Small online merchants both within and outside of the European Union are feeling the pinch due to new value added tax (VAT) regulations which came into force on January 1st, 2015. The new rules could prove to be a significant road-block for start-ups and self-employed people selling any kind of digital products to customers in the EU. But is there any silver lining?
As of the new year, online merchants are required to pay the VAT on products sold based on the location of the customer, rather than the location of the merchant. This means that when a business in the UK makes a sale to a customer in France, the business will have to pay taxes on the sale to the government of France, rather than their own government.
The effects the rules could have on small businesses are wide and by most accounts potentially very harmful. Before getting into the effects, let’s take a look at the specifics of the new regulations:
- The new VAT regulations only apply to digital services such as ebooks, music or audio downloads, film or video, broadcasting services, online games and other non-physical products.
- VAT is not charged on business-to-business (B2B) sales.
- Merchants that sell digital products are required to record the location of every customer.
- Merchants are required to register for VAT in every EU country where they do business.
The regulations were ostensibly put into place to prevent large enterprises from tax-dodging by funnelling their profits though low-VAT countries. For example, the European operations of Amazon and iTunes are both based in Luxembourg, where the standard VAT rate is at 15%, the lowest in the EU.
Trying to prevent VAT evasion by big multinationals is an understandable goal for the European Commission on behalf of the high-tax EU member states, but it’s the way these regulations are applied across the board that will disproportionately affect small and medium-sized enterprises (SMEs). While the different taxation rates will have a relatively small effect on the bottom line of SMEs, the real harm comes from two things:
- The new rules ignore existing taxation thresholds.
In most of the 28 EU member states, businesses have been exempt from paying VAT on products sold if their annual turnover rate is below a certain threshold, i.e. £81,000 in the UK. Under the new regulations, any business selling digital products to a customer in an EU member state will lose their VAT exemption.
Even companies located outside of the EU are required to pay VAT on digital products sold to customers in the EU. For example, a US-based merchant would now have to register for VAT payments in each EU country they do business in.
- SMEs don’t have the resources in place to manage the new requirements.
Realistically, most small merchants would have little or no experience with international taxation since they had only been required to pay taxes to their own government. To charge VAT on a sale to an EU customer, the company needs to be registered for VAT in each of the 28 EU member states where it does business. Few SMEs would have the resources in place to navigate such a complex landscape.
More complex still is the need to collect and store personal information about the customer. This information falls under the data protection acts of each EU member state, and the new VAT regulation requires that businesses hold the data for 10 years – longer than businesses selling physical goods are required to do so. Storing that data for so long in the correct format requires the kinds of resources most SMEs simply don’t have.
Many small businesses manage their sales by outsourcing secure checkout duties to portals and marketplaces, which may not be prepared to take on the burden of VAT remittance on behalf of their customers (whether the portal is based in the EU or not). In reality, if a portal is based outside of the EU, the burden of VAT compliance will fall on the business owner based in the EU, and not on the marketplace.
A marketplace or portal that does not wish to move from being an intermediary to a retailer/reseller will not do so, because both the European Commission and individual member states lack the jurisdiction to compel those organizations based outside the EU’s territory to change their business model.
It’s enough to make a business owner think about incorporating their business outside the EU, if they don’t have that many EU customers!
How the New VAT Regulations Affect Your Business
Perhaps most worryingly, the added complexity to running a cross-border e-commerce business in Europe imposed by the new rules could stifle innovation. Start-ups and entrepreneurs may simply disappear – in fact, some already have.
But there is no need to be so pessimistic. Here are a few examples of how the market is already evolving to accommodate the new regulations:
- The EU has introduced VAT MOSS (Mini One-Stop Shop), a service which eliminates the requirement to register for VAT in each country, though merchants will need to supply two pieces of personally identifying information about each of their customers. While the effectiveness of VAT MOSS is yet to be seen, it’s notable that businesses are able to use the service for cross-border e-commerce only, thereby maintaining their VAT exemption for local sales.
- A new start-up called Taxamo has developed VAT management technologies for e-commerce businesses, including a plug-in for businesses using DalPay-supported shopping carts from WooCommerce.
- Bandcamp, a platform for music sales that caters primarily to independent artists, has announced that they will register for, charge and pay the VAT for their users. This is a model that could potentially be followed by similar platforms such at Etsy and Steam.
On the one hand, entrepreneurs, early-stage start-ups and self-employed people are facing a roadblock that makes it difficult for them to rationalise making cross-border sales within the EU. On the other hand, the new regulations are inspiring new technologies and services which take the tax burden off of the merchant.
Time will tell how the new rules will effect the e-commerce industry within and outside of the EU, but you can rest assured that we’ll be keeping a close eye on how the market develops. Subscribe to the DalPay Blog and follow us on Facebook and Twitter for the latest news and industry insights about e-commerce around the world.