Do you sell digital products to customers in the EU?
If so, you might have to take drastic action by 1 January 2015.
This is the case even if you and your business is based outside the EU (European Union).
Here is a list of example ‘digital services’ that are and are not covered by the new rules:
What’s happening & why should I care?
The bottom-line is that from January 1st, you will be responsible for accounting for VAT based on the location of your customer rather than where your business is based – subject to certain conditions which we’ll get to in a moment.
VAT (Value Added Tax) is a form of consumption tax: for the buyer it is a tax on the purchase price, and for the seller it is a tax on the value added.
The rules are defined by the European Union (EU) VAT Directive and have supposedly been communicated to all concerned since 2008. I say supposedly because no-one I’ve spoken to including accountants, business owners and payment providers seems to had heard about them until a few weeks ago!
All of a sudden there’s now an almighty panic brewing all over the web as thousands of entrepreneurs, sole-traders, micro & small businesses, musicians, authors and educators all over the world are waking up to the fact that this is serious and there is no obvious or clear way forward other than to stop selling digital products!
What’s behind these new rules?
The motivation is to ensure that corporate marketplaces and digital distribution platforms like Amazon, Apple App Store & Google Play collect VAT on a more equitable basis for digital products sold to EU consumers.
Under the current system where sellers and platforms pay VAT according to where they are based for tax purposes, they are incentivised to base themselves in the EU country with the lowest VAT rate, e.g. Amazon operates its European business from Luxembourg because at 3% it has one of the lowest VAT rates in the EU.
Do I have to comply?
You will have to comply if:
- You sell electronically supplied digital products: when they’re delivered largely without human intervention.
- to ‘consumers’: in practise a consumer is either an individual or a non-VAT registered business
- from anywhere in the world: inside or outside the EU
- whether or not you are currently VAT-registered in your ‘home’ country or tax district
- even if your revenues below the current VAT tax threshold: even if you only make £1 all year
Note: Selling a digital product to a VAT-registered EU business does not come under these rules.
For details of what qualifies as a digital product (or service as the EU define them), and how they are delivered, see EU VAT Directive, the UK’s HMRC guidance (as of 19 December 2014) or ask your accountant.
How do I comply?
In summary, unless you switch to selling all of your digital products over a qualifying (see below) marketplace then you are about to become legally responsible for:
- Registering for VAT either a) with each of the 28 EU member states, or b) with a single tax authority in your home country where they account for all of the EU VAT via their MOSS (Mini One Stop Shop) service, or c) if you’re based outside the EU you can register with the MOSS service of any member state.
- Determining whether your customer for each transaction is VAT-registered or not. The rest only applies if they are not.
- Establishing a customer location for each transaction, supported by at least 2 pieces of non-contradictory evidence for the location, e.g. billing address, IP address, bank details.
- Storing the above evidence securely for 10 years from 31 December of the year following the date of each transaction.
- Calculating and collecting the applicable VAT amount according to the customer location for each transaction.
- Making quarterly VAT tax submissions to up to 28 relevant tax authorities: this is where MOSS can help.
Check out this One Stop Shop for all the hard facts over at EU VAT Action.
Note: A recent concession by HMRC (the UK tax authority) has confirmed that registering for VAT for MOSS for sales elsewhere in the EU does not mean you have to charge UK VAT on UK sales: assuming you’re beneath the UK VAT threshold.
What happens if I don’t comply?
You could be penalised by any of the 28 EU member countries that you sell into or out of.
And don’t forget this applies even if you (as a provider of digital services / products) are based in the US, Australia or Timbuktu – anywhere in the world.
Non-EU businesses have apparently been subject to these rules for several years but in practise have ignored them, or more likely didn’t even know about them. But… the indications are that the EU is going to start playing hard-ball from January 1st, and so watch out. Again, please take professional advise.
Problems & unintended consequences
These rules are so fundamentally flawed in so many ways, it’s hard to know where to start…
First off, I agree with Tim Gray that it’s clear they have been drafted by people who do not understand the internet in general, nor the nature of online business in particular.
Online business works best in an environment that is flexible, fluid, friction-free, low cost and borderless. The EU VAT rules work against all of them. I’ve grouped the issues into areas which I’ll take one by one…
The EU Commission assumed that everyone is selling digital products exclusively through 3rd party online platforms or marketplaces like Amazon or Google.
A quantitative study by EU VAT Action found that only 40% of affected UK businesses sell through 3rd party platforms, and just 5% across the rest of the EU. What’s more, most of these platforms will be unable to comply by January 1st.
Lesson: Assumptions should have been tested before publishing the rules.
Lack of communication
Sellers, accountants, payment providers and platforms: very few of them seem to have been aware of these rules before last month, i.e. 8 weeks before the deadline.
As a result there has simply been too little time or scope to spread awareness, foster understanding, make improvements, implement & test changes to systems and procedures.
Lesson: Tax authorities need to do a better job of communicating critical changes to all the people who may be affected. In this case everyone registered as self-employed, directors of companies even if they are not VAT registered and all accountants. Accountants perhaps need to do a better job of proactively explaining to clients what changes are coming-up and how to comply.
I’m seeing hundreds of examples of specific implementation uncertainties, issues and risks being discovered and discussed daily on blogs like this and this, on Facebook groups & pages, and over Twitter (#EUVAT, #VATMOSS, #VATMESS).
Some of the issues I’ve seen discussed with no resolution in sight:
- Exactly what qualifies as an electronically supplied service with ‘minimal or no human intervention’? Even if one member state clarifies your particular case, what happens if another member state disagrees?
- Proving where your customer is located is complicated and impractical in many cases for most small businesses. [Update: 29 December 2014. UK’s HMRC has conceded that UK companies selling to EU customers to rely on the available country evidence provided by PayPal and other payment processors until 30 June 2015.]
- Very few payments systems are set up to capture the right location data and thereby calculate the right VAT amount. Many I’ve been tracking are saying they’re working on it and hope to have something ready for the 1st January deadline. This is not going to give sellers anywhere near enough time to implement and test those systems on time. For example, WooCommerce announced a potential solution just yesterday but there are all kinds of unanswered objections in the comments to the announcement. PayPal only provides one type of evidence for country location which is not enough, even then it’s too late in the payment cycle and doesn’t cater for a bundle of products needing to attract different VAT rates.
- When can and should you display the price inclusive of the ‘real-time’ VAT: before or during checkout? If ‘before’ is required then how practical is that?
- What data exactly needs to be stored for 10 years? Does it need to be on servers in the EU or servers covered by the safe-labour laws? Does is need to be encrypted? If so, to what level? What are the privacy implications of thousands of sole-traders, & micro-businesses each storing personal data on thousands of customers for 10 years+ on random PCs or servers? Does the supplying business need to register as a data controller?
- What if a customer is on holiday in the EU when they buy?
- What if a customer is using a VPN connection and/or lies about which country they’re in?
- What if the transaction is in Bitcoin?
Lesson: The tax authorities really ought to have thought this whole thing through more carefully and reduced the scope for unintended consequences. If they had floated the initial proposals among those who are going to be affected (e.g. business owners, accountants, payment providers, platforms) and positively sought their input then perhaps we’d have avoided the pain and panic we’re now going through, as well as the devastation around the corner.
Many of the issues I’ve seen stem from the fact that these rules will have to be enforced by 28 different tax authorities simultaneously. Not only will they be dealing with merchants (sellers) from these 28 states within the EU but from potentially any country anywhere in the world.
An example, is what qualifies as an exempt digital service by one authority (even in writing) may not qualify by another. This example I saw on a Facebook Group post was apparently confirmed by HMRC as being exempt:
“Online membership site with pre-recorded videos + downloadable PDFs along with a closed Facebook group with live tutoring – I described this as personally responding to individual questions + posting prompts in the group as well as allowing my users to email me for help. I also provide periodic live webinars.”
Lesson: As for implementation, this stems from the whole thing just not having been thought through and syndicated with those concerned.
It’s clear to me that this whole EU VAT thing is a ginormous toxic mess that threatens the livelihoods and prospects of thousands of honest, hard-working, small business owners, freelancers, entrepreneurs, artists, musicians and people trying to supplement their incomes or pensions.
It also has the effect of dampening entrepreneurial spirit by closing down opportunities, innovative business models and reducing the prospects for businesses to create more value in national and international economies and create more employment.
The only beneficiaries are entrenched corporations.
Lesson: Again, not thought through and syndicated with those concerned.
The global market for digital products is already showing signs of distortion. For example, according to this Gigaom article on 3rd December, Google have rolled out a new Helpouts platform for experts to offer paid advice to clients but their T&C’s expressly tells users: “Providers from Ireland or the United Kingdom many only offer free Helpouts. Customers from the EU may only take free Helpouts.” This is a disturbing unintended consequence that I really hope, but suspect could be, the thin end of the wedge.
It could well be that many non-EU digital service / product providers simply stop selling to customers in EU because they just see it as too risky. Many US providers are small themselves but serve thousands of other small businesses. In many cases they get only get a small percentage of their revenue from EU customers and so this would not be a big deal to them. It could however be a disaster to many startups and small businesses in the EU that rely on affordable Software-as-a-Service, eCourses and membership sites for everything from building websites to business learning to stay up-to-date with the fast moving online business world.
At the very least, the cost of digital services and products are going to go up by anything up to 20% or so depending on where the customer is. This is because the VAT rate of the customer say in the UK is 20% compared to the 3% in Luxembourg, or 0% for non-EU supplying companies that simply didn’t used to comply at all. Bottom-line again is that EU startups and small businesses are going to face increased costs.
Lesson: Not thought through again.
What do I do now?
Pretend it’s not happening, do nothing & hope it all goes away
Probably the worst option. Unfortunately, I suspect many will end up doing nothing by default because they just don’t know what they don’t know! Others will, understandably, be paralysed by just not knowing what to do.
There is a small chance this might partially not happen: though I suspect the best case is we might get a bit more time. But we can’t afford to hold our breath and we certainly can’t rely on that.
Upside: You may have a marginally more, albeit artificially, relaxed Christmas.
Downside: The cost of getting caught are potentially devastating.
Sell through a third-party platform
The rules state this is OK so long as your chosen platform handles payment and supply as well as their standard T&C’s confirm they are responsible for VAT.
Many of them appear to have only learned of what they need to do in the last few weeks and are scrambling to comply.
Another issue is that HMRC appear to believe that 3rd party payment providers that “authorize delivery” of your digital product is liable for VAT and not the seller. This needs clearing up ASAP if we’re not to see a whole slew of low cost Software-as-a-Service solutions for micro and small business EU businesses simply walking away from EU small businesses.
Last night, just 5 days before the deadline, Etsy declared that they so not see themselves as being responsible for dealing with VAT for sellers. This would appear to contradict HMRCs guidance that marketplaces will be responsible for handling VAT so let’s see how this one plays out.
Better news is that Payhip now claim to be able to fully handle VAT for selling ebooks and other digital products.
[Update: 29 December 2014] Shopify have released their guidance for selling digital goods over their platform from 1st January.
[Update: 31 December 2014] Bandcamp have announced at the 11th hour that they will take care of EU VAT for musicians.
Upside: Potentially the least work and least risk but…
- Don’t blindly assume they will take care of everything for you or that they will shoulder all the risk.
- Don’t forget to factor in platform fees that will cut into your profits.
- Most won’t be able to comply on time.
- Perhaps the biggest downside is that you could lose the relationship with your own customers, for example, going through Amazon means they own the relationship with your customers rather than you. This means you lose the chance to communicate with them, build a relationship with them, spread your message, up-sell and cross-sell to them.
Get your own act together
Unless you know you’ll only be dealing with one or two specific member states then you’ll almost certainly will find it easier to hook up with the relevant MOSS. At least that should in theory help with VAT reporting to anything up to the 28 separate tax authorities.
As for the rest: identify or get help to figure out how to comply with all the other steps as outlined above and as fully defined by the EU VAT Directive, and by your local tax authority: start here. And of course you should always take professional advice.
The challenge is that even if your professional advisor is fully up-to-speed on the rule requirements they probably won’t be able to help on how to comply from a logistical and technical standpoint. Why should they?
- Get your hands dirty. Depending on what sort of products you sell and how technically competent you are there are a number of options. Easiest: hook-up with a 3rd party digital distribution platform like Selz or SendOwl that claim to be EU VAT-ready – but you’ll still have to register for VAT and report via a MOSS system. Harder: there are a number of WordPress plugins that can also help, e.g. here’s a 3rd party plugin to make Easy Digital Downloads digital sales compliant, and WooCommerce claim to have a solution. Hardest: check out taxamo. They claim to have integrated their solution with shopping carts and payment systems such as WooCommerce, Magento, Prestashop, PayPal, Braintree and Stripe.
- Find someone technical who understands the rules, who can quickly appreciate what you’re trying to do, and can help you implement the rules. [BuzzIndie takes the hassle out of getting digital products into the world for independent small businesses via a Website-as-a-service so you can focus on doing what you do best.]
- Workarounds. If the above options don’t work for you then get your thinking cap on and come up with creative ways to re-jig what services/products you offer and how you deliver them so that they become exempt. But… at minimum get your accountant’s advice, and your local tax authority to confirm exemption in writing. A simple example is to manually email a PDF to a customer instead of making it automatically downloadable. (I can’t believe I’m writing this. It’s like the world’s going backwards!)
- You retain a direct relationship with your own customers. This means you can continue to communicate with them, deepen that relationship, spread your message, up-sell and cross-sell more business.
- You’ll won’t lose profits to 3rd-party platforms.
Downside: There’s so little time. It could get expensive, though the alternatives of throwing in the towel or non-compliance could be way more expensive.
Give up & get a job
This would be so sad… please try very hard not to do this.
If however you have a very low level of sales then it may make sense to temporarily halt affected services / products (at least to EU customers) and think of alternative ‘hands-on’ and therefore exempt alternatives from the rules. Meanwhile, wait and see what happens over the coming weeks, and months and play by ear.
Upside: Suspending digital sales for a while may make sense for some, while they see how things shake out.
Downside: Many others I fear will see this whole issue as terrifyingly complex and / or too costly to bear. They will as a result throw in the towel, dashing their dreams of making a living from doing what they love, or building a business they’ve been dreaming of, and benefitting their families, employees and society at large in the process.
The tragic irony is that the only winners are set to be the same giant corporations whose power the rules were drafted to tackle in the first place.
The EU is already working on extending these rules to physical goods from 2016. If they go ahead in their current form for digital services then the door is open for even more widespread snuffing out of small business and a complete carte blanche for the Amazons of the world.
A suggestion to the EU Commission for minimising the impact: set an EU-wide minimum turnover threshold, below which the rules do not apply.
I urge anyone who is affected by this insidious mess to take proactive action as suggested over at EU VAT ACTION before it’s too late. As I write this, there is very little time.
On a positive note, a recent update from EU VAT ACTION describes how the UK tax authority seem to have got the message, as have certain EU officials and that talks are happening behind the scenes that could result in some kind of concession very soon. We shall see…
Disclaimer: I am not an accountant nor a tax lawyer, and I am not responsible for the accuracy of any of this. I’m merely trying to figure it what on earth I need to do my own business and to help others who are trying make an honest living over the internet.
What are you going to do?
Photo credit: By marco18678