Global VAT Changes Reflect E-Commerce Boom
By Nina Kingsley, VAT Manager
With global e-commerce expected to surpass $1.6 trillion this year and $3.5 trillion by 2020 (constituting more than 12% of worldwide retail sales), e-commerce and its accompanying tax revenue can no longer be dismissed as de minimis by tax authorities. Indeed, national and regional tax policy is being updated for the 21st century to account for the growth of e-commerce and the advent of digital products and services — innovations that have transformed the very definition of “goods.”
The ad hoc development of e-commerce policies for value-added taxes (“VAT”) has resulted in a hodgepodge of inconsistent tax regulations that vary widely by country. Recognizing the growing importance of e-commerce, the confusion resulting from current systems, and the magnitude of frequently forgone VAT revenue, many countries as well as the Organization for Economic Cooperation and Development (“OECD”) have set out to clarify, systematize and coordinate VAT regulations. These changes, many of which have been or are being implemented in 2015, have significant implications for businesses with e-commerce operations. Understanding and complying with these VAT laws is important to success in international e-commerce.
E-commerce complicates VAT in two ways. First, it calls into question the very nature of what is a product and whether it ought to be taxed. Second, it clouds the determination of how VAT is assessed, collected and remitted.
From music to books to software, digital goods and services are rapidly displacing their tangible predecessors. Music is one notable example of this phenomenon. Music industry sales, which amounted to nearly $15 billion in 2014, are now evenly split between digital and analog revenue (46% to 54%). The shift to digital products has presented novel challenges to tax authorities, many of which have responded inconsistently, with many previously not subjecting such transactions to VAT. Now, there is a growing recognition that many countries are missing out on important sources of tax revenue.
Recently, a number of countries have implemented or announced their intention to implement indirect taxes on e-commerce and digital products. In 2015 alone, Argentina, Japan, South Korea and Australia each announced plans to charge VAT for digital goods and services. For example, in May, Australia decided to subject digital services by nonresident firms to its general 10% goods and services tax (“GST”). This was followed in August by the government’s decision to levy GST on tangible goods such as books sold to residents from foreign e-commerce sites. (Both will take effect in July 2017.) These changes to the Australian tax system are intended to level the playing field for Australian e-commerce merchants to whom the GST always applied and to raise an estimated $1 billion (USD) in annual tax revenue. These measures reflect a broader, indeed global awareness of the rising importance of e-commerce and the potential associated tax revenue pools available.
Central to the question of taxing e-commerce products is whether the product ought to be taxed by the country of origin or the country of destination. Though this distinction may seem arcane, it is important for firms engaged in international e-commerce. Formerly, many VAT policies were based on the “origin principle,” which provides for VAT to be collected by the company selling the good or service for remittance to the tax authority in the country of the producer. Increasing recognition that the origin principle is unwieldy has resulted in efforts to replace it with the “destination principle.” This change has been championed by the OECD, which, in recently released draft guidelines, affirmed the destination principle whereby "tax on cross-border supplies is ultimately levied only in the taxing jurisdiction where the final consumption occurs."
Determining the consumer’s destination can be complicated, particularly given the portability of the digital product she has purchased. Conceivably, the product could be taxed in every country in which it is used (e.g., a businessperson’s three-country trip could incur VAT on the software used on her laptop in each country), but, generally, the destination is determined to be the consumer’s primary place of use. The OECD states that the aim of indirect taxation rules ought to be to determine the place where the end consumer is most likely to use the service or intangible good and levy the tax accordingly.
As noted, though the adoption of the destination principle may be arcane, it has serious implications for businesses engaged in e-commerce. Under the principle, the merchant must register for VAT with the relevant tax authorities in all countries where it sells products electronically. Take, for example, Netflix; if it wishes to continue to provide its service to a viewer in, say, Australia, it must register with the Australian tax office. This is quite a burden for a company like Netflix, which provides its digital product to consumers in over 60 countries, with plans to expand into 200 countries by 2017.
Despite the efforts of the OECD among others to create a uniform standard for assessing, collecting and remitting VAT on international e-commerce, indirect tax laws remain inconsistent, with each country enforcing its own regime. Just as some countries persist in their application of the origin principle, so too do others continue to exempt digital goods from VAT. As a result, businesses engaging in e-commerce must understand and monitor changes to the VAT rules of each country in which they do business.