So, what’s happening?
From 1 January 2015, new EU tax rules will require value added tax (VAT) to be charged on paid digital content (like video games, apps, digital music and video) at the VAT rate of each EU country where its customers are based.
How is this different to the existing system?
Previously digital businesses could charge VAT across the whole EU based on the country where its business was located (e.g. a UK business could in principle charge VAT of 20%, being the UK’s VAT rate). Now, in principle they will have to use up to 27 VAT rates (one for each EU Member State) if they fall under the new rules.
Why is the EU introducing these rules?
It is an effort to ensure that Member States receive their ‘fair share’ of VAT revenue and put a stop to large multinationals basing themselves in a single low-VAT Member State (e.g. Luxembourg) and using that low VAT rate for the whole of the EU in order to keep prices down. However, these rules apply equally to smaller digital businesses.
OK, so this applies to ‘digital services’. What exactly is that?
The UK’s HMRC has provided us with some helpful, but non-exhaustive, examples:
- Broadcasting: this includes the supply of radio or TV shows to a schedule by the person that has editorial control over them.
- Telecommunications: this includes the service of sending or receiving signals by wire, radio, optical or other systems – and includes fixed and mobile telephony, fax and connection to the internet.
- Electronic services: this includes mobile apps, music downloads, video games, e-books and other online transactions like online auctions.
Each of these kinds of paid services in principle would be subject to the new VAT rules.
So what do I have to do?
In theory, a digital business would need to register for VAT in every single Member State and remit tax payments directly to each of the tax authorities. Obviously, that could be rather difficult in practice for many smaller and medium sized digital businesses. So, the EU believes that it has a solution called ‘VAT Mini One Stop Shop’ (MOSS for short).
How MOSS is meant to work:
The digital business fills out a single VAT return which sets out how much VAT is owed in each EU Member State under their relevant VAT rate – this saves having to fill out multiple country-specific VAT returns. The actual VAT revenues are then meant to be remitted via MOSS. So, MOSS in principle lightens the administrative burden considerably under the new system…but that new system is still rather more burdensome than was the previous system.
Accountants and lawyers are holding their breath: the MOSS system is the first of its kind at this scale, is untested and little known, so it remains to be seen how it performs once the first VAT returns are submitted.
How are the new VAT rules going to affect games, apps, e-books, digital music/film/TV and other digital services?
We do not know for sure yet, for two reasons. The first reason is that the tax authorities are not themselves completely clear yet and more official guidance is needed. The second reason is that a lot is going to depend on what the big platforms do. What follows therefore is a working summary based on the information available to date.
(1) If you sell digital services directly to EU customers, then you need to ensure compliance with the new VAT rules.
For example, if a games developer or music studio self-publishes and distributes its products online and direct to customers (e.g. via its website), it will be responsible for calculating and collecting VAT from customers based on their national VAT rate – in practice, this means:
- Going through the MOSS process;
- Investing in sales/accounting software which can automatically carry out different VAT calculations;
- Ensuring you can identify the customer’s location: the guidance so far suggests that you make a reasonable effort to identify the customer’s location, which involves gathering at least two pieces of evidence – such as a billing or invoicing address; country of residence; or IP address; and
(2) If you sell digital services in the EU through a digital distribution platform, then the platform (probably) will deal with the new VAT rules.
Based on my discussions so far, it seems likely that most (and possibly all) the digital distribution platforms will effectively deal with the VAT issue themselves: this includes Apple, Google, Steam and quite likely Amazon, Microsoft, Sony and others. It’s not always clear when a platform accepts VAT responsibility though so, if in doubt, it’s worth asking.
Exactly how this will work is yet to be established (partly because virtually none of the platforms have made an official statement about it yet), but it may well involve a platform simply charging some customers more if their national VAT rate is higher than the platform’s previous effective VAT rate. One alternate possibility though is that the platform does not change its end-customer prices but instead passes the VAT increase on to product owners like games or app developers (this seems unlikely because it would damage product owner/developer margins, but it is not impossible). Another possibility is that the platform could absorb the VAT increases itself, in the interests of not increasing end-customer prices (but then its margins are affected).
It is worth bearing in mind that, due to the complex operation of tax law, it is not absolutely certain that platforms would be entirely responsible for managing the new VAT rules – but commercially and practically it seems probable that they would take responsibility nonetheless.
So, are digital products going to cost more now in the EU?
Yes, depending on where customers live. The cost of games, e-books, digital films etc. is going to vary based on the VAT rate of where the customer lives: it ranges from 15% in Luxembourg (the lowest in the EU), 19% in Germany, 20% in the UK and France and up to 25% in Denmark and Croatia (for a full breakdown, see here). We should begin to see these price differentials begin to be reflected in online transactions in the EU in 2015.
Are the platforms going to make all these changes for free?
We don’t know, but it seems reasonably likely that if these new rules involve additional cost to the platforms, then they may want to pass that cost on – either to product owners and/or on to end customers. So this prove to be an additional cost for digital services sales in the EU.
I use a payment processing service like PayPal. Do I still have to follow these new rules?
Yes, probably. Most payment processing services are just there to facilitate a transaction, they don’t ensure that the transaction complies with any particular tax requirements – that, unfortunately, is likely to remain your job.
What if my business is not VAT registered – do I still have to follow these new rules?
Yes, apparently. This is causing a headache for small traders and the tax authorities are going to have to do something about it (apparently the UK’s tax authority, HMRC, already is).
I only sell physical goods online. Am I affected?
Apparently not. However, if you sell B2C digital and physical goods, then it seems that once you have registered for MOSS you may have to report for both digital and physical goods. More official guidance is awaited on this.
I’m an EU business exporting to the USA. Do I have to charge VAT on US sales?
No, though you will likely still need to record this in your VAT return and financial records generally.
I’m a US business exporting into the EU. Do I have to charge VAT?
In principle the VAT rules can apply even though you are a US business, although in practice many US businesses do not charge VAT (or indeed localise the purchase process at all) until they have established a physical presence in the EU. That can run risks, though for better or worse it has been influenced by the fact that the practical enforcement risk by an EU tax authority against a US company with no physical presence in the EU historically has been low.
I don’t like to give legal caveats for the sake of it, but it’s worth it here. This is a fast changing area of law and tax practice which is likely to be amended over time in 2015 and could have a significant impact on any digital business operating in the EU, from small businesses up to large international companies. It’s therefore worth discussing it with your accountant and lawyer in order to help put together the right strategy for your business.