The digital economy has transformed the way businesses operate and generate value across the world. However, the current international tax system is not well suited to capture the new sources of value creation in the digital sector, such as user data, algorithms, and online platforms. This has led to a mismatch between where profits are taxed and where value is created, as well as potential double taxation and tax avoidance issues.
To address these challenges, several European countries have introduced or proposed digital services taxes (DSTs), which are taxes on selected gross revenue streams of large digital companies. These taxes are intended to target companies that have a significant digital presence in a country without a physical presence, such as online advertising, social media, e-commerce, and cloud computing services.
However, DSTs are controversial and have faced criticism from various stakeholders, including the United States, which considers them discriminatory against its tech giants. The US has threatened to impose retaliatory tariffs on goods from countries that impose DSTs on its companies. Moreover, DSTs are seen as unilateral and inconsistent measures that deviate from the established principles of international taxation and create additional compliance burdens for businesses.
In response to these concerns, the Organisation for Economic Co-operation and Development (OECD) has been leading multilateral negotiations with more than 130 countries to reform the global tax system and ensure a fair and consistent taxation of the digital economy. The OECD proposal consists of two pillars:
- Pillar 1 aims to allocate more taxing rights to market jurisdictions where consumers or users are located, regardless of the physical presence of the company. This would apply to some of the world’s largest multinational businesses with global turnover above €20 billion and profitability above 10%.
- Pillar 2 seeks to establish a global minimum corporate tax rate of at least 15% to prevent profit shifting and tax competition among countries.
In October 2021, the OECD announced that 136 countries had reached an agreement on the key elements of both pillars, paving the way for a historic overhaul of the international tax system. The agreement also includes a commitment from countries to repeal their existing or planned DSTs by the end of 2023, once the new rules are implemented.
The European Union (EU) has welcomed the OECD agreement and expressed its support for a swift and coordinated implementation of both pillars. The EU has also announced its intention to introduce its own digital levy from 2023 onwards, which would be designed in a way that is compatible with the OECD framework and would not result in double taxation for businesses. The EU digital levy would aim to raise additional revenues for the EU budget and finance its recovery plan from the COVID-19 pandemic.
The new VAT regulations for digital marketplaces and their online sellers
Besides the corporate taxation of digital activities, another important aspect of the digital economy is the value-added tax (VAT) treatment of cross-border e-commerce transactions. VAT is a consumption tax that is levied on goods and services at each stage of the supply chain and ultimately borne by the final consumer.
In July 2021, the EU introduced new VAT rules for e-commerce that aim to simplify and modernise the VAT system for online sales within and outside the EU. The main changes include:
- The extension of the One-Stop Shop (OSS) scheme, which allows online sellers to register and declare VAT for all their sales across the EU in one single Member State, instead of having to register in each country where they sell. The OSS scheme covers both business-to-consumer (B2C) sales of goods and services within the EU (Union scheme) and B2C sales of services from outside the EU (non-Union scheme).
- The introduction of the Import One-Stop Shop (IOSS) scheme, which allows online sellers or intermediaries to register and declare VAT for all their low-value (up to €150) B2C sales of goods imported from outside the EU in one single Member State, instead of having to pay VAT at customs in each country of destination. The IOSS scheme aims to facilitate faster delivery and lower costs for consumers and businesses.
- The removal of the VAT exemption for low-value imports (up to €22) from outside the EU, which means that all goods imported into the EU are subject to VAT, regardless of their value. This measure intends to ensure fair competition and a level playing field between EU and non-EU sellers.
- The new rules for online marketplaces or platforms that facilitate online sales of goods within or outside the EU. Under certain conditions, online marketplaces are deemed to be the supplier of the goods sold through their platform and are responsible for collecting and remitting VAT on these sales.
This applies when:
- The goods are sold by a non-EU seller to an EU consumer and are either already located in the EU at the time of sale (domestic supplies) or imported into the EU in consignments not exceeding €150 (distance sales of imported goods).
- The goods are sold by an EU or non-EU seller to an EU consumer and are transported within or across EU Member States in consignments not exceeding €10,000 per year (intra-EU distance sales of goods).
The new rules for online marketplaces aim to ensure VAT compliance by non-EU sellers who sell goods online to EU consumers and avoid VAT fraud and evasion.
The UK, which left the EU in January 2020, has also introduced similar VAT reforms for e-commerce that took effect from January 2021. The UK reforms include:
- The removal of the VAT exemption for low-value imports (up to £15) from outside the UK, which means that all goods imported into the UK are subject to VAT, regardless of their value.
- The introduction of a new model for collecting VAT on low-value (up to £135) B2C sales of goods imported from outside the UK. Under this model, online sellers or intermediaries are required to charge and collect UK VAT at the point of sale, instead of at customs.
- The new rules for online marketplaces that facilitate online sales of goods within or outside the UK. Under certain conditions, online marketplaces are deemed to be the supplier ofthe goods sold through their platform and are responsible for collecting and remitting UK VAT on these sales.
This applies when:
- The goods are sold by an overseas seller to a UK consumer and are either already located ithe UK at the time of sale (domestic supplies) or imported into the UK in consignments not exceeding £135 (distance sales of imported goods).
- The goods are sold by an overseas seller to a UK consumer and are transported from an EU Member State in consignments exceeding £135 (distance salesof goods from Northern Ireland).
- The UK reforms aim to ensure VAT compliance by overseas sellers who sell goods onlineto UK consumers and avoid VAT fraudand evasion.
Value Added Tax (VAT) for Digital Services:
The EU has introduced special VAT rules for digital services provided to customers located within the EU. The rules apply to various digital services, including online sales of software, electronic publications, streaming services, online gaming, and broadcasting services. Under these rules, businesses must register for VAT in each EU member state where they have customers and charge the applicable VAT rate based on the customer’s location.
Mini One-Stop Shop (MOSS):
To simplify VAT compliance for digital services, the EU has introduced the Mini One-Stop Shop (MOSS) system. MOSS allows businesses to register for VAT in one EU member state and submit a single VAT return covering all digital services provided to customers across the EU. This avoids the need for multiple VAT registrations in different member states.
Distance Selling Thresholds:
For e-commerce businesses selling physical goods across EU borders, there are distance selling thresholds in place. These thresholds determine when businesses must register for VAT in the customer’s member state instead of the country of origin. Once the threshold is exceeded in a particular member state, businesses must comply with the VAT rules of that country.
VAT Reverse Charge Mechanism:
The VAT reverse charge mechanism applies to certain B2B transactions involving digital services. Under this mechanism, the responsibility for accounting for VAT is shifted from the supplier to the customer. The customer accounts for the VAT on their VAT return, rather than the supplier charging and collecting the VAT.
Digital Services Tax (DST):
The EU has proposed the introduction of a Digital Services Tax (DST) to address the issue of digital companies generating substantial revenues in certain jurisdictions but paying minimal taxes. DST would apply to companies with significant digital business activities, such as online advertising, digital marketplaces, and data-driven services. The tax would be levied on revenues generated from users or customers within the EU.
Anti-Tax Avoidance Measures:
The EU has implemented various anti-tax avoidance measures to prevent aggressive tax planning and profit shifting by digital services and e-commerce businesses. These measures include controlled foreign company (CFC) rules, interest limitation rules, and general anti-abuse rules (GAAR), which aim to ensure that profits are taxed where value is created and to prevent the erosion of the tax base.
Data Protection and Privacy Regulations:
Digital services and e-commerce businesses also need to comply with data protection and privacy regulations, such as the EU General Data Protection Regulation (GDPR). These regulations impose obligations on businesses to protect customer data, obtain consent for data processing, and ensure the lawful transfer of personal data across borders.
Transfer Pricing Considerations:
For digital services and e-commerce businesses operating in multiple jurisdictions, transfer pricing becomes important. Transfer pricing rules determine the prices at which transactions take place between related entities within the same multinational group. Businesses must ensure that transfer pricing arrangements comply with the arm’s length principle to avoid tax-related issues.
While there are overarching EU tax regulations, individual member states may also have their own specific rules and requirements for digital services and e-commerce businesses. It is crucial for businesses to understand and comply with the tax regulations of each country in which they operate.
Place of Supply Rules:
The EU has specific rules to determine the place of supply for digital services. The place of supply determines which member state’s VAT rules apply. For business-to-consumer (B2C) transactions, the place of supply is usually where the customer is located. However, for business-to-business (B2B) transactions, the place of supply may differ based on whether the customer is a taxable person or not.
MOSS for Non-EU Businesses:
Non-EU businesses that provide digital services to EU customers can also benefit from the Mini One-Stop Shop (MOSS) system. By registering for MOSS in an EU member state, non-EU businesses can fulfill their VAT obligations for all EU transactions without the need for a physical presence in each member state.
Platform and Marketplace Obligations:
Platforms and online marketplaces that facilitate digital services or e-commerce transactions may have specific tax obligations. They may be required to collect and remit VAT on behalf of their sellers, or they may be subject to reporting requirements to ensure compliance with tax regulations.
Digital Advertising Services:
The EU has introduced specific rules for digital advertising services. These rules aim to ensure that VAT is properly accounted for in the advertising supply chain. Digital advertising platforms and intermediaries may have obligations to collect and remit VAT based on the location of the customer or the type of service provided.
E-Commerce VAT Package:
The EU has implemented an E-Commerce VAT Package, which includes various measures to simplify VAT compliance for cross-border e-commerce activities. This package aims to streamline VAT registration, reporting, and payment obligations for businesses engaged in distance sales of goods and services.
Distance Selling of Goods:
In addition to digital services, e-commerce businesses that sell physical goods across EU borders must consider the VAT implications of distance selling. Different thresholds apply to determine when VAT registration is required in the customer’s member state instead of the country of origin.
Import VAT on Goods:
Importing goods into the EU may attract import VAT, which must be paid at the point of entry. E-commerce businesses that sell goods to EU customers from outside the EU should be aware of the import VAT implications and the requirements for collecting and remitting the tax.
VAT Recovery and Input Tax Considerations:
Digital services and e-commerce businesses may incur VAT on their business expenses. Understanding the rules for VAT recovery and input tax deduction is essential to ensure that businesses can reclaim the VAT they have paid on their inputs.
The EU has implemented various anti-fraud measures to combat VAT fraud in the digital services and e-commerce sector. These measures aim to detect and prevent fraudulent practices, such as carousel fraud and missing trader fraud, which can lead to significant revenue losses for tax authorities.