Heather Burns explains how proposed changes to the taxation of cross-border digital services represent an acknowledgement of the unintended consequences of digital legislation.
The road to hell is paved with good intentions, and this was never truer than in the case of the EU place of supply reforms. This E-commerce Directive, legislated by the EU in 2008 and having effect from 1 January 2015, was designed to target the creative tax games played by multinational sellers such as Amazon and Apple. Its unexpected and devastating impact on small businesses and sole traders, however, generated international outrage, widespread condemnation, and a volunteer grassroots campaign.
On 1 December 2016, the European Commission announced a proposed raft of reforms and changes to the system, a rare acknowledgement that they had indeed got this digital legislation very, very wrong.
Before the reforms, e-commerce giants could effectively split transactions to state that the sale of a product took place in one country while the physical fulfilment took place from another. This creative accountancy allowed multinationals to engage in jurisdiction shopping, charging the lower VAT rate of the country of sale rather than the country of fulfilment. (Luxembourg and Ireland were the most common countries of 'sale.')
This legal but dubious practice meant that member states were losing billions of pounds of tax revenue from online sales. In response, the place of supply reforms decreed that, as of 1 January 2015, an online sale within the EU is billable in the country of the buyer's location, not the seller's location – hence the concept of 'place of supply,' meaning the place where the goods or services are being supplied to, not from.
Charging tax based on the buyer's location, and not the seller's, meant that sellers became obliged to charge the VAT of the buyer's location, collect that VAT, and remit it to the buyer's national tax authority. To facilitate this, the EC set up a system called the Mini One-Stop Shop – or MOSS – which allows sellers to pay in all collected European VAT revenues through an online portal provided by their domestic tax authority. In other words, sellers do not need to register with the tax authorities of every country where they have made sales. (The subsequent controversy over the reforms co-opted the name of the portal and was hashtagged as VATMOSS.)
Although the reform was meant to target physical goods, as indeed it will from 2021, the first phase of the reforms targeted digital products and services. This is where the trouble began. If Amazon UK sells books to a buyer in Germany, the place of supply is Germany. But what if a French web developer who works in Belgium buys web hosting at a Spanish conference for a Portuguese client? Where, then, is the place of supply, who is responsible for determining it, and how? What, as they say, could possibly go wrong?
The road to hell
The place of supply reforms were legislated at time of rapid and dynamic change in the e-commerce world. That perspective, as is frequent in digital legislation, meant that the directive did not keep pace with the reality of e-commerce development. The assumptions which formed the structure of the directive, however, were not merely flawed, but disastrous.
First, the place of supply reforms legislated no minimum threshold before EU VAT obligations became applicable to online sellers. While some EU member states have very low or no tax thresholds, other member states have thresholds sympathetic to SMEs, while the UK has the highest VAT threshold in Europe. The lack of a minimum threshold meant that hundreds of thousands of microbusinesses, sole traders, and even non-commercial hobbyists were brought into the VAT system, inclusive of all the financial and administrative burdens inherent within it, despite the UK median annual earnings from self-employment standing at £10,800. Nor was there a minimum threshold for product costs. A hobbyist who made just one sale of a 99p downloadable needlework pattern to a buyer in another EU country would be brought into both the domestic and the European VAT system.
Second, under the original implementation of the place of supply reforms, the responsibility fell on sellers to collect at least two pieces of data about customers to correlate the place of supply. In addition to the basic data provided during the checkout process, correlating data could include the location of the customer's bank, the country code of the SIM card used by the customer, the location of the customer's fixed landline, or the ambiguously worded 'other commercially relevant information'.
Critically, these requirements were legislated with no regard for practical implementation. Software developers were infuriated by the apparent presumption that e-commerce systems could simply be tweaked to collect this data. Payment processors were neither consulted nor informed about these fundamental changes to their systems and processes; PayPal learnt about their 'obligations' from concerned sellers days before the compliance deadline. Affected sellers faced often ridiculous implementation costs as well. One typical example saw the author Cory Doctorow spending over £700 to reprogram his shopping cart in order to determine that he owed £18.74 in European VAT. A related point of anger was the implied requirement for sellers and e-commerce developers to monitor Europe's 106 constantly fluctuating VAT rates across 28 member states and to adjust their shopping carts accordingly.
Third, once those multiple data points were collected (assuming they could be collected at all), affected sellers were required to keep them, along with all other MOSS-related sales records, on an EU-hosted server for ten years for tax auditing purposes. This data retention period, which is well in excess of most member states' record-keeping requirements, imposed data protection and security obligations onto the domestic laptop of the aforementioned hobbyist selling needlework patterns on the side.
Finally, under the place of supply reforms, third-party platforms – such as Amazon, iTunes, Etsy, Patreon, and even adult entertainment sites – are responsible for the technical and financial aspects of EU VAT. However, the reforms were legislated on the presumption that all online sellers trade through platforms. Cosseted tax officials expressed genuine bewilderment at the existence of sole traders running self-hosted shopping carts, and collecting payments through processors like PayPal, with seemingly no comprehension that the administrative and tax burdens of the reforms could fall onto individuals rather than corporate finance departments.
On paper, then, the place of supply reforms were about reining in the creative tax games played by giant multinationals. In practice, the place of supply reforms meant the micromanagement of micropayments to microtraders, and compliance obligations which were absurdly disproportionate to the tiny amounts of tax revenues raised. While the targeted multinationals could meet compliance obligations with ease, kitchen table businesses, the self-employed, and hobbyists were made beholden to international taxation, data protection, and programming obligations.
In response to the problems caused by the flawed implementation of the place of supply reforms, a volunteer grassroots campaign began on social media in late 2014. Remarkably, within months of their first blog post, the EU VAT Action Campaign had achieved consultative status with the EU. Its members were invited to Downing Street, Brussels, and to the FISCALIS summit of European finance ministers in Dublin to advocate for the concerns of affected traders. This lobbying activity was done in the volunteers' own time, uncompensated, and the campaigners in fact had to crowdfund to cover their travel costs and expenses. (As self-employed individuals, the volunteers paused their own businesses and incomes to work on the campaign, often at great personal and emotional cost.)
In addition to overcoming these obstacles, Campaign members remained professional throughout the EC's initial dismissal of them as disgruntled knitters who just didn't understand the legislation properly and, later on, as British moaners whingeing about the lack of a VAT threshold.
Incredibly, the Campaign's tireless, constructive, and positive lobbying paid off. Their work on behalf of affected SMEs was the key to making the European Commission cognizant of the barriers that digital legislation can impose on microbusinesses. The Campaign, and their work, were directly cited in the EU's impact assessment document of the planned reforms.
On 1 December 2016 the European Commission announced a series of proposed reforms to the place of supply rules.
First and most critically, there will be a threshold of €10,000 pa before cross-border taxation rules apply. Businesses trading under that threshold will be able to apply domestic VAT rules. This threshold, although low, was fiercely contested by member states which preferred no threshold at all.
Second, SMEs and microbusinesses which make less than €100,000 in online sales per annum will no longer be required to source and retain two pieces of correlating evidence to prove the place of supply. One piece of evidence, including the basic information received during the transaction, will suffice.
Third, microbusinesses will be allowed to use domestic VAT rules on invoicing requirements and record keeping, rather than having to memorise which member states require a supplemental VAT invoice. The ten-year data retention period for MOSS records has also been scrapped.
Fourth, the first point of contact for queries from other member states' tax administrations will be the seller's own tax authority. This is in response to sellers receiving direct, and often baffling, communications and invoices from other tax authorities over trivial sums.
Once approved, these changes would take effect in 2018, with the system rolling out to cross-border physical goods in 2021.
MOSS after Brexit
The proposed rule which would permit domestic VAT rules to apply to traders under the €10,000 threshold would effectively remove all UK microbusinesses – including the ones who were forced to register for VAT solely to comply with VATMOSS requirements – from further VAT obligations.
However, this simplification, as with the other proposed changes, would not come into effect until 2018.
This, as has been noted, will place the reforms squarely in the middle of the Article 50 process.
After Brexit, UK-based sellers will be required to continue charging and remitting European VAT on sales within Europe. They are likely, however, to lose access to the UK's MOSS portal. Domestic traders would then have to register as non-union members, as for example American and Canadian sellers do, with a European member state's tax authority.
That administrative inconvenience is eclipsed by the fact that the UK will also lose its seat at the EU's tax and finance table, and will no longer have a voice in future iterations of the place of supply changes, or indeed in any European digital legislation, despite UK e-commerce businesses being required to continue following those rules.
At that point, online traders will be nostalgic for the days when acquiring two pieces of correlating place of supply data was their biggest problem.
Heather Burns is a digital law specialist. She researches, writes, publishes, consults, and speaks extensively on internet laws and policies, most specifically those that affect the crafts of web design and development: https://webdevlaw.uk/