EU Digital VAT reform

From the early days of ecommerce, a vexing question has persisted — how to tax digital transactions?  At first they were not taxed at all, and bricks and mortar retailers cried foul. Why should they have to pay transaction or value added taxes (VAT), when ecommerce retailers did not?

Hmmm … at first blush, it seems like a pretty good argument. Customers can avoid the VAT by buying online. And where the VAT rate goes up to 20% or so, that can mean a lot of money.

Just to be clear, employing strategies to avoid VAT is nothing new. Jurisdictions that impose VAT have been snookered by neighboring jurisdictions that don’t for as long as the VAT has been around. For example, Pennsylvania has VAT but Delaware does not. Guess what you find in huge amounts just over the Pennsylvania border in Delaware? Right. VAT free shopping. It happens in Europe too, especially where the tax on booze in one place is dramatically higher than in a neighboring locale.

But ecommerce is not just about neighbors poaching a bit of trade at the border. It is a more ubiquitous phenomenon. Stuff comes in from all over the place. Local retailers face competition from thousands of web locations and they don’t like it. So the EU has responded to their concerns by changing their VAT rules on digital sales in order to “level the playing field”.

So far so good. But what does this mean? For digital sales, the seller now has to charge the VAT based on where the buyer is located. The change goes into effect on January 1, 2015. Yikes! If you think this is going to be a pain in the butt for digital retailers, you are 100% correct. And this article from HP explains some of the reasons why.

Let’s assume for now that this regulation stays in effect. What will happen? Very simple. Digital retailers — except for the few big boys who can muddle through the paperwork — will stop selling in Europe and focus more on selling elsewhere. And what will that mean? It will mean that Europe will fall behind in development of digital markets (it already is, btw). Is that important? European entrepreneurs may still thrive (see above).  But EU buyers will face more limited options. No big problem as long as there are bricks and mortar options around. But what if there are not? Like where you can only buy a software product via download? If the software products develop quickly, requiring regular transactions to keep up with the pace of innovation, we may have a problem for the little guys. And no doubt, this will give rise to a new generation of VPN tricks to disguise where one buys from.

Is it worth it? European governments rely fairly heavily on VAT revenue. It is well known that VAT is regressive — it hits the poor much harder than the well to do. But as we get further into the digital era,  the above reveals another dimension of problems. I, for one, am not confident that they will be worked out so easily.

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