This year marks the start of a new era for internet retailers in the European Union (EU). Starting on January 1, the European Commission changed the way value-added tax (VAT) is calculated for direct-to-consumer sales of electronically supplied services. If your business conducts digital commerce in the EU, it’s vital to understand who is affected by the law — and, if you are, to have a system in place to deal with the ongoing complexity of compliance.
Having served as a merchant and seller of record around the world for more than 20 years, Digital River has worked to master the complexities of complying with international regulations like the new VAT law. The following are important insights on how VAT has changed, key considerations for online retailers, and some suggestions to help merchants succeed in this new era of European commerce.
How VAT has changed
What has changed?
While the new VAT law is exceedingly complex, the central change it makes is simple. Before this year, VAT in the European Union was calculated in the country of the seller, allowing businesses based in low-VAT member countries to enjoy a competitive advantage. This is no longer the case. Now, the seller of an electronic service must charge VAT in the EU country where the customer belongs rather than where the business is based.
For businesses operating from an EU member country with an already high VAT rate, the effects of the new law may be beneficial. Businesses in other circumstances, however, may see their tax liability and regulatory costs increase substantially.
Who is affected?
The new VAT scheme affects all business-to-consumer (B2C) digital delivery transactions in the EU; specifically, telecommunications, broadcasting and electronic services. The internet retail market will likely be most concerned with regulations that cover suppliers of electronic services, which the European Commission defines as “services which are delivered over the Internet or an electronic network.” Because of the increasingly interconnected networks of companies involved in the sale of digital products, the EU provides nuanced ways of defining the “electronic services” to which the law applies and who counts as the taxable business in each case. But you can quickly figure out if the new VAT scheme likely applies to your business. If your business has enough revenue to be required to collect VAT, answer these questions:
1. Is your business transacting related online sales to consumers located in the European Union?
2. Does your business offer digital, broadcasting or telecom services online?
3. Are you the seller of record?
If you answered yes to all three questions, then the new VAT law probably applies to you.
What electronic retailers must do
Determine and document customers’ location
The most daunting challenge of complying with the new VAT scheme is simply determining where your customers are. In some cases, the new law requires businesses to supply two pieces of non-contradictory location evidence for every consumer. In the process, merchants must counter the significant potential for consumer fraud. Some retailers will respond to increased VAT liability by passing the cost along to consumers in high-VAT countries, and sensible Europeans will quickly figure out that they can save money by falsifying their purchase location. Every retailer will need to find a way to determine and document the actual location of every customer, every time.
Passing on the cost of the new VAT to consumers is only one way for businesses to respond to the new taxation scheme, and retailers will want to consider their pricing strategy carefully. Merchants of electronic services have three basic options:
1. Absorb the cost and leave VAT-inclusive prices as they were in 2014, without passing new costs on to consumers. This strategy stabilises prices and might increase sales by shielding consumers in high-VAT countries from increased prices. But it might also reduce profits.
2. Increase prices for all customers to adjust for average increases in VAT liability. With this approach customers all pay the same price for the same product or service, regardless of their location — which benefits consumers in direct proportion to the VAT rate where they live. For retailers, this strategy requires careful calibration to remain strategically coherent.
3. Implement net pricing to adjust prices according to each customer’s location. This way, consumers absorb the real amount of VAT for their own purchases. This is the clearest and most transparent way to reckon with the new VAT law. But floating prices might alarm consumers and put tension on consumer-protection obligations that require VAT-inclusive (or “pretty”) pricing.
Once you’ve put systems in place to verify and record the location of each of your customers, and once you’ve settled on a pricing strategy that makes sense for your business, all that’s left is paying the VAT you owe to all the EU countries where you have customers. Fortunately, EU lawmakers have come up with a helpful alternative to paying VAT in 28 member states separately: the mini One-Stop Shop, or MOSS, allows companies based in the EU to register to file their VAT returns in a single country.
In the UK, tax authorities have responded to an outcry from small digital enterprises by allowing businesses with annual turnover below the UK VAT reporting threshold to pay VAT for European sales through the UK’s MOSS without requiring VAT for sales to British customers. But this exemption only applies to sales into the UK, leaving sales into other EU states subject to VAT and leading some British digital microbusinesses to contemplate abandoning sales into Europe altogether.
The MOSS approach makes the new VAT easier for businesses to handle, and the UK’s new rules for small business will help ease the burden there somewhat. Still, the MOSS is of limited use. While filing with a single MOSS is much easier than filing 28 separate VAT returns, the hard work of compliance comes long before the return is filed. First, companies must compute VAT correctly, determine and report the tax attributes of buyer and seller correctly, and defend against local audits. The actual filing of the return is a small matter by comparison.
Succeeding in the new era
At Digital River, we listen closely to the ways businesses in Europe discuss their response to the new VAT. We know that many businesses have worked hard to adapt and were ready to succeed in the new world of European commerce on the first of January. But we’ve observed with dismay that some digital enterprises are so overwhelmed by the complexities of the new VAT that they are simply ignoring it. If your business is in this position, we urge you to take action immediately. The new VAT is here to stay, and every business has the chance to respond to its challenges more quickly and intelligently than the competition. How will your business seize the opportunity?
Please be advised that the information presented above is a representation of Digital River’s interpretation of EU VAT changes. This information is to be used for informational purposes only and not for the purpose of providing legal or tax advice. You should consult with your legal counsel or tax advisor with respect to any particular issue or problem.
James Fredlund is vice president of tax at commerce-as-a-solution provider Digital River