Foreign Income & Taxpayers
Recent discussions of tax reform in the United States have identified a value-added tax (VAT) as a possible vehicle for closing fiscal gaps and enhancing the reliability and efficiency of the U.S. tax system. In more than 150 countries, including Organisation for Economic Co-operation and Development (OECD) member countries, experience has shown that a VAT can be an important part of the fiscal structure in developed countries, which have seen the backbone of their economies shift from manufacturing to service-oriented businesses, most notably with expanding use of the internet and information technologies. As the oldest and most developed in the world, the European Union VAT system is often used as a model for countries implementing a VAT, and a study of the EU system could influence any future U.S. VAT.
The EU is in the process of fundamentally modifying the structure of its VAT and adapting it to the business models of the 21st century. In 2010, the EU began modifying the sourcing rules for services to provide for taxation at the place of consumption, as opposed to taxation at the supplier’s location or point of production. The process should be finalized in 2015, when the rules for sales to individuals and households will change to mandate taxation of telecommunications, broadcasting, and electronically supplied services where the customer is established, as opposed to where the supplier is established. These new sourcing rules have already inspired legislative amendments in Norway and Switzerland, among other countries.
This item discusses the basic principles of the EU VAT; the existing sourcing rules for sales of telecommunications, broadcasting, and electronically supplied services to businesses and individuals; the modifications being made to those rules; and what those modifications could mean for future changes to the EU VAT.
Basic Principles of the EU VAT
The EU VAT is a harmonized system in which a member state may apply different VAT rates, exemptions, and interpretations of VAT law within the limits of the EU legislation. The EU VAT is a broad-based consumption tax on all goods and services that is fractionally collected at each stage of consumption and is designed as a tax that does not rest on business inputs (i.e., businesses receive a credit for VAT paid on purchases against VAT collected on sales). The burden of the tax is on the final customer, and as with U.S. retail sales taxes, businesses collect the EU VAT on behalf of the state.
Under the EU VAT, there is no corresponding consumer use tax. Unlike in the United States, where physical presence is necessary to establish nexus for indirect tax purposes, EU VAT registration and collection obligations are dictated not by physical presence but rather by sourcing rules. Sourcing rules in the EU vary depending on whether there is a sale of goods or a sale of services. Under the EU VAT, the transfer of the right to dispose of ownership of tangible property qualifies as a sale of goods, whereas everything that is not considered a sale of goods by default falls under the category of sale of services, including broadcasting, telecommunications, and electronically supplied services (“electronically supplied” meaning services that are provided via the internet or an electronic network and that are essentially automated). Sales of goods are generally taxed based on the destination to which they are delivered.
Since 2010, for the sourcing of services, the EU VAT Directive (EU Council Directive 2006/112/EC, as amended by EU Council Directive 2008/8/EC) distinguishes between business-to - business (B2B) transactions and business-to -consumer (B2C) transactions. For B2B transactions, the EU VAT Directive states that services are generally sourced to where the recipient is established, and B2C transactions are generally sourced to where the provider is established. Thus, a seller is in principle obligated to collect tax based on where the seller is, unless the sale is to a business customer, in which case the customer, when established in another member state, is required to self-accrue VAT on its VAT return (known as the “ reverse-charge mechanism”).
Sourcing Rules for Broadcasting, Telecommunications, and Electronically Supplied Services
In B2B transactions, according to the general rule, sales of broadcasting, telecommunications, and electronically supplied services are sourced to where the customer is established.
Example 1: A U.K. service provider performs web-hosting services for a German company. The German company must declare the purchased service on its VAT return.
In B2C transactions, the sourcing of broadcasting, telecommunications, and electronically supplied services is more complicated because the rules vary depending on where the seller and customer are located. Broadcasting, telecommunications, and electronically supplied services provided by an EU business to a non-EU resident are sourced outside of the EU and thus are not subject to VAT.
Example 2: A U.K. business performs distance teaching via the internet to a U.S. individual; the U.K. business will not charge U.K. VAT on those services.
The sourcing of B2C services provided to an EU resident depends on where the service provider is established and what type of service is performed. Broadcasting, telecommunications, and electronically supplied services provided by an EU business to an EU resident are sourced to where the provider is established.
Example 3: A U.K. company providing its services to a German individual will charge U.K. VAT and declare the service on its U.K. VAT return. The German individual has no obligation to declare the purchase to German tax authorities.
The EU VAT Directive specifies that broadcasting and telecommunications services provided by a non-EU business to an EU resident are taxable where they are effectively used and enjoyed.
Example 4: A U.S. company provides access to American television programming to a U.S. citizen living in Germany. The U.S. company is required to charge German VAT on those services.
Finally, electronically supplied services provided by a non-EU business to an EU resident are taxable where the customer resides.
Example 5: A U.S. company provides web-hosting services to residents of France, Germany, and the U.K. The services are taxable in France, Germany, and the U.K.
These rules require a provider of electronically supplied services established outside the EU to register in all the member states where it provides services to nonbusiness clients. To ease the compliance burden, the EU VAT Directive provides for a special mechanism, the one-stop-shop program. The provider chooses a member state for VAT reporting purposes, called the member state of identification, and registers there. Each quarter, the company prepares a VAT return detailing the total value of electronically supplied services provided, the applicable VAT rate, and the total VAT due for each member state. The information is transmitted by the member state of identification to the consumption member states. The company pays the total amount of VAT due to the member state of identification, which transfers the amounts to the consumption member states.
Member states have criticized the current sourcing rules because they allow businesses to take advantage of different VAT rates applicable across the EU. A business providing electronically supplied services is more likely to be established in Luxembourg, which has the lowest VAT rate in the EU—and thus all of that business’s sales to nonbusiness customers in the EU are taxable in Luxembourg, while the member states where consumption occurs are excluded from the revenue stream. In response to these and other issues, effective Jan. 1, 2015, the sourcing rules for broadcasting, telecommunications, and electronically supplied services provided to individuals and households established in the EU will be amended such that services are taxable where the recipient is established, regardless of the provider’s location.
In addition, the one-stop-shop program is extended to telecommunications and broadcasting services that non-EU businesses provide to EU individuals or households. The one-stop-shop program will also apply for the first time to businesses established in the EU and providing telecommunications, broadcasting, and electronically supplied services to individuals and households established in other member states. To create an incentive for member states to participate, EU Council Regulation No. 143/2008 allows a phase-in period (through 2018) during which the member state of identification can retain a portion of the taxes to be transferred to the member state of consumption for broadcasting, telecommunications, and electronically supplied services performed within the EU.
The Future of VAT?
The modification of the sourcing rules for broadcasting, telecommunications, and electronically supplied services and the introduction of the one-stop -shop program for transactions within the EU are early steps in modifying the sourcing rules for B2C transactions to ensure taxation in the consumption state. However, some member states and businesses are skeptical about broadening these new rules because many questions remain unanswered. The sourcing rules refer to the location of the customer; however, this location can vary depending on where the services are accessed (e.g., at home, at work, or in a café) and by which means (e.g., on a public computer, laptop, or phone).
In a recent legislative proposal, the EU addressed these issues by requiring member states and businesses to use evidence such as billing address, internet protocal (IP) address, or bank details to identify the customer’s location . Moreover, tax authorities must determine how they will audit these transactions when taxpayers are registered in one country but source transactions to other countries. Businesses must also adapt their systems and processes to the new sourcing and compliance rules, the challenges of which include determining applicable VAT rates and exemptions and maintaining an up-to -date customer location database. Member states will closely monitor the changes in revenue streams and the administrative costs of the new sourcing and compliance rules. The EU has already declared that it will closely follow the implementation of the 2015 changes to identify possible improvements.
Mary Van Leuven is senior manager, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with KPMG LLP. This article represents the views of the author or authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.