxation on digital services
May 23, 2022
It is perhaps a strange way to begin an article about the indirect tax compliance obligations associated with offering digital services globally, but I think it is worthwhile trying to understand why, recently, I have been working with a number of businesses in this sector; those that had not fully appreciated the extent of their indirect tax obligations. This is important as it is a reminder to clients why they should look again at this area, because the consequences of not taking action at the right time is an unexpected loss of profit – in having to pay tax retrospectively – and possibly penalties as well.
I think the main reason we are seeing issues is to do with the Covid pandemic and lockdowns. During that time streaming, downloads and other internet sales went through the roof, highlighting for some an exposure that may have been lurking for some years, masked by a previously immaterial income stream. I also believe the issue lies partly with the fact that there is a lack of human physical performance with digital services. These are not supplies that are clearly visible and the tax consequences thereon considered, as you would with a cross border sale of goods or a construction service supplied overseas, for example.
A further reason is that in many cases customers can access digital services from anywhere in the world or via a marketplace, that either acts in its own name or as pure agent; it is not as easy to manage the compliance obligations as it is for physically performed services or goods, where a business can control which countries it wishes to do business with.
In addition, we must not forget that whilst taxation on imports and exports of goods has been around for hundreds of years, the area of digital services is a relatively recent proposition. The internet has only been around for about 30 years, and only really generated sales of sufficient substance to trouble tax authorities within the last 20 years.
Some tax authorities quickly woke up to the loss of tax revenue from digital sales as these began to replace conventional product sales, such as videos and CDs. For example, the EU (and UK at that time) introduced requirements to register for and pay VAT in 2003. Those rules and the use of a single registration and filing facility covering all EU member states were updated in 2015 with “MOSS”, the Mini-One-Stop-Shop, and again in July 2021 with “OSS”, the One-Stop-Shop. But not all countries have followed suit quite so quickly and thus while there are now many countries that have a digital service tax requirement of some sort, a digital services business will have had to keep on its toes in order to move with the times, the changes and the legal obligations that will have arisen in recent years.
There is one other factor which I would say leads to missing compliance requirements. That is, to determine what a digital service actually consists of. Some are obvious, such as downloaded movies, music or games, but other types of service that may have an element of human activity are not so clear cut.
Perhaps it would help, therefore, if I set out at this point some of the key considerations.
Which digital services are affected by indirect tax?
In looking into this global issue, my colleagues and I researched rules in various territories and although the exact definition may have differed from country to country, “digital services” are generally understood to mean the following:
- The supply of digitised products such as software, e-publications, apps etc
- Services provided over the internet including website hosting
- Provision of databases
- Services are automatically generated through electronic means (without human intervention)
- Downloads or streaming of music, films, games etc via the internet.
A typical supplier which might be affected would be:
- An online gaming supplier
- A news agency which has a subscription channel
- A computer software provider
What are the indirect tax issues for digital services?
Many countries across the world have introduced some form of consumption tax, more commonly referred to as a Sales Tax, a Goods and Services Tax (GST) or Value Added Tax (VAT) or similar. Typically, this is a transaction tax and is levied on the price of the goods or services at the point of consumption. The rules as to whether something is taxed can be complicated. For example, for supplies of goods the VAT position usually follows where the goods move from and to, whereas the position for services and, perhaps more importantly for digital services, is more complicated.
It is a common misconception that VAT is not due on services to foreign recipients. For a UK company, it may be the case that no UK VAT is due, but VAT may be due in the recipient’s country, i.e. where the service is effectively used and enjoyed.
Recognising that there is a potential revenue loss many countries have, as I mentioned, introduced over recent years a requirement to register for and charge VAT (or equivalent) on the supply of certain services which are deemed to be received or consumed in their country. For many, these rules apply only to B2C transactions, but there has been an increase in the number of countries which have also introduced new VAT registration rules for B2B transactions, would you believe.
Enforcing VAT registration can be difficult and anecdotally many businesses do not comply with foreign rules. As such, some tax authorities have considered alternatives to ensure the tax is collected, such as:
- transferring the liability to register to an online facilitator, where it is deemed to be supplying the service
- adopting a withholding tax regime
- requiring the payment service providers (e.g. credit card companies) to deduct the VAT from the payment to the merchant and remit this VAT to the tax authorities
In some ways these solutions can be better for suppliers as they remove the requirement to register for VAT and deal with the administration costs of being registered. But VAT is of course still due and prices may have to be adjusted to reflect this.
What impact does indirect tax on digital services have on a business?
In theory, where a non-established business supplies relevant digital services to a country it may be required to register for and charge local VAT. There will be a cost in doing this.
Failure to register could, as mentioned at the outset of this article, result in retrospective assessments for unpaid tax and potentially penalties. Might it also lead to local restrictions which perhaps prevent the business trading in the jurisdiction?
Which countries are affected by indirect tax charges on digital services?
It takes a lot of work to consider the indirect tax consequences for all countries around the world but as at March 2022 my colleagues and I have researched the VAT position for 136 countries.
Of these 136 countries, we found that:
For business to business supplies (B2B)
- The majority of countries do not require VAT registration for B2B supplies.
- VAT is accounted for by the recipient under the ‘reverse charge’ mechanism
- 18 countries, however, do require a VAT registration and, of these:
- 11 – have a nil registration turnover threshold – Algeria, Bolivia, Dominican Republic, Honduras, Mexico, Myanmar, Namibia, Nicaragua, Nigeria and Russia (although this can be paid by the recipient as a withholding tax if agreed by them) and Uruguay
- 7 – have a registration threshold – Barbados, Malaysia, Mauritius, Philippines, St Lucia, South Africa and Zimbabwe.
- In addition to the above, 3 countries operate a withholding tax position – China, Panama and Paraguay
For business to consumer supplies (B2C)
- Most countries require a VAT registration for B2C supplies
- The United States has been excluded from this overview as the rules vary per state, although a number of states require a Sales Tax registration if a nexus is created.
- 113 countries require a VAT registration and, of these:
- 80 have a nil registration turnover threshold – This includes the 27 member states of the EU – there is a threshold for EU members of €10,000 across the EU but this is not applicable for entities established outside the EU. In addition, the EU has the OSS simplification, making it possible to register for VAT in one member state but to charge and account for VAT in any other member state through a simplified VAT return covering all member states.
- This also assumes that all GCC countries will have no threshold (three of the GCC have not finalised their rules at present)
- 33 countries have a threshold
- In addition to the 113 above, 2 countries collect VAT through the finance provider – Argentina and Costa Rica
- 4 countries operate a withholding tax – China, Mongolia, Panama and Paraguay
- Currently only 16 do not require VAT registration for B2C supplies.
What action should a digital business take to address indirect tax issues?
A business supplying digital services on a B2C basis around the world is likely to be required to register for VAT in many locations. B2B services may also give a business that requirement. Whilst the administration costs of this may be high, failure to comply at the right time can be costly.
The starting point has to be for a business to consider its obligations and, I would suggest, as soon as possible, in order that any exposure is limited. There will likely be a need to obtain support in terms of local country advice on the particular local nuances, and to receive assistance in terms of filing returns and dealing with tax authority enquiries. Suppliers should also perhaps consider whether there are alternative commercial solutions to minimise compliance costs.
The Kreston Global network has advisory and compliance specialists in over 120 countries and with links to others too and so is very well placed to assist you in this regard, to obtain specific, local, specialist advice and to implement compliance obligations cost effectively.
If you would like to discuss your obligations in any country you can contact a firm in the appropriate territory or contact me or one of the Directors of our Global Indirect Taxes steering group.