VAT in a digital economy
Driving co-operation across borders
Electronic commerce has allowed for diminished physical presence in countries and accelerating growth of the digital economy has had a significantly adverse effect on VAT collections. This is because high volumes and low value of supplies has also increased the volume of transactions in which VAT is not collected.
Global rule changes get a handle on eradicating the artificial shifting of profits, but hurdles remain.
The increasing ease of transacting across borders is making profit shifting - even if achieved by means of legal structuring - an area of grave concern for tax authorities, including those in Africa.
Base erosion and profit shifting (BEPS) has been aptly described by the Organisation for Economic Co-operation and Development (OECD) as tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.
Electronic commerce (ecommerce) has allowed for diminished physical presence in countries and accelerating growth of the digital economy has had a significantly adverse effect on value-added tax (VAT) collection. This is because high volumes and low value of supplies has also increased the volume of transactions in which VAT is not collected.
Action 1 in respect of the 2014 BEPS deliverables relate to “addressing the tax challenges of the digital economy”. If all VAT jurisdictions apply the “destination basis”, as endorsed by the OECD, and place of consumption rules set out by the OECD, the ability for multinationals to shift profits can be curbed as the imposition of VAT is based on where the recipient is located and not where the supplier may have established itself.
In terms of the destination basis VAT should be imposed in the jurisdiction where the good or service is consumed, which is the jurisdiction where the recipient of the good or service is located.
The OECD has, furthermore, established in its 2014 VAT Guidelines, as well as the draft 2015 VAT Guidelines due to be adopted shortly important principles in respect of VAT accountability.
In respect of business-to-business (B2B) transactions, where the recipient is an entity entitled to the full input tax (i.e. when a VAT registered company buys goods or services from another VAT registered supplier) deduction in respect of the goods or services acquired if VAT were imposed, the reverse charge mechanism should be applied whereby the recipient business is required to account for the VAT on the supply.
In terms of the reverse charge mechanism, the foreign supplier is not required to register for VAT in the recipient’s jurisdiction. However, this does not imply that the supply will not be subject to VAT in the recipient’s jurisdiction but merely that the recipient is required to collect and account for the VAT to the revenue authority and not the supplier. As the recipient is entitled to claim an input tax deduction in respect of the good or service acquired, the recipient’s VAT return would effectively reflect output tax (the VAT you charge on sale of your own goods and services) in respect of the VAT owing to the revenue authority, as well as a corresponding input tax deduction on the same return. This allows for an audit trail of the goods or services acquired despite resulting in a net nil cash effect for the recipient.
In this regard the destination basis still applies, as the VAT is due and payable in the jurisdiction where the recipient is located, but nevertheless provides simplicity and reduces the administrative burden of the foreign supplier having to register for VAT in the recipient’s jurisdiction.
In respect of business-to-consumer (B2C) transactions, where the recipient is an entity or individual not registered for VAT, the foreign supplying company is required to register for VAT in the recipient’s jurisdiction and impose, collect and account for VAT on the supply to the revenue authority in the recipient’s jurisdiction.
It must, however, be borne in mind that some multinationals, in terms of the B2C rules, would be required to register for VAT in multiple jurisdictions. It, therefore, is crucial for a simplified VAT registration and administration process to apply to such foreign suppliers. This is, furthermore, in keeping with the OECD principles of efficiency of compliance and administration and simplicity. The B2B and B2C rules, along with the destination basis and the OECD five principles, allow for an effective application of VAT which may contribute to the reduction of BEPS.
While the destination basis, B2B and B2C rules and the OECD five principles appear to be a simple and straightforward solution to addressing BEPS, especially in the digital economy, a remaining hurdle to overcome is global co-operation and effective application of such rules and principles.
A movement towards harmonising with OECD principles and guidelines may be evident in Africa. An example of this may be the interim BEPS reports recently released by the Davis Tax Review Committee for public comment, with specific reference to the digital economy, which greatly references OECD commentary and principles. While final recommendations have not been released as of yet and, therefore, we still await amendments to the legislation as a result of such recommendations, it is evident that greater emphasis is being placed on what the rest of the world is doing, especially the OECD and assessing our current system in terms of the OECD guidelines.
In fact, the consistent application of these rules by all jurisdictions is essential to effectively combat BEPS and to ensure global tax equality. This means that these rules and principles, which may address and reduce BEPS from a VAT perspective, can only be achieved if all VAT jurisdictions are willing to co-operate. Where global co-ordination may have been difficult to achieve before, the digital economy is quickly contributing to an increasing corroboration between jurisdictions.