VAT on digital services

The world is changing from a technological standpoint and it is practically unlimited as to where you can reach out to, to acquire digital services and content from the comfort of your own home, thanks to the advances in the world wide web and online facilitators. However, as suppliers of such services, have you considered if you are exposing yourself to potential consumption tax problems?

We have carried out research in relation to the supply of digital services around the world and whether this creates a VAT registration requirement.

The simple answer from our research is “Yes – there is an obligation to register for and charge VAT in many countries around the world”.

What services are affected?

For the purposes of our research we have reviewed the rules relating to “Digital Services”. The exact definition may differ per country but these are generally understood to mean the following:

• The supply of digitised products such as software, e-publications, apps etc
• Services provided over the internet including website hosting
• Provision of databases
• Services automatically generated through electronic means (without human intervention)
• Downloads or streaming of music, films, games etc via the internet.

The typical supplier which might be affected would be:

• An online games supplier
• A news agency which has a subscription channel
• A computer software provider

What is the issue?

Many countries across the world have introduced some form of consumption tax (more commonly referred to as Goods and Services Tax (GST) or Value Added Tax (VAT) or similar). Typically, this is a transaction tax and is levied on the price of the goods or services at the point of consumption. The rules as to whether something is taxed can be complicated. For example, for supplies of goods the VAT position usually follows where the goods move from and to. But the position for services and, perhaps more importantly for digital services, is more complicated.

It is a common misconception that VAT is not due on services to foreign recipients. For a UK company, it may be the case that no UK VAT is due, but VAT may be due in the recipient’s country – where the service is effectively used and enjoyed.

Recognising that there is a potential revenue loss many countries have, over recent years, introduced new rules and a requirement to register for and charge VAT on the supply of certain services which are deemed to be received or consumed in their country. For many, these rules apply only to B2C transactions but there has been an increase in the number of countries which have also introduced new VAT registration rules for B2B transactions.

Enforcing VAT registration can be difficult and anecdotally many businesses do not comply with foreign rules and so other potential alternatives are considered by tax authorities, such as:

• transferring the liability to register to an online facilitator where it is deemed to be supplying the service
• adopting a withholding tax regime
• requiring the payment service providers (eg credit card companies) to deduct the VAT from the payment to the merchant and remit this VAT to the tax authorities

In some ways these can be better for the suppliers as they remove the requirement to register for VAT and deal with the administration costs of being registered, but VAT is still due and prices may have to be adjusted to reflect this.

What does this mean?

In theory, where a non-established business supplies relevant services to a country it may be required to register for and charge local VAT. There will be a cost in doing this.

Failure to do so, if discovered, could result in assessments for unpaid tax and potential also penalties, although these vary across the countries. It could also lead to local restrictions which could perhaps prevent the business trading in the jurisdiction.

Which countries are affected?

Our research reviewed the VAT position as at March 2022 for 136 countries.

Of these 136 countries:

For business to business supplies (B2B)

• The majority of countries do not require VAT registration for B2B supplies.
• VAT is accounted for by the recipient under the reverse charge mechanism
• 18 countries, however, do require a VAT registration and, of these:
  • 11 have a nil registration turnover threshold – Algeria, Bolivia, Dominican Republic, Honduras, Mexico, Myanmar, Namibia, Nicaragua, Nigeria and Russia (although this can be paid by the recipient as a withholding tax if agreed by them) and Uruguay
  • 7 have a registration threshold – Barbados, Malaysia, Mauritius, Philippines, St Lucia, South Africa and Zimbabwe.

• In addition to the above, 3 countries operate a withholding tax position – China, Panama and Paraguay

For business to consumer supplies (B2C)

• Most countries require a VAT registration for B2C supplies
• The United States has been excluded from this as the rules vary per state although a number of states require Sales Tax registration if a nexus is created.
• 113 countries require a VAT registration and, of these:
  • 80 have a nil registration turnover threshold – This includes the 27 member states of the EU – there is a threshold for EU members of €10,000 across the EU but this is not applicable for entities established outside the EU member states. In addition, the EU has a simplification mechanism in place known as the One Stop Shop (OSS) such that it is possible to register for VAT in one member state but to charge and account for VAT in any other member state through a simplified VAT return covering all member states.
  • This also assumes that all GCC countries will have no threshold (three of the GCC have not finalised their rules at present)
  • 33 countries have a threshold
• In addition to the 113 above, 2 countries collect VAT through the finance provider – Argentina and Costa Rica
• 4 countries operate a withholding tax – China, Mongolia, Panama and Paraguay
• Currently only 16 do not require VAT registration for B2C supplies.

What action should a business take?

A business supplying digital services on a B2C basis around the world is likely to be required to be registered for VAT in many locations. Whilst the administration costs of this may be high, failure to comply can be costly.

A business needs to consider its obligations in the first instance and, we would suggest, as soon as possible, in order that any exposure is limited. There will likely be a need to obtain support in terms of local country advice and accounting and filing assistance. Suppliers should also perhaps consider whether there are alternative commercial solutions to minimise compliance costs.

The Kreston Global network has advisory and compliance specialists in over 120 countries and is therefore very well placed to assist you in this regard, to obtain specific local advice and to implement compliance obligations cost effectively.