Click And Tax

The VAT man came to call on the Internet
...and even the world's last surviving super power couldn't stop him regulating it.

Plain Words reports

On July 1st, the Internet - that last bastion of free trade - got regulated. Under the new Online Sales Tax Directive, European Union member states are now obliged to apply Value Added Taxes to e-commerce transactions between non-EU firms and EU customers.

In addition, non-EU companies have to register with EU authorities and levy, collect, and remit the VAT applicable in the country where the customer lives. EU companies will be allowed to charge VAT at the rate of the member state in which they are based (the rate varies between 13% in Madeira to 25% in Denmark).

Taxation is rarely popular. But, in this case, the new measure has been welcomed by the majority of European firms. This is not surprising as it is designed to level the online playing field and close loopholes that allowed providers of digital services from outside the EU to sell them tax free.

The new rules apply to a number of so called "e-services", including web hosting and website design, downloadable games, music, electronic books, online learning, and software. These are all classified as services, not goods, by the VAT authorities - presumably because they are seen as "intangible".

Unfair advantage

Aside from the loss of revenue, the EU was concerned that European businesses were obliged to charge VAT, while countries outside the EU were not. This made it easy for foreign firms to undercut their European rivals.

Not surprisingly, EU companies complained that this gave non-EU firms an unfair advantage. UK ISP Freeserve was one. It went to great lengths to highlight the fact that rival ISP, AOL UK, did not pay VAT and estimated that the loophole had saved AOL UK £150M since summer 2001.

Freeserve welcomes the new legislation, but considers it came too late. "No one likes taxes, but the failure of the UK to levy VAT on digital content meant that AOL got away with it. This will level the playing field and remove a market distortion," said David Melville, general counsel at Freeserve.

Heavy burden on U.S.

Eminent voices in the U.S., however, are strongly opposed to the legislation. Karen Myers, an EDS Corp. executive, told a congressional panel last month that levying VAT on electronic commerce would place heavy burdens on American companies and put them at a competitive disadvantage in the expanding EU marketplace.
"In trying to level the playing field, the European Commission has created a trading environment that discriminates against the U.S. and other non-EU businesses," said Myers, who was testifying on behalf of the United States Council for International Business (USCIB), a leading pro-trade group.

She went on to say that the new measure may contravene World Trade Organisation rules on liberalisation of services trade. And that the USCIB "is deeply concerned that the requirement for non-EU firms to collect VAT based on the location of their EU customers ignores the fact that most firms lack the technical means of verifying this information in a cost-effective manner."

She is right. There are two options for overseas suppliers of digital goods - both are costly. One is to establish a subsidiary in the EU and pay all VAT at the rate of the country of corporate residence. AOL has taken this route and moved its European headquarters to Luxembourg with its 15 percent VAT rate, the second lowest in the EU.

The other option for a foreign supplier is to register in an EU country. This would mean sending a return to that country's tax authority detailing all trading and paying VAT at the rate of each customer's country. EU tax authorities would then clear the payments among themselves.

"It's a bureaucratic nightmare," said Frank Hartley of accountancy firm Grant Thornton. "And there is little to persuade a small foreign business to be law abiding. It will be quite hard to police and enforcement will be very difficult."

Complicated for British firms too

Adhering to the legislation will not be all roses even for European companies. Commenting on how it will affect UK firms, Jeffrey Mann, vice president of Analyst Meta Group, said: "The legislation may make e-commerce more complicated. British companies selling goods online to other countries will have to deal with varying tax regimes, depending on where their customers are based."

He also pointed out that the new regulations need to be seen to work effectively.

"The rules have been set up, but not all of the working details are entirely resolved. The next battleground will involve reducing the complexity of the legislation, and moving towards more transparency and evenness," he said.

Following the implementation of the Online Sales Tax Directive, the European Commission set about investigating possible changes to the VAT law for the supply of services. It is considering changing rules putting the burden of payment on the trading customer, rather than the supplier.

In 1831 a British member of Parliament asked Michael Faraday, the pioneer of electrical theory, what use his discovery might be. Faraday replied that he didn't know, but he was sure governments would one day tax it. The Internet might be harder to tax, but it looks like the VAT man has finally found a way.

Plain Words editorial
8.7.2003