VAT on Electronically Delivered Products

25 July 2003

Simon Briton

In the last edition of our Communications Law Bulletin (April 2003) we reported that new VAT rules are to come into effect from 1 July 2003 (see Taxation of Electronically Delivered Products).

An important change has occurred since the draft of the directive (Dir 2002/37/EC) which we reported on – the €100,000 threshold below which those rules were not to apply has been deleted. Therefore the new regime applies now to everyone making taxable supplies of electronically delivered products (e-supplies) from outside of the EU, where those services are used by non-VAT registered customers in EU Member States.

The new rules require such suppliers to register for VAT purposes and then to charge VAT on all of their taxable supplies into the EU. A ‘special scheme’ allows the supplier to register in just one country and to administer VAT on their EU-wide taxable supplies. It is also possible for a business to operate through a taxable presence in the EU, rather than operate from outside of the EU. If that is done VAT is administered under the normal rules for EU taxpayers, and only the VAT rate of the country of registration would be applicable (supplies to VAT registered customers for business purposes in other EU countries would fall under the reverse charge procedure whereby the customer administers the charge). The choice of country in which the supplier should establish such a presence is important as rates vary massively between different Member States (see below).

Which supplies are caught?

The EU has published guidance (‘Annex L’) giving general criteria and specific examples of which services fall under the new rules. The general criteria state that an ‘electronically supplied service’ is a service that (i) in the first instance is delivered over the Internet or an electronic network; and then (ii) the nature of the service in question is heavily dependent on information technology for its supply (i.e. the service is essentially automated, involving minimal human intervention and in the absence of information technology does not have viability).

Annex L states that the following are relevant supplies for the purposes of the new rules:

Note – these examples are not exhaustive.

  • Website supply, web-hosting, distance maintenance of programmes and equipment – which includes remote systems administration, on-line data warehousing and on-line supply of on-demand disc space.
  • Supply of software and updating thereof – which includes accessing or downloading software (e.g. procurement / accountancy programmes, anti-virus software, etc), bannerblockers, downloading of drivers, on-line automated filter and firewall installation.
  • Supply of images, text and information, and making databases available – which includes downloading images, screensavers, e-books, on-line newspapers and journals, weblogs and web-statistics, traffic information and weather reports, on-line information generated automatically by software from specific data input by the customer (e.g. continually updated stock market data), sale of media placement on the Internet and the use of search engines and Internet directories.
  • Supply of music, films and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific and entertainment broadcasts and events – which includes accessing or downloading music, games or ringtones onto PCs or mobile phones, and playing games on electronic networks where the players are remote from one another.
  • Supply of distance teaching – which includes virtual classrooms and automatically assessed workbooks.

Other services coming within the scope of the new regulations are on-line auctions and ISP services where the telecommunications services are a subordinate part of the supply (e.g. if content is also supplied).

A service will not become an electronically supplied service simply because it is supplied via email.

Should VAT be charged on your sales?

Non-EU suppliers should now be looking at the following:

  • Does your customer ‘belong’ in the EU? This will be the case if their place of residence is in the EU or if their place of business most closely related to your supply is in the EU.

If ‘yes’;

  • Which EU Member State does your customer belong to? The supply will fall within the VAT regime of whichever country the customer belongs to. The specific rules in each Member State are different, but broadly one should then ask;
  • Are the services being bought for business purposes? If not, the supply will be deemed to take place in the Member State in which the customer belongs and you should account for VAT on the supply under that country’s regime. If the services are supplied for business purposes;
  • Are the supplied services used and enjoyed outside of the EU? If so, the supply is outside of the scope of VAT. If they are used in the EU the customer should account for VAT, under his own State’s regime, using the reverse charge (self-supply) method.

If ‘no’;

  • Are the services being bought (by your non-EU customer) for business purposes? If not, the supply is outside of the scope of VAT. If the supplies are bought for business purposes;
  • Are the services used and enjoyed in the EU? If not, the supply is outside of the scope of VAT. If the supplies are used in the EU;
  • Which Member State is the service used and enjoyed in? The supply will fall to be chargeable under the VAT regime of the Member State in which the services are used. Broadly speaking, unless the customer provides you with a VAT registration number and reverse charges the supply then you should charge VAT.

Special registration scheme

Suppliers who register for the ‘special scheme’ allowing them to administer VAT from just one point of registration in the EU would then charge VAT on their taxable supplies at the rate applicable in each country in which they make supplies. The scheme allows the taxpayer to submit only one return in relation to his EU supplies in each relevant period, rather than submitting a return to each jurisdiction in which he has made taxable supplies. The customs body of the Member State in which the supplier has registered then distributes the VAT on the supplies to the authorities of the relevant Member States accordingly. This is simply an administrative measure and does not affect the amount of tax which is ultimately charged.

Special attention should be given to the fact that the non-EU supplier is responsible for the correct application of VAT legislation. In other words, the non-EU supplier should audit the information provided by his EU customers in order to ensure that the information is correct. Should the use of incorrect information result in too little VAT being charged the supplier will be liable for the difference. It is not yet clear how non-EU suppliers can adequately manage this risk.

Implementation of the EU Directive and enforcement of VAT

It is generally known that some EU countries have not yet finalised the implementation of the EU Directive, and in several of the countries that have implemented the EU Directive criticism is widespread regarding the quality of that legislation.

In some EU countries it is still unclear how the tax authorities will deal with the enforcement of VAT on electronically supplied digital services both with respect to the compliance of non-EU suppliers to the new rules, and with respect to the compliance of EU consumers to the new rules. However, the tax authorities of the EU countries have announced that they will strictly supervise the legislation on VAT.

Alternative VAT structure

Together with Cooley Godward LLP, MeesPierson Intertrust and Oostvogels & De Meester, we have developed a structure that aims to simplify matters by reducing the administrative burden and associated cost of these new rules.

The essence of the alternative structure is that the electronically supplied digital services of the non-EU suppliers are provided through an independent distribution company located in Luxembourg. That company, instead of the non-EU supplier, contracts with the EU consumers. As the Luxembourg distributor is a taxable entity for VAT purposes, the transactions between the non-EU supplier and the Luxembourg distributor are neutral for VAT purposes. The transactions between the Luxembourg distributor and the EU consumers suffer a VAT charged at 15% (the Luxembourg rate). The non-EU suppliers do not need to worry about their VAT position, as the Luxembourg distributor will handle all VAT administration. In comparison with the other EU countries Luxembourg has the lowest VAT rate of 15%. The Luxembourg distributor operates as an independent company. Each non-EU supplier will conclude a distribution contract with the Luxembourg distributor. The benefits that arise for the non-EU supplier are:

· The administrative burden is transferred to the third party Luxco;

· VAT liability is reduced to a fixed rate of 15% instead of a variety from 15% to a possible VAT rate of 25% in another EU country.

The nonrecurring costs for entrance into this structure are budgeted at €5,000. Further, the Luxembourg distributor will charge each non-EU supplier a fee of €5,000 per year.

Please email tax@twobirds.com if you would like to register your interest.

Written by Simon Briton and Martin Rabenort.