Most E-Commerce businesses should now be aware that the scope of the VAT charge on digital products will be radically extended from 1st July 2003 when the EU Directive on VAT and E-Commerce comes into force. In this bulletin we explain the key steps which businesses must take before 1st July.
Key points
- Supplies of digital products by non-EU businesses to EU private customers will become subject to VAT for the first time.
- Non-EU businesses affected by this change need to ensure that, by 1st July 2003, they are registered for VAT in each EU member state in which they have customers (subject to certain minimum turnover thresholds). They must then account for VAT at the rate which applies in each state and submit regular VAT returns to the tax authorities of each state.
- Alternatively, non-EU businesses may use the "Special Scheme for non-EU Businesses". This scheme allows non-EU businesses to register for VAT in only one member state. However, for each sale, VAT must still be paid at the rate which applies in the state in which the customer is located.
- EU based suppliers will no longer be required to charge VAT on supplies of digital products to non-EU customers.
This bulletin outlines the position under UK law. Through our network of offices and associated firms, we are able to advise on the implementation of the VAT and E-Commerce Directive throughout Europe.
VAT – what are the basic concepts?
As a rule, UK VAT is chargeable whenever digital products are supplied in the UK by a business. The rate of VAT is normally 17.5% of the price paid. The person making the supply must account for the VAT to Customs & Excise, although the cost is normally borne by the customer.
What will change on 1st July 2003?
Generally speaking, the VAT charge for digital products will now be determined by the location of the customer, rather than the business supplier. If the customer is located in the EU, VAT will be due. If the customer is located outside the EU, no VAT will be due.
Which products will be affected?
The new VAT rules apply to all "electronically delivered services". The definition of electronically delivered services ("EDS") in the Directive includes any electronic supplies of:
- Web-hosting, website design and distance maintenance of programmes and equipment
- Software, including updates
- Images, text and information, and making databases available
- Music, films and games, including gambling
- Distance teaching
- Webcasts
- On-line auction services
- Internet service packages
Supplies of EDS will generally be treated as made where the customer is located.
Pay-per-view TV and telecommunications services (including pure internet access) will generally be treated as supplied where they are used and enjoyed.
Who must account for the VAT under the new regime?
The mechanism for collecting the VAT due depends on whether the customer is acting in a private or business capacity.
Business customers
Where EDS are supplied to a business customer, it is generally the customer who must account for the VAT under the "reverse charge" procedure at the rate of VAT applicable in the state where the customer is located. The only exception is where the business customer is located in the same state as the supplier. In this situation, the supplier must account for the VAT at the rate applicable in the state where the supplier is located.
Non-EU businesses still do not have to account for VAT on EDS supplied to EU businesses under the new rules.
Private customers
Where EDS are supplied to private customers in the EU, the supplier business must account for the VAT. In this sector, non-EU businesses will generally be in a worse position than their EU-based competitors.
- EU supplier
If the supplier is established in the EU, the supplier must account for VAT at only one rate - the rate applying in the member state in which it is established – regardless of where in the EU its customers are located. An EU based supplier of EDS also only need register in the member state in which it has its business establishment.
- Non-EU supplier
By contrast, where a non-EU business supplies EDS to EU private customers, the business must determine where each customer is located and charge VAT at the rate applicable in the customer’s state. The business will also need to register for VAT and submit VAT returns in each of these states. This means that non-EU businesses face either registering for VAT in up 15 states or restricting their sales to EU private customers. Non-EU businesses will avoid this new VAT regime if their turnover in a particular member state is below that state’s minimum threshold for VAT registration. By way of illustration, a business is not required to register for VAT in the UK if its annual UK turnover does not exceed £56,000.
What is the Special VAT accounting scheme for non-EU businesses?
The VAT on E-Commerce Directive requires each member state to put in place a Special Scheme to permit non-EU businesses supplying EDS to private EU customers to register for VAT in only one member state. This is an alternative to registering for VAT in every state in which the business supplies EDS.
The key features of the Special Scheme for non-EU businesses are:
- A business can opt to register in any member state in which it has customers
- The business must pay VAT quarterly, at the same time submitting a VAT return. The VAT is calculated for each sale at the rate which applies in the state in which the customer is located.
- The VAT return and VAT payment must be made in euro, although member states which have not adopted the euro can permit returns and payments to be made in their national currency.
- Registration, VAT payments and submission of VAT returns must be done electronically. Businesses can register for the UK’s Special Scheme at www.hmce.gov.uk/business/electronic/vat-on-e-services.htm
- Records relating to supplies made under the Special Scheme must be kept for 10 years
Customer verification – what must non-EU businesses do?
Non-EU businesses need to put in place measures to:
- verify whether an EU customer is a business or a private consumer
- verify the location of their private EU customers
- ascertain the VAT rate which applies in each member state in which they have private customers, including details of any relevant reduced rates of VAT or exemptions.
Customs & Excise has published non-statutory guidelines to enable suppliers of EDS to identify the status (business or private) and location of its customers. An EU business customer can normally be identified by requesting and checking its unique VAT registration number. So far as private customers are concerned, VAT law requires the supplier to determine where the customer is "established" or has their "permanent address" or where they "usually reside". Businesses need to ensure that they gather sufficient information from customers to comply with the verification requirement.
How will the new VAT charge be enforced?
The normal fines and penalties for failure to comply with VAT rules will apply but enforcing these rules against a business which has no physical presence in the EU may prove difficult in practice. The European Commission hopes that businesses will comply voluntarily – or face the risk of being unable to enforce their intellectual property rights in Europe.
A simplification? Oui. A level playing field? Non.
The Commission has said that the new rules will create a level playing field for the taxation of digital e-commerce: " The rules will ensure that when these services are supplied for consumption within the EU, they will be subject to EU VAT and that when they are supplied for consumption outside the EU, they will be exempt from VAT". This statement, whilst true in itself, does not fully take account of the way in which the new VAT rules will operate in practice. It is clear that, for businesses with customers in more than one EU state, the balance has been tipped in favour of EU established businesses. The Directive has not generally been well-received outside the EU.
The Special Scheme simply allows non-EU businesses to register and account for VAT in one single member state. Non-EU businesses must still verify where in the EU each customer is located and charge VAT at the rate applicable in that state.
By contrast, EU businesses supplying EDS to private EU customers will charge VAT at one single rate – that of the member state in which the supplier has established its business. The compliance burden suffered by non-EU businesses is therefore significantly greater than their EU based competitors.
A solution may be for non-EU suppliers to create a business establishment in an EU state. EDS would then be supplied from that business establishment and the business would charge VAT only at the rate applying in that state. Further VAT savings may be possible if the business is established in a jurisdiction with a low rate of VAT, for example Madeira or Luxembourg. Other tax issues, including tax on profits, would also need to be considered before this route is adopted.
Article by Christopher Rees, Neil Warriner and Emma Nendick