The VAT treatment of e-commerce in the EU

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The European Union (EU) is an economic and political union560 consisting of 27 Member States561which originated from the European Coal and Steel Community (established in 1951),562 and the European Economic Community (established in 1958).563 The EU has established a single market through the standardisation of laws that apply to all Member States. EU policies are aimed at the free movement of people, goods, services, and capital between Member States.564 Harmonised trade rules and the use of a single currency (the Euro) in Euro-zone countries ensure regular and virtually trouble free cross-border trade between Member States.565 However, the EU VAT model is seriously underminded by numerous exemptions and derogations of all sorts.
The EU offers a favourable environment for the proliferation of e-commerce. In this Chapter, I examine the VAT treatment of e-commerce by the harmonised consumption tax policies applied in the EU. Since VAT as a consumption tax originated in Europe, I consider it necessary to discuss the history of VAT in the EU. The purpose of this historical discussion is to highlight the issues associated with the taxation of e-commerce, and further indicate how EU harmonised consumption tax rules have developed to address or circumvent these issues. In this discussion I focus on finding possible solutions in the EU VAT rules that can be applied to the current issues faced under the South African VAT Act566 as discussed in Chapter 3.

The history of VAT in Europe

VAT is a relatively modern tax that originated in the early twentieth century. Before VAT was introduced, indirect taxes were limited to certain products like excise on tobacco and alcohol.567 In addition to these taxes, very few countries also levied sales tax or turnover taxes.568 Most sources differ on the exact year in which VAT was introduced for the first time in the world. The basic idea of a VAT system can be attributed to two sources:569 the writings of the German businessman Wilhelm von Siemens in 1918,570 and the writings of the American economist Thomas S Adams from 1910-1921.571 Von Siemens’s technical innovation brought improvements to turnover taxes that can today be regarded as some of the key ideas of VAT.572 As VAT allows for the recovery of taxes on business inputs, it eliminates the cascading problems created by turnover taxes.573 In Adams’s case there was no national sales tax to improve and, unlike von Siemens’s technical innovation, he was interested in a major alteration of the federal tax system.574
Germany and the rest of Europe saw VAT as a technical alternative to sales tax which ultimately led to the current widespread implementation of VAT in Europe.575 By contrast, in the USA VAT has never been introduced, mainly because policy makers wished to introduce VAT as a substitute for federal income tax.576 It is interesting to note that the USA, in later years, assisted many developing countries to adopt a VAT system but failed to adopt a VAT system itself.577 VAT was first introduced in France in 1948 with limited scope and application.578 The tax system was converted to a consumption-type VAT system in 1958.579 It was not until 1968 that France would implement VAT on a broader spectrum of transactions.580 In 1967, Denmark was the first European country to introduce a thoroughbred VAT system, although it was not a Member State of the then European Community.581 Denmark became a member of the European Community in 1973.582 After Denmark, many European countries followed by each introducing its own version of VAT systems.583 The spread of VAT in Europe can, in the main, be attributed to the European Union Council Directives584 and the harmonisation of VAT rules.585 In 1960 the EEC Treaty tasked the EEC Commission to consider the implementation of a harmonised consumption tax for Europe.586 The Commission’s report highlighted the cascading effect of turnover taxes and the limiting effect this has on cross-border trade in a single market.587 As a result, the EEC adopted the First Council Directive588 instructing Member States to replace their existing turnover taxes with a common VAT system based on the consumption of goods and services, by no later than 1 January 1970.589 The Third,590 Fourth,591 and Fifth592 Directives repeatedly extended the January 1970 deadline.593
The First and Second594 Directives permitted Member States so wide ranging a discretion, that nine separate and different systems of national laws existed by 1973.595 National rules in Member States differed dramatically as to when and where services were deemed to be performed, whether a supply was deemed to be a supply of goods or services, and whether a supply was exported or imported.596
As a result, the Sixth Directive597 was adopted further to harmonise the different national laws.598 The new rules introduced by the Sixth Directive cover the areas where national laws dramatically differed on territorial application, taxable transactions, place of supply, rates and exemptions, deductions, persons liable to collect or pay VAT, and vendor registration.599
When the ySixth Directive was implemented, e-commerce was unheard of and the rules were designed to fit the retail trends common to that era.600 With the advent of e-commerce, many non-EU suppliers were able to circumvent the application of VAT on supplies made in the EU, placing these suppliers at an advantage over EU vendors whose supplies were subject to VAT in Member States.601 It was feared that consumption patterns would be distorted which would further induce EU vendors to establish their e-commerce enterprises in VAT-free countries to retain their market share.602 This forced the EU to review and amend the VAT legislative base to take account of greater international collaboration.603 In collaboration with the OECD, the EU adopted a set of guidelines in 1998 and the first true attempt to finalise a solution was published in the Proposal for a Council Directive amending Directive 77/388/EEC as regards the value added tax arrangements applicable to certain services supplied by electronic mean.604 This proposal was not well supported and was replaced by the proposal of 7 May 2002 which contained many of the basic objectives of the June 2000 proposal.605
The first amendment to the Sixth Directive to provide for the taxation of cross-border e-commerce transactions, and to eliminate the competitive disadvantages created by the Sixth Directive, came in the form of Council Directive 2002/38/EC606adopted on 7 May 2002. This was followed by Council Directive 2006/58/EC,607 Council Directive 2006/138/EC,608 Council Directive 2006/112/EC,609 and Council Directive 2008/8/EC.610
Member States are obliged to follow EC law and ensure that harmonised rules are correctly applied on a national level.611 Despite a harmonised tax base, differences in national VAT legislation exist between Member States in respect of rates and exemptions.612 To determine the exact tax treatment of the supply of digital products in a particular jurisdiction, several questions need to be answered:

  • Is there a supply of goods or services?
  • Where is the supply made?
  • When is the supply made?
  • What is the value of the supply?
  • Is it made by a taxable entity?
  • Is it made in the course or furtherance of an enterprise?
  • Is the supply taxable?
  • How is VAT on the transaction collected?

The VAT treatment of e-commerce in the EU

Is there a supply of goods or services?

Where tangible goods are ordered electronically by private consumers, and where these goods are delivered by traditional means, existing rules in respect of distance selling (telephone or postal orders) apply.613 There are well-established channels in the Sixth Directive to tax these transactions adequately. However, problems occur when intangible goods are ordered and delivered electronically.
Uncertainty with regard to the classification of supplies causes difficulties for the supplier who is required to levy and account for VAT on cross-border digital transactions.614 It is likely to increase the administrative burden on suppliers and may have an adverse economic effect on these companies.615 Ideally, suppliers should be able to classify supplies without difficulty to ensure smooth and fast cross-border trade.
Article 5(1) of the Sixth Directive defines the supply of goods as “the transfer of the right to dispose of tangible property as the owner”. Electricity, gas, heat, refrigeration, and the like are regarded as tangible property.616
As a result of the intangible nature of digital supplies, they cannot be classified as goods. It has, however, been argued that digital supplies require some form of electrical current, and could accordingly be classified as goods if a strict textual interpretation of the definition of “goods” is applied.617 This argument should not be accepted.618 Electricity is traditionally classified as goods because authorities have greater control over its supply, unlike electronic deliveries.619
Article 6 of Sixth Directive defines the supply of services as “any transaction which does not constitute a supply of goods within the meaning of Article 5”. Similar to the meaning of services under the South African VAT Act,620 the meaning of services envisaged in the Sixth Directive allows for a wide scope of application. Digital products should, therefore, by default, be classified as services. On 17 June 1998, the European Commission issued a set of guidelines in terms of which the EU policy on indirect taxes on e-commerce is set out.621 In terms of these guidelines, it is a policy of the EU to consider “products ordered and delivered on networks” as services.622 This means that all types of electronic transmission and all types of intangible product delivered by electronic transmission, are deemed to be services for EU VAT purposes.623
In contrast to the South African position, the taxation of the supply of goods and that of services differ in EU Member States. As e-commerce is a global phenomenon, Van der Merwe’s question whether a differentiation between goods and services is at all necessary in jurisdictions where goods and services are taxed at a single rate, becomes irrelevant.624 While a differentiation could be obsolete on a national level, trade with jurisdictions where differentiation is actively applied could cause market distortions.625 Jurisdictions acting in isolation cannot resolve all the issues raised by e-commerce. As a result, a uniform global approach should be followed in the classification of digital products.
Article 1(a) of Council Directive 2002/38/EC,626 amended Article 9(2)(e) of the Sixth Directive to provide for the inclusion of electronically supplied services in the definition of services. In addition, Annexure L to Council Directive 2002/38/EC, lists types of transaction that would be deemed to be electronically supplied services. It should be noted that transactions covered by the provision governing “electronically supplied services”, are not restricted to the services listed in Annexure L. These services are the:

  • website supply, web-hosting, distance maintenance of programmes and equipment;627
  • supply and updating of software;628
  • supply of images, text, and information, and making databases available;629
  • supply of music, films, and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific, and entertainment broadcasts and events;630
  • supply of distance teaching.631

This list is incorporated in the re-cast version of the EU VAT Directives under Annex of Council Directive 2006/112/EC, and its later amendment by Council Directive 2008/8/EC. The guidelines further defining the items in the list as envisaged by Annexure 1 of the Council Regulation of 17 October 2005, are re-cast in Annexure I of Council Implemented Regulations (EU) no 282/2011.
The mere fact that the supplier and the recipient communicated by electronic means, does not mean that the transactions or the goods will be regarded as electronically supplied services.632 However, where the supplier has created a portal providing relevant information to its clients at a subscription fee, the services would qualify as electronically supplied services.633
As a result of the evolving nature of e-commerce and technology, electronically supplied services should, at best, not be defined to result in a restrictive meaning or a meaning that would result in limited application.634 It is trite that technological changes are far more advanced and frequent than legislative amendments. It often happens that by the time legislative amendments have been incorporated, technology has already advanced to render the amendments obsolete.635 Save for the types of supply listed in Annexure L, Council Directive 2002/38/EC does not provide a general definition of what constitute electronically supplied services.636 In reiterating that electronically supplied services are not limited to the services listed in Annexure L, the Council Regulation of 17 October 2005637 provides for a general definition of electronically supplied services. Article 11 of the Council Regulation of 17 October 2005, defines electronically supplied services as:
…services which are delivered over the Internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and in the absence of information technology is impossible to ensure.
A definition in these general terms can be applied to cover all types of electronically supplied service, irrespective of the type of service and the technological delivery method used. It would be difficult to circumvent the application of article 9(2)(e) under the general definition. To further eliminate possible circumvention, the words “Indicative list” were added to the heading of the list in Annexure II by Council Directive 2008/8/EC and have applied since 1 January 2010.
The tax consequence of electronically supplied services differs from that of other services.638 It is therefore not sufficient (when dealing with customers in the EU) to classify digital products as “services” based on a blanket classification method. The specific digital product should further be classified to determine if it is taxable under the provisions governing electronically supplied services, or any other provision.639 A general broad definition of electronically supplied services could complicate the classification by vendors. The Council Regulation of 17 October 2005 provides for a list of services that would qualify as electronically supplied services,640 and a list of services that would not qualify as such.641 Rendahl opines that these guidelines, despite their extensive nature, are already obsolete in certain cases, and cannot be applied to correctly classify the type of service rendered.642 As a result of the dynamic evolution of the Internet and e-commerce, many transactions that should in principle be taxed, escape the application of VAT as a direct consequence of the unsatisfactory list of electronically supplied services.643 In the case of combined or bundled services, the general definition of electronically supplied services is inadequate to classify the type of services correctly. Furthermore, where the specific service is not provided for by specific inclusions, different views and applications of the classification between Member States can develop.644 This can best be explained by way of example.
Example 4.1: X plays a trial online video game in which X creates a character that has to complete a quest in a modern city. As part of the graphics, streets are lined with billboards with real-life advertisements. Any player can click on the advertisement to be linked to the advertiser’s webpage. X purchases the executive gaming package which allows him to play all the online levels which includes free advertising space for 10 virtual billboards per level.
In this case the supply of the online gaming facility can be classified as electronically supplied services.645 However, it is uncertain whether the sale of advertising space amounts to electronically supplied services,646 or if it is specifically excluded from the definition of electronically supplied services.647 Where the game itself is not hosted on a webpage but requires an Internet connection to be played, it could be argued that the advertising space falls under article 12(6), and should not be classified as electronically supplied services. Where the game is played by logging into a website, the advertising space falls under item 3(h) of Annex I and should be classified as electronically supplied services. Despite the difference in the distribution method, where the fundamental nature of the product is the same, the online and offline versions should be taxed the same.648 This is currently not the case in Member States. Rendahl points out that the immediate difference between advertising services and pop-ups or banners, lies in the fact that the latter is the provision of advertising space as oppose to the supply of advertising services.649 Even so, the difference cannot easily be determined and each case must be evaluated in its own right.650
Businesses, tax authorities and courts stand before rules that allow for multifarious interpretation and application. For example, traditional services rendered by attorneys and accountants are excluded from electronically supplied services because of the human intervention required to provide these services. Where technology, such as automated responses or self-help calculators, is applied, these traditional services require minimal human intervention and could be classified as electronically supplied services under the general definition.651 Suppliers could effectively be taxed differently depending on the interpretation in the jurisdiction of supply.652 In the example provided by Rendahl, she points out that the supply of generic building plans, which require minimum human intervention and which do not relate to specific immovable property, can be classified as either services related to immovable property,653 or as electronically supplied services.654 This results in alternating place-of-supply rules. Currently, suppliers are obliged to familiarise themselves with national rules and to develop and apply software that determines the jurisdiction of supply. This allows them to tax the supply correctly at the applicable rate. There is a clear risk of double taxation or failure to tax if supplies are taxed differently on the basis of differing applications in Member States.655 Until 31 December 2014, in the case of supplies between EU suppliers and EU customers located in different Member States, the supplier has only to establish the VAT treatment of the supply in the country of origin.656 From 1 January 2015 when the destination principle will apply to these transactions, the supplier will have to establish the VAT treatment of the supply in 28657 different Member States.658

List of abbreviations
1.1 Introduction
1.2 Purpose of the study.
1.3 Research question(s)
1.4 Methodology
1.5 Limitations
1.6 Organisation of the study
1.7 Conceptualisation
1.8 Conclusion
2.1 Introduction
2.2 A brief history on the introduction of the Internet
2.3 What is digital technology?
2.4 The impact of the Internet on society
2.5 The future of e-commerce
2.6 Impact of cross-border digital trade on VAT collection
2.7 Conclusion
3.1 Introduction
3.2 The history of VAT in South Africa
3.3 The basic design of a VAT system
3.4 The rise of e-commerce and the South African VAT system
3.5 Conclusion
4.1 Introduction
4.2 The history of VAT in Europe
4.3 The VAT treatment of e-commerce in the EU
4.4 Conclusion
5.1 Introduction
5.2 The history of the OECD
5.3 The OECD proposals on consumption taxes on cross-border e-commerce
5.4 Conclusion
6.1 Introduction
6.2 VAT collection by financial institutions: How does it work?
6.3 Benefits of VAT collection by financial institutions
6.4 Objections and concerns
6.5 Conclusion
7.1 Introduction
7.2 Is there a supply of goods or services?
7.3 Where is the supply made?
7.4 When is the supply made?
7.5 Was the supply made by a taxable entity?
7.6 Is the supply made in the course and furtherance of an enterprise?
7.7 Is the supply taxable?.
7.8 How is VAT on the transaction collected?
7.9 Conclusion

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