back to Upstream USA – European business issues - July 2008
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As the e-commerce industry is constantly evolving, it is important that non-European businesses are aware of the pitfalls that the EU system of VAT can present as they do business with customers in Europe, and the solutions and opportunities that are available to the well-advised business.

Value Added Tax (VAT) is a vast and complex subject.  We focus here on the special VAT rules that apply to supplies of broadcasting, telecommunications and online services like downloadable software ('digitised services') to customers in the UK and other EU Member States. 

In February 2008, the EU adopted new legislation changing the rules on the place of supply of services for VAT purposes.  Ultimately, these rules will eliminate the advantages of establishing Business to Consumer (B2C) businesses in low-rate Member States. 

The changes are intended to create a level playing field between EU and non-EU suppliers by making all supplies to private consumers of electronically delivered services taxable in the Member State where the customer is resident.  However, it has been announced this change to the treatment of digitised services will not be implemented until 2015, leaving plenty of time to take advantage of the opportunities offered by the current system, which we look at in more detail in the remainder of this article. 

What is VAT?
VAT is in essence an EU tax.  All 27 EU Member States are required to operate VAT and there is a high degree of harmonisation between the various national systems across the EU.  Like its US counterpart, European VAT is a tax on consumption, borne by the end consumer of the goods or services supplied.  The standard rate varies between Member States from 15 to 25% of the price of the goods or services supplied.  The standard rate of VAT in the UK, for example, is 17.5%. 

Whilst VAT is a tax borne by the end consumer it is generally paid over to the relevant country's revenue service by the supplier of those goods or services.  A supplier will generally pay over to the revenue service the difference between the VAT they have incurred on goods or services they have bought for use in their business ('input tax') and the VAT they have charged on the goods or services supplied to their customers ('output tax'). 

Businesses that are registered for VAT in a Member State can generally recover any input tax they have suffered.

Place of supply - the basic rules
Supplies of digitised products are generally treated as supplies of services for VAT purposes.  A supply of services will be subject to VAT in the Member State in which it is made, which (see below) is usually taken to be the Member State where the supplier has established his business under the "place of supply" rule.  If a supplier has establishments in more than one Member State the place of supply will be in the country most closely connected to the supply.

It is possible for a US business unwittingly to acquire an establishment in an EU Member State for the purposes of VAT, merely by trading through an agent.  If this occurs a US business may be required to register and account for VAT in the relevant Member State, and the agent's fees will also be subject to VAT. 

These rules are particularly complex and can vary depending on the EU countries involved.  Businesses should always seek advice on the VAT implications of any agency relationship.

Digitised and International services in Europe
Digitised services and so-called "international services" (such as advertising or professional services performed outside the EU for EU customers) have a special place of supply rule, which is where the customer belongs.

Business to Business (B2B)
When a US business supplies digitised services or international services to a business customer based in Europe (for example, a UK business customer) the US business is not required to register for or charge VAT in the UK. 
However, this does not give the US business the competitive advantage that you might first imagine.  In such circumstances its UK business customer will be required to account for VAT as if it had supplied the services to itself in the UK.  This rule is referred to as the 'reverse charge' or 'tax shift mechanism'.  The cost to the UK business customer of standard-rated services worth €100 will therefore be €117.50, after the reverse charge at the UK standard rate of 17.5 %.

Business to Consumer (B2C)
When services are supplied by a US business to a private consumer (or other non-business customer such as a government department) in the UK, the consumer is not obliged to operate the reverse charge.  This means that, except in the case of digitised services (see below), no VAT can be charged on most international services.
As competition might be distorted if the supplies were not subject to VAT at all, special rules treat digitised services supplied to private consumers (and other non-business consumers such as government departments) as made in the country where the consumer belongs (or, in certain cases, where the services are used or enjoyed), regardless of the location of the supplier.

This means that, where a US business supplies digitised services direct to private consumers in more than one EU country, it will be required to register and account for VAT in each country separately and charge its customers VAT at the local rate. 

Special EU Scheme for Non-EU Suppliers
To ease the administrative burden for suppliers when making supplies to consumers, businesses have the option of registering electronically for VAT in a single country under the Special Scheme for Non-EC Suppliers of Electronically Supplied Services.  In the example above, the US business would still charge its EU customers VAT at the customer's local rate but account for this to a single EU country online.  That country would then distribute the VAT collected to the countries where the services were consumed.  This scheme is currently only available if the US business:

• " supplies electronically supplied services to consumers (private individuals and non-business organisations) belonging in the EU; and
• " is not established within the EU; and
• " is not registered for VAT under the normal rules in any Member State.

VAT Planning opportunities under the current rules
A US business making a large volume of supplies to private consumers might choose to set up a trading establishment and register for VAT in a low-rate state such as Luxembourg from which it can make its supplies around the EU charging VAT at 15%, with a lower overall cost to the consumer. 

For example, if services worth €100 were supplied to a UK-based private consumer by a Luxembourg-established business, it would have to account for €13.04 in VAT, giving a net price of €86.96.  If the same services worth €100 were supplied to a UK customer by a business established in Sweden, it would have to account for €20 in VAT, giving a net price of €80.

Registration for VAT also has the advantage of allowing the business potentially to recover any VAT that it incurs on purchasing goods or services which it then uses to make its own Vatable supplies of digitised services.

The direct tax and commercial implications will need to be carefully considered, particularly given that such structures will no longer be effective once the new VAT rules are introduced.

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