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Changes to EU VAT place of supply of services rules threaten constitute a threat to small businesses which provide digital services.
From January 1 2015, The place of taxation will be determined by the location of the consumer, not the location of the supplier.
This essentially means that businesses will need to pay VAT to each country where sales originate.
In this post, I'll attempt to explain the new rules and how they may affect SMEs.
What are the new regulations?
The changes are explained here on Gov.uk. In summary:
Whereas VAT was previously charged in the country of the supplier, the new rules state that it will now be payable in the country where services are bought.
This applies only to digital services such as ebooks, downloads and other non-physical resources.
It has particular effects for small businesses with turnovers of less than £81,000 per annum, who had previously been exempt from VAT.
In a nutshell, once they register to pay VAT in EU countries, they lose this exemption and will be forced to pay VAT in the UK as well.
What is VAT MOSS?
If a business sells, for instance, an ebook to a customer in Italy and one in Spain, it will have to pay VAT at the rate for each country, and to each country.
The alternative to this is to register for the VAT Mini One Stop Shop (VATMOSS) which will remove the need to register in each country they sell to.
Under VAT MOSS, businesses will have to determine the place of supply by providing two of the following pieces of information (I'm quoting gov.uk here).
- The billing address of the customer.
- The IP address of the device used by the customer.
- Location of the bank from which payment was made.
- The country code of SIM card used by the customer.
- The location of the customer’s fixed land line through which the service is supplied to him.
- Other commercially relevant information (for example, product coding information which electronically links the sale to a particular jurisdiction).
In addition, this information needs to be stored for 10 years. It's also personally identifiable data, the storage of which is covered by other laws.
As Heather Burns states:
The most astonishing oversight of the buildup to VATMOSS has been a failure to recognise that the data collection and retention obligations are so onerous that sole traders and the self-employed will be required to register as data processors and controllers with the Information Commissioner’s Office.
The problems for small businesses
- They will lose their VAT exemption if they sell to Europe. This will mean a choice of more costs or passing these on to customers, which will inevitably mean a less competitive price and fewer sales.
- More bureaucracy. Small businesses, by their very nature, have fewer staff and resources. Time spent on ticking boxes and ensuring they aren't breaking any laws is time wasted.
Determining location is a real challenge. Many SMEs will sell via services like PayPal rather than setting up their own checkout, so an email address is all they may have as a record.
So businesses face a choice of making purchases harder by asking for more customer details, or hunting around for details such as IP addresses every time they make a sale.
- Storing personal data. The obligation to store personal data such as addresses and phone numbers brings its own problems.
What can small businesses do?
The options are limited unless someone at HMRC or the EU has a change of heart.
The basic choice is between losing sales from Europe and thus remaining VAT exempt in the UK, or having to pay an extra 20% on all earnings in the UK. This decision may well depend on the split in sales between Europe and the UK.
Chris Spooner runs a business selling resources for designers, and is currently VAT exempt due to UK rules.
He posted a letter on Twitter that he had sent to HMRC about the issue, which outlined three possible options in the light of the new rules.
- Register with VAT MOSS to pay a small amount of VAT to EU states and lose the UK VAT exemption.
- Ban any European customer from joining or buying from the site. Ethically unsound and technically difficult.
- Run the site illegally. Obviously not a real option.
The small business view
I asked Chris a few questions about the rules and how they might affect his business...
How much of a threat do the new rules pose to your business?
I risk losing thousands of pounds from my overall income for the sake of a couple of hundred pounds per year earned from EU customers.
The major flaw in this new rule is that the existing tax thresholds in the UK and across continent are not upheld, therefore anyone under the VAT threshold (like myself) must register for VAT regardless and suffer the loss of income in tax.
My business in particular relies on affiliate based earnings, so I can't feasibly recoup the VAT by adding it onto my sales, nor do I have many expenses that I can reclaim the VAT on.
Even though these affiliate earnings and my freelance design services aren't targeted in this law, I still risk losing income from these avenues because of the requirement to register for VAT to use the MOSS service, and in turn pay 20% VAT on my entire UK based income.
Do you currently receive many orders from Europe?
Until now I haven't collected any user data from my customers other than an email address, so it's difficult for me to say for sure how many sales are from Europe.
I recently began to collect country info from signups, and I can see around 10-15% are from European countries in the past couple of weeks.
You're required to find out and store two pieces of data to determine the customer's location. In practice, is this possible?
If I continue to use PayPal as my payment gateway it will be very difficult. My only option is to add extra fields to my website sign up form to ask for a home address.
However, even this isn't enough to qualify as evidence for the HMRC/EU, I'd also need to acquire an IP address, customer's bank address or land line telephone number.
This rule only affects Business to Customer sales, so any EU customers who run their own businesses are exempt, except to prove they are a business, I'd also need to collect their VAT registration number.
That's if they have one of course! If they aren't VAT registered, as many small businesses aren't, they're classed as B2C sales that I'll still have to pay tax on.
You mention three options in your letter, I presume number two is the most realistic?
Mr Webb from HMRC kindly sent a response to my letter. He suggested that I set up a separate business for my EU or international sales, which could be registered for the VATMOSS scheme without risking my UK based income.
I found this very interesting though, as this suggestion was brought up in a meeting with my accountants a couple of months ago, but it was immediately dismissed because they cited that HMRC were cracking down on this style of tax avoidance.
Even if I did follow Mr Webb's advice, the admin behind submitting quarterly VAT returns for this second business, alongside yearly returns for two businesses and the hassle of collecting the required evidence we've already talked about still pushes me towards simply banning EU citizens from registering on my site.
This rule will literally affect millions of people worldwide (not just the EU/UK). A teenager in the USA who records a song and sells it online to someone in France will be incriminated if they don't register for VAT in said country, even if they don't have a job!
The number of people who will be doing business illegally come January 1 will be vast. It tempts me to just bury my head in the sand and treat it like the EU Cookie Law, but there's always the chance of unlimited fines if you happen to be audited by UK, French, German, Romanian or Bulgarian authorities!
All in all, this seems to be another case of legislators creating laws with little understanding of their real impact, and how the digital economy works.
It is reminiscent of the Cookie Law, though in this case it is small businesses alone who are effected, those with the fewest resources to challenge or adapt to it.
We also have a similar paucity of information and advice about the new rules and the various options for dealing with them.
There's a petition on Change.org if you'd like to let Vince Cable know what you think of this...