VAT on electronic services – the rules are changing

The rules on charging VAT on electronic services are changing. All businesses supplying such services will have to charge VAT at the consumer's country rate from 2015 (non-EU businesses without an EU subsidiary already have to do this).

Background

Without special VAT rules, businesses based outside the EU could be at a competitive advantage as they would not be required to apply VAT to electronic services to consumers. EU businesses are required to charge VAT on all such business-to-consumer (B2C) supplies, regardless of where the consumer is located. Electronic services include many provided by intellectual property focussed industries, such as telecommunications, broadcasting, and internet-delivered services (music downloads, video streaming, webhosting etc).

Rules introduced in 2003 required non-EU businesses to charge VAT on these B2C services and also removed the need for EU businesses to charge VAT to non-EU customers. Business-to-business supplies are not affected – businesses self-charge VAT on services received from out-of-country suppliers.

However, these rules aren't perfect and there has been criticism that non-EU and large businesses are still able to get a competitive advantage by setting up in locations such as Luxembourg, with a 15% VAT rate. Smaller businesses are less equipped to set up an overseas subsidiary just for electronic services delivery and so have to charge their local VAT rate – up to 25% in Sweden and Denmark.

Outcome

To 'level the playing field', all businesses supplying electronic services will have to charge VAT at the consumer's country rate from 2015 (non-EU businesses without an EU subsidiary already have to do this).

To make things easier, a centralised reporting system is to be introduced in 2010 for cross-border VAT compliance. This means that only one central registration and report is required for EU activity, rather than separate registration and reporting in each country. The VAT payments are then allocated to each country and payment is administered by each VAT authority. As an added bonus, this system will allow VAT registered businesses to recover VAT paid in other EU countries. At the moment, only local VAT paid can be recovered.

Comment

These changes will make things fairer for smaller businesses in particular, but will involve a lot of work for all businesses making B2C supplies of electronic services.

2015 seems a long way off, but the changes to systems and, potentially to business models that wuill be required should not be underestimated. Although VAT is ultimately governed by EU Directives, each country has its own interpretation of those Directives, and different rates for electronic services.

Systems will need to be updated to be able to identify where a consumer is based and to apply the correct rate of VAT to transactions. VAT recording processes will need to be updated to ensure that the requirement to report by country can be met.

The business model may also need to be reviewed, to consider the competitiveness of pricing when local VAT in each country is taken into account. Larger businesses that have set up subsidiaries in locations such as Luxembourg and Madeira to be able to charge lower VAT rates will need to consider whether these subsidiaries will remain cost-effective once they no longer offer a competitive advantage.