TaxationofElectronicallyDeliveredProducts

09 April 2003

Simon Briton

VAT on Electronically Delivered Products

Broadly speaking, until now, VAT has applied throughout the EU on supplies of goods and services. This means that suppliers outside of the EU have not had to charge VAT if they are selling services to EU consumers. However a change due to take effect in July 2003 will extend the scope of the tax such that some businesses outside of the EU will have to start charging VAT if they are electronically supplying certain services to consumers in the EU.

Goods or services

UK VAT applies only to taxable supplies made in the UK (and the same is generally true of VAT in the other EU Member States). The rules determining the place of supply are, therefore, important and they apply differently to goods and services. Goods are generally treated as supplied where the purchaser is located. If the supplier is abroad customs duty and VAT are chargeable – the Post Office will collect the amounts due when the goods are delivered (although practically this is not often the case). The position for services becomes more complicated – but, subject to special rules, the supply is treated as being made where the supplier is located. In principle, if the supplier is in the EU, VAT is charged; if the supplier if outside of the EU, no VAT is charged.

Back in 1998 the OECD stated (in the e-commerce Framework Conditions) that the supply of digitised products should be a supply of services rather than a supply of goods and this has been the accepted way of thinking since. This applies to electronically delivered digitised products (e-supplies) such as software, photographs, music, films, games, books, etc.

Hard media formats such as DVD and CD are treated for VAT purposes as goods, but when the same content is delivered online it is treated as a service. The difference comes from whether or not something tangible is being bought. When you go to the cinema you pay for the service of having the film shown to you. Similarly when you stream media over the internet you are paying to have that content delivered to you. This has its own inherent complications but also often fails to respect the principle that electronically delivered goods should be taxed in the same way as hard goods. An example of a discrepancy is that books are zero rated for UK VAT purposes, but an e-book is a service, and as such VAT is charged at 17.5%.

If you go to the cinema in Europe VAT applies – the supplier is in Europe. The problem with e-supplies is that the supplier can be outside Europe and the consumer in Europe. EU suppliers making the same supply would have to charge VAT and non-EU suppliers would not have to charge VAT. This means that the competitive position of European businesses is prejudiced and so to rectify this, under the new rules (Directive 2002/37/EC), non-EU businesses making supplies over a certain level will have to register for, and charge, VAT.

Services deemed to be supplied where received

The e-supply of off the shelf software or tailored software is treated as a service supplied where received (Schedule 5 VATA 1994), typically as a grant of a licence to use the software or as a consultancy service respectively. This treatment has relatively broad application, but in relation to e-supplies it will apply to grants of licences, banking and finance services, and provision of information. Therefore this will cover such things as computer games, downloaded music, remote software maintenance and subscription and pay-per-view internet-TV and internet-radio. The treatment also applies to any service supplied to a VAT registered business customer not specifically covered under the Schedule.

This means that an EU VAT registered supplier will charge standard rated VAT on supplies made to all customers in his own Member State and also to non-VAT registered customers in the EU. Supplies made outside of the EU (unless the customer is VAT registered – see below) are beyond the scope of VAT. VAT registered customers outside of the supplier’s Member State would apply the reverse charge to the supply (treating it both as a purchase and a sale – the idea being to even out discrepancies between rates such that there is no disadvantage to a purchaser if he sources his business supplies in from within his own Member State or another). Equally, if a VAT registered person buys services from someone outside of his Member State he must apply the reverse charge to that supply.

The principle behind the disapplication of VAT to sales outside of the EU is that EU suppliers should be able to compete in the global market against non-EU suppliers who don’t have to charge VAT. The shift in principle marked by the new Directive is that the EU now expects non-EU suppliers to apply VAT if they are to compete over a certain level in the EU.

Therefore if a non-EU supplier is caught by the new rules, by making e-supplies into the EU over the threshold, he will have to charge VAT. This is matched by making input credits (VAT on purchases) available to set off against the output tax (VAT on sales). The difference is paid over to the VAT authorities, or repaid to the supplier accordingly. However this is poor compensation given that the non-EU supplier wouldn’t be paying VAT anyway unless he was registered.

Services supplied where supplier is located

Where the supply of digitised products isn’t covered by the Schedule 5 rules they are deemed to be supplied where the supplier is located. Therefore, until the new rules come into effect, a non-EU supplier can sell services without having to apply VAT. However, the general catch all provision of Schedule 5 which makes it applicable to all services supplied between businesses means that the ‘usual’ rule will only apply when supplies are made by a VATable business to a consumer. Before the introduction of the new rules an EU supplier making e-supplies not covered by Schedule 5 would have to charge VAT at the standard rate regardless of where the consumer is.

Once the new rules come into effect any services supplied electronically which pass into or out of the EU will be treated as being supplied where the recipient is located. The effect of this is that if the services are used in the EU VAT applies, and if they are used outside of the EU no VAT applies.

For these purposes the recipient is located in a Member State if he is established there, has a permanent address there or usual place of residence in that State.

How the new rules apply

Under the new rules non-EU e-suppliers to ‘identify themselves’, and, under a special scheme, such a supplier can register in one of the EU Member States and administer VAT in that jurisdiction. Those e-suppliers who do register will be required to do electronic VAT returns and pay over any surplus of input credits over output tax once a quarter.

As the new rules only change the place of supply for services passing in or out of the EU, EU suppliers will carry on charging VAT on sales in the EU on the basis that the supply is made where the supplier is located. For that reason a point of contention between the EU and some third parties concerned about these rules is that EU suppliers will charge VAT at a consistent rate fixed by their Member State, whereas registered non-EU suppliers will have to charge VAT at the rate applicable in the country where the customer is located. With such wide variations in rates as are currently being seen around Europe this will cause an extra administrative burden to such suppliers, making the already complicated task of finding which country the customer is located in even more important.

One of the problems with the new rules is that they will be difficult to enforce. The type of suppliers at which the new rules are aimed are not otherwise required to be registered for VAT, and if the supplies in question are being made to non-registered consumers it will be difficult to identify and to prove which suppliers this applies to.

The benefit of voluntary compliance with the scheme is that registered suppliers will be able to recover VAT charged to them in relation to the registered trade. However, as noted above, they would not be charged this VAT unless they were registered, so this offers no real advantage. There is also the threat in the new rules that the availability of input credits may be taken away if a registered taxable supplier persistently fails to comply with the special scheme. As each Member State is allowed to introduce the special scheme in its own way it is likely that those who impose the fewest requirements will be the most popular with registering suppliers.

Although this represents a dramatic shift in the application of consumption tax to digitised products it will be some time before we can appreciate any real effects.