This global pandemic’s ever-increasing cost to governments; an acceleration of laws to fix archaic tax systems that have failed to keep pace with the evolution of the digital economy; new shocks to the global economy (e.g. Brexit), and the ongoing issue of VAT fraud, resulting in billions of lost annual revenue, have combined to create the perfect storm of tax compliance obligations.
According to recent projections global cross-border sales are booming and will exceed $4.9 trillion by 2021. As these sales continue to rocket, there will be a rigorous application of existing rules with a particular focus on these online sales. The feeling among tax authorities and the public is that large online sellers have benefited the most from the COVID-19 crisis. One such example is a French development where 120 influential figures penned an open letter to the government calling from an exceptional tax on such companies.
As a means to increase revenue and finance subsidies (e.g. furlough schemes), tax authorities are ramping up efforts to review levels of compliance from digital companies. One of the main targets of this review are business-to-business (B2B) digital companies.
In the past, a B2B digital company with global sales would be under the impression that it had fewer VAT obligations to meet as the VAT would, generally, be accounted for via the reverse charge by its business clients.
This impression is far from reality. Today, these companies are likely going to be the specific targets of new legislation and increased audits. Why? Well, with the aforementioned need to generate more revenue to cover for the impact of the pandemic on government accounts, the authorities perceive such companies to have benefited financially from the crisis.
So - what are the rules, what is currently happening, and what have we seen?
Let’s start with the basics: U.S. sales tax is a final cost for end users (consumers or business customers) while VAT/GST is neutral for business customers. Companies can recover the VAT/GST charged to them.
The taxation of B2B supplies is merely a means of achieving the taxation of final consumption through the staged collection process.
To reduce fraud, and so as not to create an unnecessary burden on foreign suppliers and tax authorities, a 2017 OECD report on mechanisms for the effective collection of VAT/GST recognises that there is an alternative collection mechanism. Specifically, this is the reverse charge mechanism that generally works more effectively in a B2B context. Another option is supplier collection when the supplier is not located in the jurisdiction of taxation.
The reverse charge mechanism allows the foreign supplier to exempt sales to local business customers who then self-account for the VAT/GST (via reverse charge).
Such recommendations have been followed to the letter by many tax jurisdictions. They also create a challenge to determine whether customers are a business or a private consumer for VAT/GST purposes. It can also create opportunities for fraud if a private consumer or an unregistered business falsely claims it is a registered business that will account for the tax under the reverse charge mechanism.
What’s interesting is that this exemption is generally not based on the type of service provided but on the status of the customer. It means that services can be targeted at companies but the foreign seller needs to prove the VAT/GST registered status of its customer. A customer can indeed be a business or a company without being VAT/GST registered while an individual can be VAT registered.
Each country has its approach to validate the status of a customer. However, they all include as a minimum to save the VAT/GST number provided by a customer. This requirement can have a significant impact on the subscription model. When a new country introduces legislation, affected companies need to contact their customers to collect VAT/GST registration numbers. This request for additional information brings with it a risk of losing dormant customers. For this reason, it is recommended to add a VAT/GST number request of the customer as a default setting on checkout forms, even for countries that have yet to introduce such legislation. This additional request will not disturb the customer journey. Customers are now familiar with this request as major regions/markets have already introduced such legislation.
While the request and collection of VAT/GST numbers are minimum requirements, additional checks need to be added.
In the European Union (EU), for example, VAT numbers need to be validated in real-time against the EU’s VAT Information Exchange System (VIES). However, VIES can be unavailable or not online and return a number as valid when it is not.
In India, companies need to validate the number in real-time against a database that is accessible only with an Indian IP address. A CAPTCHA test must also be solved in real-time which, at least in theory, requires human intervention. In practice, this may cause a delay in the conclusion of a transaction raising the risk of a sale not being completed.
In other countries such as Taiwan, Turkey, Chile and Singapore it is acceptable to not validate numbers in real-time but to ask for a confirmation during the check-out process that VAT/GST will be accounted for by the customer.
Some countries do have a database available for validation, but actual validation of numbers is not mandatory. This situation exists, for example, in Australia where the Australian Taxation Office (ATO) expects the supplier to take reasonable steps such as using its ABN Lookup web service but does not specifically prescribe its use. It is for the supplier to decide what reasonable steps may entail and will withstand an audit by the tax authorities.
A syntax check of the VAT/GST registration number presented may be regarded as an extra layer of security to pass the reasonable steps test. However, complexities around the allocation of tax registration numbers in some jurisdictions can mean such solutions are not so straightforward.
Companies will also have to keep in mind that the validation of the VAT/GST number should not only be confirmed during the registration of a new customer but every time a customer renews a subscription.
We have seen far more questions during the audit process. In Europe, for example in the Netherlands, if a number is not validated at the time a company’s European Sales List (ESL) is filed they may have an automatic request for additional VAT. This request is possible even if the invalid number is a result of a late update of the VIES system occurring between the time of checkout and the filing of the ESL.
In Taiwan, the audit is based on total sales as provided by the financial institution to the tax authorities. The companies will have to demonstrate that the difference between VAT collected and remitted toward the total amount of sale is due to the exemption of B2B sales.
In Singapore, auditors queried why the numbers were not validated against the Singapore database even though this action is not a requirement and, further complicating matters for real-time sales, it involves solving a CAPTCHA test. Interestingly, syntax checks performed by digital companies were still not enough as the tax authorities were still able to identify invalid numbers.
We have also seen a different approach taken that is to remove this exemption and the obligation of the reverse charge. This trend occurred in Russia first who amended in 2019 its legislation to increase the scope to B2B sales. The changed approach had a direct impact on registrations which increased exponentially in the few months following the change of legislation. We have also seen Russian business customers acting as a kind of auditor by requesting their foreign supplier to register and charge VAT.
In 2020, three major countries that introduced new pieces of legislation – Malaysia, Mexico and Indonesia – introduced the rules for B2C and B2B sales without distinction. One of the first companies targeted by the Indonesian government is Zoom. Zoom targets its offering predominantly at companies and it, of course, benefited significantly from the pandemic. Such an approach may be seen as a simplification for an audit.
These are recent examples, but the targeting of B2B transactions was already visible in other countries such as Switzerland, South Africa or Serbia.
We will track if this is going to be a continuing trend and we already know that it will be the approach in British Columbia from April 2021 as it is a sales tax.
One final consideration would be this: we are in extraordinary times with national lockdowns in the times of COVID and the inevitable economic consequences which will require governments all over the world to find substantial sources of money and a quick and reliable way of tapping into these. Not only will this probably mean the faster introduction of general VAT/GST legislation but also probably more focus on B2B transactions rather than just B2C.
This quest for revenue will lead to review the correct application of the relevant rules when auditing taxpayers in order to reduce the VAT Gap and combat fraud. Another worry is that this rush to introduce legislation may also lead to compliance complexities for businesses as countries do not cooperate with each other leading to a series of unilateral moves.
The information contained in this publication (“Information”) has been provided to you for general information purposes only and we recommend that you obtain professional advice before acting or refraining from action as a result of the Information. Taxamo accepts no liability for any loss occasioned to any person acting or refraining from action as a result of the Information.
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