When policymakers started to tax the digital economy under indirect taxation systems such as a value-added tax (VAT) or goods and services tax (GST), they quickly realised that these changes were highly effective. Between 2015 and 2022, more than 100 countries introduced such options.
While tax authorities have enjoyed early successes in raising revenues from the largest digital services providers, a new phase is impacting smaller businesses embarking on their digitalisation journeys.
The risk of overreach is becoming increasingly real
Recent examples we have seen include a small start-up digital platform selling collectible sneakers and other niche products; local high-street retailers building their online presence; and a group of young business leaders creating a social media platform for those entering new professions. All have had to grapple with complex indirect tax issues in the countries where their customers are located.
Now there is a new phase on the horizon where the risk of overreach is becoming increasingly real. We have seen several examples of the same service being taxed more onerously because it is delivered digitally. For example, a virtual gym was denied tax concessions available to traditional gyms because it did not rent or own its premises. Similarly, in education and health, online learning and telemedicine services will often fail to attract the same VAT treatment as traditional consultations.
Initially, tax authorities introduced measures designed to tax ‘digital services’. (The generic term is used here, although countries and regions will use different labels, including ‘electronically supplied services’.)
The distinction between ‘digital services’ and ‘non-digital services’ has become blurred
While the concept of what was included varied from jurisdiction to jurisdiction, the EU’s 2002 adoption of the ‘electronically supplied services’ definition largely influenced policy formulations elsewhere.
Three key developments have since occurred, which have resulted in the boundaries of digital services subject to VAT being redrawn. First, the distinction between ‘digital’ and ‘non-digital’ services has become blurred due to technological and product developments such as the shift to virtual events and online training courses, largely driven by the Covid-19 pandemic.
Digital gaming transactions, more recently in the metaverse, have proliferated; a recent German federal tax court decision highlights the problems these products present to judges and policymakers.
Blurring the boundaries
Second, several countries have sought to redraw the boundaries between digital and non-digital services, in many cases bringing within the net traditional services that are merely delivered digitally or with relatively insubstantial levels of human involvement.
For example, Cambodia’s VAT defines a ‘digital service’ as including all ‘services performed online’; Vietnam’s VAT seeks to tax ‘digital-based business activities’; and South Africa has expanded its definition to include all ‘electronic services’.
The EU has debated the need for further updates to its place-of-supply rules to ensure that live-streaming is taxable based on the location of the consumer (Geelen, Case C-568/17). From 2025, live-streamed events and related transactions will be taxable.
Third, and perhaps most importantly, countries such as Australia, Canada and New Zealand (and soon Singapore) have decided that the whole concept of ‘digital services’ should not be the cornerstone for taxing non-residents and instead have shifted to taxing all forms of ‘remote services’. This ensures that supplies of anything from overseas to consumers in the jurisdiction falls within the scope of VAT.
An important issue is whether the consumer is paying for the digital service or the remote service
Australia accomplished this through legislation treating the supply of ‘services, rights or digital products to an Australian consumer’ being within scope of its GST (Section 9-25(5)(d) of the A New Tax System (Goods and Services Tax) Act 1999). In Singapore, ‘all business-to-consumer (B2C) supplies of imported remote services, whether digital or non-digital, will be taxed by way of the extended overseas vendor registration regime’ with effect from 1 January 2023. Norway and Chile are considering a similar path.
Under this new formulation, in which ‘anything’ provided crossborder B2C is potentially taxed, the only safeguards from taxing ‘everything’ are de minimis registration thresholds, coupled with (often very traditional) preferences in the form of exemptions and zero rating.
An increasingly important issue is the need to identify whether the consumer is paying for the digital or the remote service. In other words, when a bundle of rights is purchased, such as commonly occurs with membership subscriptions, identification becomes more complex.
Consider, for example, the multi-million-dollar investments made through online banking or trading services. It is not hard to foresee a day when consumers are regarded as paying for the technology access and usage (ie the digital service) and not the underlying (traditional) banking or trading service.
A way forward
While not necessarily advocating for any particular outcome, we predict that the Australian/Canadian/New Zealand model will be increasingly used by other countries, as it simply future-proofs the indirect tax system against further technological advancement.
VAT measures for taxing the digital economy will grown into a substantial component
It also removes many of the fine distinctions that exist across the EU. The logical consequence of this is not only that (virtually) everything will be taxed under VAT but that the compliance footprint of affected suppliers will be immeasurably expanded. VAT measures for taxing the digital economy will grow from a minor element of a country’s indirect taxing regime into a substantial and perhaps even a dominant component.
The next stage will be considerably more difficult to manage. We are witnessing perhaps the greatest era of digitisation in our history. Traditional businesses are seeking to digitise to compete. New products and services are emerging, both in the ‘real’ and virtual worlds, while yet undiscovered unicorns continue to challenge the status quo.
Meanwhile, the new consensus-driven world of international tax is, at the time of writing, showing signs that it is under attack. We are about to emerge from the eye of the storm, and there are still troubled seas ahead.