LINKS IN THIS SECTION

- Executive Summary
- US Sales and Use Taxes and E-commerce
- Corporation Tax and E-commerce

RELATED SECTIONS

- Regulation of Offshore E-commerce
- Offshore E-commerce Facilities
- Offshore Professional and Financial Services
- Offshore E-commerce Applications

All but three of the 28 OECD countries apply VAT, and as with sales taxes, operation of VAT depends heavily on the ability of the taxing authority to find traces or records of transactions, thus motivating taxpayers to comply with the law because of the near-certainty that they will be found out if they don't. It is obvious that once an individual consumer can buy and receive digital but taxable goods or services through the Internet, then it is going to be hard to collect tax if the seller is outside the tax jurisdiction. As with sales taxes, the taxing authority won't know and can't know about the transaction unless the consumer chooses to tell them.

Again, as with sales taxes, the supply of goods ordered and paid for from a distant seller and requiring physical delivery within the taxing jurisdiction is a simpler case, because a cross-border transit is necessary.

The most important VAT area is the EU, and the application of the tax is more sophisticated there than in other countries.

At present there is a clear distinction between goods and services: for goods, VAT is charged on an origin basis within member states (countries), while for a supply between member states the supplier does not charge VAT and the buyer has to pay it by a reverse-charge mechanism (and can offset it against output tax). Individuals and non-registered traders buying goods across borders will pay the origin tax concerned. Imports of goods from outside the EU are charged with destination VAT at the time of importation.

For services, there is also an origin basis for trading within member states, but for intra-Union cross-border trading the rules become complex. Most services are taxed where delivered, and the supplier has to set up a local office or agent to account for the tax, ie to become a registered trader, once turnover is over a low level (depending on the member state).

Services delivered from outside the EU to a registered trader will normally give rise to a reverse-charge tax liability, again deductible for the importer. Until July, 2003, services delivered from outside the EU to a non-registered person (individual or company) were not taxed, but if the non-EU supplier had a fixed establishment in any member state, then it was liable for tax in that State. E-commerce naturally assists suppliers to avoid the need for a fixed establishment in a member state, as we have seen.

The distinction between goods and services caused problems in connection with e-commerce, since what is clearly a good in a shop (a compact disc) is considered to become a service when it is in digital form. In practice, this avoided a compliance problem, since a consumer buying digital information from a vendor outside the EU is not likely to account for VAT on it; but the tax is lost. The problems for VAT collection authorities, as for corporation tax collectors, are first that suppliers of services via e-commerce can increasingly avoid a fixed establishment in the EU by placing their servers elsewhere, and second that digitising goods turns them into services, which then escape taxation in many situations.

It is fairly clear that under the pre-2003 system there was an incentive for suppliers of services to non-registered traders (meaning in practice, small traders in addition to individuals) to be based outside the European Union, if possible. At first sight, location should make little difference to an EU supplier of services to EU registered traders, since in theory they can reclaim the tax paid; but in practice the procedure for reclaiming VAT across borders is complex and seldom used. Therefore, even registered traders prefered to import services from outside the European Union (and be able to use the reverse-charge mechanism) rather than having to pay origin VAT which they could not offset and for which they could not easily obtain a refund.

In July, 2003, the European Union introduced a new basis for the taxation of sales of electronic (downloadable) products. Any non-EU supplier with sales to EU consumers (ie., non-VAT-registered buyers) exceeding a designated amount (EUR100,000 at the time of introduction) must register for VAT in one EU Member State (any one) and channel its EU supplies through that Member State in a fiscal sense, charging VAT at the rate obtaining in the state of supply of the product. The VAT collected is distributed by the state of registration among the states of supply, with some being kept back.

The VAT rules were changed by the EU after complaints from European firms that they were at a competitive disadvantage compared to their US and Asian competitors, who were able to sell to consumers VAT free through their European subsidiaries.

However, US firms contend that far from levelling the playing field, which was the intention behind the EU Commission's decision, the situation was then discriminatory to US firms, who have to keep abreast of 25 different VAT regimes.

This problem will be exacerbated by the requirement for US firms to verify where their customers are resident, which in e-commerce transactions is not always straightforward. No such obligation is placed on European firms.

In May, 2006, the European Commission adopted a proposal which would extend the application period of the 2003 e-commerce VAT directive to December 2008.

In June, 2006, however, German insistence that the European Union change its tax legislation to crack down on widespread value added tax fraud put the brakes on renewal of the VAT Directive and associated e-commerce VAT reforms which would prevent firms from taking advantage of low rates of VAT in locations such as Madeira and Luxembourg.

At a meeting of European Union finance ministers (Ecofin), German Finance Minister Peer Steinbrueck told fellow ministers that Germany would not support the e-commerce VAT measure unless it was given permission by the European Commission to introduce 'reverse charging' to reduce missing trader fraud.

Germany's hardline stance on the issue meant that a separate proposal to charge VAT on electronically delivered services on the basis of where the customer is situated rather than the jurisdiction in which the vendor is based also stalled - albeit temporarily - to the great relief of companies taking advantage of the fact that VAT rates differ widely across the EU by registering their businesses in jurisdictions where VAT rates are low, particularly in Luxembourg and the Portuguese island of Madeira, which have the lowest permitted rate of VAT in the EU, at 15%.

In December 2006, meanwhile, it emerged that France had lifted its objection to a proposal for VAT 'reverse charging' in the UK to combat widespread tax fraud.

The French government had objected to the UK's request to the European Commission to introduce reverse charging, arguing that it would merely shift 'carousel' VAT fraud to other countries and cause chaos and confusion within the EU's VAT system.

Goods covered by the reverse charge regime are expected to include mobile telephones, computer chips/microprocessors/central processing units, electronic storage media, handheld devices for recording or playing of sound and or images, handheld computers, handheld communication devices other than mobile telephones, positional determination devices for GPS system, games consoles with screen, or of the kind used with a television or computer.

LINKS IN THIS SECTION

- Executive Summary - A quick overview of major developments in the taxation of E-commerce with special reference to offshore e-commerce.
- US Sales and Use Taxes and E-commerce - US taxation of onshore and offshore e-commerce transactions including recent legislative developments.
- Corporation Tax and E-commerce - The impact of corporate taxes (income or corporation tax) on the profits of e-commerce, the location of servers and business units onshore and offshore.