10 key global VAT operational system, data and process issues facing digital service providers
Tax can be complex for any business; however cross-border digital services can create some very specific and onerous global indirect tax compliance requirements. In an ever-changing VAT and GST legislative landscape, these requirements can multiply very quickly, particularly as a business scales and starts selling into more jurisdictions. In this article, we look to set out the top ten key operational issues facing digital service providers across systems, data and process, and how technology and strategic partnering can be leveraged to manage these.
1. Awareness of which countries tax non-resident supplies of digital services
One of the main challenges facing digital service providers, from dynamic start-ups to large multinationals, is being aware of which countries have introduced, or are going to introduce, legislation that requires foreign businesses to register for VAT/GST and charge, collect and remit the tax on sales of digital services to consumers. The European Union (EU) first introduced legislation back in July 2003 that required non-EU digital service providers to register for VAT when providing digital services to consumers across the EU member states. Fast forward almost 20 years and there are now over 100 jurisdictions globally that have introduced similar rules. Keeping on top of changing global indirect tax regulations effecting digital services is challenging.
The increase in countries levying VAT/GST on foreign suppliers of digital services is due to Governments and tax authorities looking to level the playing field between resident and non-resident suppliers, removing the competitive advantage of being able to provide services to individuals without tax, as well as raising much needed tax revenues. The OECD supports this move and in its International VAT/GST Guidelines, confirms its view that “…the jurisdiction in which the customer has its usual residence has the taxing rights over business-to-consumer supplies” of digital services. Indeed, the OECD has championed countries that have introduced VAT/GST on digital services regimes. In partnership with the World Bank, it has released VAT Digital Toolkits to assist tax authorities in Latin America and the Caribbean (LATAM) and Asia-Pacific (APAC) with the design and implementation of tax reform to ensure the effective collection of VAT on e-commerce activities, including B2C digital services. A further toolkit for tax authorities in Africa will be released in late 2022. Taxing foreign supplies of B2C digital services is the clear direction of travel and the number of jurisdictions will continue to increase – its not a case of if, but when a country introduces legislation.
While many tax authorities look to proactively approach larger multinationals when they introduce new rules, some businesses use horizon planning to monitor legislative developments across the globe. Avalara’s Global VAT & GST on digital services tracker highlights the key countries which levy VAT or GST on digital services sold by foreign businesses. Digital services providers can also stay up to date with new requirements by reading indirect tax blogs and newsletters.
2. Monitoring thresholds
While many countries have introduced VAT or GST registration thresholds based on annual revenue from consumers in the country e.g. New Zealand has a threshold of NZD 60,000 (approx. $37,000 USD), there is a growing trend for countries to have a zero threshold for digital services provided by non-resident companies (e.g. the UK, the European Union, South Korea). It is therefore key for businesses to have visibility over the location of customers and to be able to regularly monitor revenue from a particular country. This helps identify when a threshold has been breached and when there is a requirement to register for VAT/GST. Of course, for countries with a nil threshold, this is as simple as having a single consumer and receiving just a single dollar or euro from them. Some countries will base the threshold on a ‘global threshold’, looking at global revenue rather than sales just made to customer in that specific country e.g. Switzerland’s CHF 100,000 threshold is based on global sales.
Another complexity when monitoring thresholds and ascertaining whether there is a requirement to register is being able to distinguish between B2B and B2C sales i.e. the status of the customer and whether they are a business customer that is able to self-account for local VAT under the reverse charge in its VAT return, or a private consumer. While most countries globally only tax non-resident supplies of B2C digital services, there are a handful of countries that do not draw a distinction based on customer type and will also tax B2B sales and include these in the threshold.
3. Registering for VAT / GST in relevant jurisdictions
Many countries have introduced simplified VAT/GST registrations for digital services with self-serve portals in English. However, sometimes the application can be complex or require the appointment of an agent or fiscal representative to register and file VAT/GST returns. Even where it is possible, and relatively straightforward, for a business to register itself, the rapid pace at which new VAT/GST rules on digital services are being introduced, many businesses see the value in having the VAT/GST registration project managed by a single partner. These partners understand what information is needed and can identify the synergies across different jurisdictions e.g., not duplicating information requests. In addition, a global VAT compliance business partner can also leverage its relationship with tax authorities.
It is also important to understand whether it is possible to backdate a VAT registration to account for VAT on historic sales prior to the date of registration or whether there is a requirement to prepare and submit a voluntary disclosure to the tax authority.
4. Identifying and evidencing customer location
Determining the customer’s location is vitally important for identifying where a transaction is taxed and calculating the relevant rate of VAT to charge at the point of sale. But is also important for audit defence – demonstrating and evidencing to a tax authority why tax was or wasn’t charged. Digital services can often be low value, relatively anonymous and be one-off single transactions. It is therefore critical for businesses to understand what data elements are available to them at the time of the transaction (or even afterwards for additional supporting evidence). While individual legislation and guidance on a country-by-country basis provides specific local rules, the following data elements are often key indicators of a customer’s location for VAT/GST purposes:
Internet Protocol (IP) address of the device used by the customer
Billing address of the customer
Credit card Bank Identification Number (BIN)
Bank account location
Billing address of customer held by Bank / Credit card provider
Mobile Country Code (MCC) of the International Mobile Subscriber Identity (IMSI) stored on the Subscriber Identity Module (SIM) card used by the customer
Location of the customer’s fixed land line
Results of geo-location software
Other commercially relevant information.
Not all of the above data points will be available to a digital service provider, however it is recommended that the business consults with its IT team and other key stakeholders (e.g. team in charge of fraud prevention) to identify what data is available and how this can be obtained, retained, and built into a scalable tax determination policy and process. In the EU, where the physical presence of the consumer is not required for receiving the digital service, a business can make a presumption based on the information available to it about the location of the customer. This includes a general presumption which allows a business to identify the location of the customer based on two items of non-contradictory evidence. Even where the tax authority (in the unlikely event) could obtain three pieces of evidence that suggests a different location, the business has a “safe harbour” unless there is fraud. Fraud is of course something to be aware of, and the weakest option for ascertaining customer location is the customer providing their own country of residence from a drop-down box or free text entry, without any further validation. In any event, a business should define a consistent and scalable tax calculation and data retention policy.
5. Distinguishing between businesses and consumers
As previously mentioned, it is crucial to be able to distinguish between businesses and consumers i.e between B2B and B2C supplies of digital services. While it may be obvious that a customer is a company and therefore in business, tax authorities view the VAT or GST registration number as the key piece of evidence and without the number there is risk and possible exposure. Therefore, digital service providers should seek to request a VAT / GST number from customers either at the checkout or as part of onboarding. In addition to obtaining the number, it should be validated. Some tax authorities provide real-time access to online validation services, for example the European Commission has The VAT Information Exchange System (VIES) web-service which allow businesses to validate a customer’s VAT identification number from across the 27 EU member states (and Northern Ireland). Where a validation service is not available in real time, business could consider adding mask format checks into the relevant data field, therefore at least identifying if a VAT number has an invalid format for the country.
Some countries will also require the reporting of B2B supplies of digital services to provide an audit trail to the tax authority. For example, EU businesses that provide cross-border B2B digital services to customers in other EU member states, must complete and submit EC Sales Lists (also known as recapitulative statements or VIES returns). These show the VAT registration number of the customer and the aggregate value of services provided in the period. Another example of this is Turkey, where all foreign businesses registered for VAT on B2C digital services, must also submit a monthly B2B sales list in XML format, detailing all sales made to Turkish business customers including their Turkish VAT registration number.
Most countries globally only require non-resident businesses to charge VAT /GST on digital services to consumers (B2C), and business customers (B2B) are instead responsible for self-accounting for local VAT/GST under the reverse charge mechanism. However, there are a handful of countries that have extended the scope to B2B, including Malaysia, Russia, South Africa, Mexico and Kenya. In addition, in Switzerland, once a foreign business is VAT registered due to B2C digital services, it must charge Swiss VAT on all digital services including to business customers.
6. Charging correct rate of VAT
Based on the issues mentioned above, real time tax determination and VAT/GST rate calculation for digital services can be extremely complex. The business’ status and location of a customer both drive whether tax is charged and if so, in which jurisdiction at which rate. As digital service providers are required to register for VAT/GST in more countries (and states in the US), it becomes even harder to maintain the tax rates and automate tax calculation natively in the ERP, accounting system, webstore or ecommerce platform.
As a result of this complexity, many digital service providers including SaaS businesses, are increasingly investing in tax engines. Avalara’s AvaTax for VAT determination solution has been built to provide global and scalable indirect tax calculation for digital services and ecommerce at the point of sale, with rates and rules maintained in the cloud.
7. Producing compliant tax invoices and receipts
Once a business is registered for VAT/GST in a foreign jurisdiction, it is generally required to meet local tax invoicing rules. This means that a document meeting local content requirements needs to be created and issued to the customer. While many countries will allow a simplified invoice or tax receipt to be issued to private consumers, there will still be key master data and transactional data that needs to be shown on the invoice, including the VAT registration number and VAT charged. In addition, there could be other non-tax legislation that mandates the use of a local language, for example the Polish Language Act can mandate the issuing of invoices and receipts to Polish consumers in Polish.
Most countries allow invoices to be raised and paid in any currency as this is a commercial decision for the business. However, where VAT or GST is charged, there is usually a requirement to show the tax in the local reporting currency on the tax invoice. Tax authorities will often mandate the use of a specific exchange rate e.g., a daily rate from the local national bank or a monthly rate for VAT and customs purposes published by the tax authority. In the EU, it is possible to use the European Central Bank’s day rate for currency conversion for VAT invoicing purposes in every EU member state.
The direction of travel for global VAT compliance is clear – it is e-invoicing and real-time digital reporting of transactional level data. We are starting to see some countries require e-invoicing for non-resident supplies of B2C digital services. An example of this is Taiwan which has mandated online Government Uniform Invoices (GUIs) since 2019. GUI's must be submitted directly to the tax authority either directly on the Ministry of Finance's platform or via an approved outsourcing e-invoice processor.
8. Preparing and submitting VAT /GST returns
Many VAT / GST returns for digital services are simplified returns and may only involve the reporting of only a few items of aggregated data. There is a streamlined pan-European VAT registration and return for selling digital services to consumers in the 27 EU member states, namely the Non-Union One-Stop-Shop (OSS). However, the complexity can increase in individual countries, or where additional data transformation that is required including:
Calculating VAT on an inclusive basis
Currency conversion using mandated exchange rates
Creating B2B sales listings.
In addition, in certain countries the use of mandated software or an API connection may be required, for example the UK requires all VAT registered businesses to use either a “Making Tax Digital” (MTD) compatible software package or bridging software to file the UK VAT return via an API link.
The level of time, resource, effort, and stress relating to VAT/GST compliance increases based on the number of indirect tax returns that need to be filed. Indeed, recent research from Cebr, commissioned by Avalara, revealed that almost two thirds (64%) of businesses agreed that staying compliant with tax obligations and regulations is the most stressful thing about running their business.
Given the current legislative trends, it is possible that many digital service providers will need to file regular periodic tax returns in between 25 to 100 countries. There can therefore be real value and synergies in working with a single tax compliance partner to help prepare and file VAT/GST returns on digital services globally. Avalara’s Managed VAT Reporting service provides VAT/GST registration and VAT/GST return compliance services in over 85 different countries across the globe including simplified digital services registrations.
9. Audit defence
Unfortunately submitting a VAT/GST return and making the required tax payment to the tax authority is not always the end of the story, or the indirect tax lifecycle. Businesses will need to retain certain mandated data and documentation for prescribed periods (which differ by country). It is likely that tax authorities will periodically look to audit a business or at least make enquiries. This may include requests for supporting data to substantiate the VAT/GST return that has been submitted, including details of VAT/GST registration numbers provided by business customers.
In the EU, digital service providers registered for the simplified One-Stop Shop (OSS) registration must be able to respond to requests from the member state of identification (i.e. the country where the OSS number was issued) on a timely basis and provide required records within a month of receiving a reminder. Any failure to do so is likely to be regarded as a persistent failure to comply with the rules of the streamlined and simplified scheme and will result in exclusion from OSS. This triggers a requirement to register in each EU member state individually and meet the full local VAT compliance obligations of each.
It is therefore recommended that digital service providers are on the front foot and take a proactive approach to being prepared for data requests and audits. One way businesses registered for OSS could prepare for this is by using the Standard Audit File for OSS (SAF-OSS) XML schema that has been designed by the European Commission to make the collation and provision of information to an EU tax authority easier.
It is not just national tax authorities that digital service providers need to be prepared for in relation to requests for information and audit defence. In fact, it could be said that the greater threat to a digital service provider is not from a tax authority but from a firm of tax accountants or lawyers undertaking a due diligence exercise on the business.
A due diligence is a systematic examination of a business ahead of a major business event such as a merger or acquisition, a capital raise, an initial public offering (IPO) or audit. It is common as part of a tax due diligence for digital services revenue to be requested split by the customer’s country and a request to prove that customers are business customers (with the relevant evidence held). Where the digital service provider is not registered in a country or is unable to substantiate that the customers are business customers, the accountant or lawyer may then simply multiply the revenue by the relevant VAT/GST rate, extrapolate the data by a set number of years, and even double the amount to account for possible penalties, interest, and remediation costs.
The result is usually a very worst-case assessment of a liability, but this is quantified and presented back in the due diligence report to the party that commissioned it (for example, a bank or the prospective buyer). This can then be used by the prospective purchaser to obtain a significant discount (equal to the liability) or require complex indemnities. In some cases it could also delay or prevent the transaction or fund raising event. Digital service businesses that are scaling fast and are likely to have an upcoming business funding or exit event in the future could opt to undertake their own due diligence, being proactive and assessing the quality of data held to substantiate its current tax policy and indirect tax footprint (nexus). The results should ensure that there are fewer surprises later down the line, as well as providing a clear roadmap of countries where the business should register for VAT/GST.
10. Digital service providers need to formulate a global VAT strategy
Supplying digital services can have challenging indirect tax implications for a business. By the very nature of the automated delivery of a digital service, it is not just a new customer and market that is only a click or download away, it could mean that a new VAT/GST registration is too. As a digital service provider starts selling to customers across the globe, it needs to put in place a proper global VAT operational compliance strategy across its systems, processes, people and data. This should include:
Strategy for monitoring foreign jurisdictions that levy VAT/GST on non-resident supplies of digital services.
Process to monitor revenue and sales data by jurisdiction and identify when a threshold has, or will shortly be, breached.
Scalable process to register for VAT/GST on timely basis and efficient manner, including leveraging a strategic partner and agent to assist.
Implement a compliant, consistent, and scalable global tax determination policy using a tax engine to automate the correct VAT calculation at the point of sale.
Leverage data validation rules and tax authority VAT number validation web-services to distinguish between B2B and B2C customers.
Automate preparation of VAT/GST returns through use of VAT reporting solutions or via a strategic partner and agent using tax technology.
Strategy and technology to meet increased global digital reporting requirements, including e-reporting of B2C data, e-invoicing, as well required enrichment of invoices with tax sensitive QR codes.
Please contact us to discuss how Avalara can assist with VAT/GST compliance for digital services across the globe - including registration and return preparation and submission, tax calculation, and e-invoicing.
You can also view Avalara’s Global VAT and GST on digital services tracker and watch our on-demand webinar with guest FinancialForce, to discuss how to overcome the operational challenges relating to VAT/GST on digital services business.
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