Article 5 – The Tax Challenges of the Digital Economy
Main principles of Indirect Taxation
In our fifth article in a series of articles on the tax challenges of the digital economy, we shall be providing you hereunder with a brief overview of the principles of indirect taxation, with a focus primarily on the VAT and the destination principle applicable to VAT on cross-border supplies of services.
Services are normally defined as ‘anything other than a supply of goods’. Many countries use different methods to identify the place of supply of such services, such as for example, the place where the service is performed, the place of establishment of the supplier, the residence of the customer or the place where the tangible property is situated (such as for example services by an architect on immovable property).In practice, two approaches can be identified for applying vat to the cross border supplies of services.
The first approach refers to the place where the customer is resident i.e. vat will be paid in the country where the customer is resident, while no vat will be charged in the country where the supplier is established. In principle, this would mean that the service provider would need to register for vat purposes in the country where the customer is resident, charge the VAT rate applicable in that country and pay same to the VAT authorities in that country.
With respect to B2B supplies, the vat is collected through the reverse charge mechanism whereby the liability to pay the tax will be shifted on to the customer. Where the vat registered business is able to recover input vat in the country of registration, he will credit the input tax immediately against the output tax.
This means that the service provider would not in this case be required to register for vat purposes in the country where the VAT registered customer is established. This also has the advantage that cross-border refunds of vat will be avoided.With respect to B2C supplies, in principle this would mean that non-registered consumers would be required to self-assess their VAT liability on services purchased abroad.
Such final consumers would have no incentive to voluntary declare their purchases and pay the tax due, unlike taxable persons who can credit their input tax against their output tax. The service provider will therefore be required to charge the pertinent vat rate applicable in the country in which the customer is registered.
To avoid multiple registrations in different countries, many countries adopt simplified methods of applying the destination based principle for taxing B2C supplies of services such as for example the EU’s ‘One Stop Shop’ scheme.More details on the EU’s ‘One Stop Shop’ scheme, will be provided in future articles.Under the second approach, the supply of service is subject to VAT in the jurisdiction in which the supplier is established, even when such services are performed abroad or to foreign customers.
Customers that are vat registered are generally able to apply for a refund of vat paid on their inputs from the VAT authorities of the jurisdiction in which the supplier is established.
