Changes to European rules on value added tax (VAT), aimed at closing loopholes for giant digital sellers, are having the added effect of putting small businesses in a tizzy.
As of Jan. 1 this year, sales of digital services—including web hosting, digitized media and database subscriptions—in the 28 EU member states are subject to the VAT rates of the country the consumer lives in, rather than where the business is based. There is no minimum sales threshold. Before the new rules went into effect, large companies could shop around for the best VAT rates when selecting their European headquarters. (Member countries each set individual VAT rules and rates, from Luxembourg’s 3% to Hungary’s 27%.)
The lack of a cross-border minimum threshold is where sole proprietors and small businesses that sell digital products are feeling the pinch: any sale to a customer in another EU member state triggers the VAT collection and reporting obligation. (Though any European company selling digital products solely to consumers within its own country can enjoy any minimums that country has for VAT activation, such as the UK’s £81,000 threshold [$125,000]).
To ease the burden of compliance, the European Commission’s Taxation and Customs Union has set up the VAT Mini One Stop Shop, or VATMOSS, as a way for businesses to register once for all 28 member states and submit VAT returns in one place.
Annette Beresford, a Reed Smith associate specializing in tax law, explains that before 2015, small businesses outside the EU had to register with one of the 28 countries’ VAT for Electronic Services portals (VOES). “What non-EU businesses did frequently was set up in an EU state of their choice with a low VAT rate,” she says. “They can no longer shop for the member state with the most advantageous VAT rate. It establishes a more level playing field.”
Small business owners joined forces last year to protest the VAT changes—via an EU VAT Action website and corresponding Facebook groups. They argue the new rules disproportionately burden small businesses selling digital products, such as web designers, craft pattern sellers and independent authors and musicians, and are petitioning for a worldwide VAT exemption threshold. ”Marketplaces run by global corporations can do this,” says Juliet McKenna of EU VAT Action. “Small traders using PayPal ‘Buy Now’ buttons simply cannot.”
McKenna recently got an audience with British prime minister David Cameron, who happens to be her local MP, and discussions are ongoing. “At the moment, other EU governments are not seeing the outcry there is in the UK because their own digital sectors remain unaware of all this chaos,” McKenna says. “As the campaign expands into Europe and finance ministries realize the damage this will to do the digital single market and economic growth, we’re confident they’ll see the need for changes.”
Thanks to the common language, the UK VAT outrage has crossed the pond into North America. But the irony is that businesses outside of the EU were already responsible for collecting VAT for digital sales based on the customer’s location. Since 2003, in fact, anyone selling digital items to EU customers without collecting VAT based on local rates has been out of compliance. In a way, the #VATMESS outrage was the best awareness campaign the European Commission could have asked for. Small sellers outside of the EU had simply been blissfully unaware that they should have been collecting and submitting value added tax for digital sales made to EU customers.
“Where the supplier is outside the EU, this is of course more difficult, and the US tax authorities in particular are not known for being particularly helpful in assisting tax authorities in the EU,” Beresford says. “However, there is a trend towards increased co-operation across different areas of taxation, and I would expect action to be taken in the future to facilitate enforcement. The EU is definitely making an effort to bring the VAT rules for supplies of digital services to the attention of suppliers, whether within or outside the EU.”
There remains some confusion over who is responsible for collecting and remitting VAT when it comes to online marketplaces. “The burden of VAT compliance on supplies to consumers lies with the ‘supplier,’ and there are complex rules on establishing who the supplier is,” Beresford says. “A digital platform facilitating a supply by delivering the digital product may be the supplier, or it may act as agent, depending on the precise contractual arrangements.”
Some marketplaces have historically shrugged the obligation onto their customers, the product creators, but persistent questions from sellers have forced them into action. Crafty marketplace Etsy in December said its sellers were responsible for staying up to date on global tax laws and deciding whether to collect VAT, then in January decided to take responsibility for collecting and remitting VAT for EU Etsy members selling digital downloads to EU buyers, before announcing it would take care of VAT for all digital sales to EU buyers in February.
Design marketplace Envato says it will manage VAT compliance for EU sellers only: “Although Envato Market operates as a platform, purely for VAT purposes Envato will be the supplier on record and we’ll be working with our EU team and EU authorities to ensure anything authors are required to do is minimal.” Music service Bandcamp likewise is “taking care of” collecting VAT for digital sales for its artists.
Casey Forbes of Ravelry.com, a social networking site for knitters and fiber artists that includes a marketplace, opted to redirect EU buyers to an EU-based shop to buy patterns.
“We decided to buy ourselves some time so that we can (hopefully) come up with a good way of handling this mess,” Forbes wrote in an email. “We, a staff of four, were able to support 5 million registered users and tens of thousands of sellers who sell direct to customers using their own PayPal accounts. The VAT changes have basically destroyed this entire way of creating marketplaces.”
For sellers who want to have an independent ecommerce store (using services such as Shopify, WooCommerce or BigCartel) rather than use a multinational marketplace (such as Amazon, the iTunes store or Etsy) to sell digital products to customers within the EU, hitches remain, and some sole proprietors are choosing simply not to sell to EU customers. (The Digital VAT 2015 Facebook group is collecting a list of small businesses doing that here.)
The question remains: How enforceable is collecting VAT on digital transactions outside of the EU? If the last 12 years are anything to go by—not very.