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Implementation A Key Factor In Europe's VAT
As the congressional debate over e-commerce taxation heightens, the European Union is close to approving its own tax structure in the form of the value-added tax. But its implementation may prove tricky as opponents label it extraterritorial.
Countries in the European Union apply what is known at as the value-added tax (VAT) to good and services that cross borders. The system is similar to the sales-tax system in U.S. states, except that most goods subject to the VAT are luxury items, such as compact discs.
When people transport tangible products across EU borders, duties collected through customs satisfy the VAT requirements. But the Internet has created a conundrum for EU tax authorities. Goods and services that can be transmitted digitally, such as digitally downloaded music files or software, do not have a physical presence within the EU, and authorities cannot easily track how a digital good or service enters EU member-states.
EU members argue that in those cases, collecting the VAT — a major revenue generator for most European countries — with rates that vary between 12 percent and 20 percent — should be the responsibility of the seller. They are eager to rewrite the VAT rules so they can be applied to e-commerce. "The question of VAT concerns how to deal with business-to-consumer [transactions] from outside to in, " said a European Commission source close to the debate.
Making The VAT Work In A Wired World
The bulk of the VAT debate concerns its actual implementation. In order for firms to pay VAT, they must register inside an EU member-state. Opponents of the VAT extension argue that the application of the tax is inherently flawed because requiring tax registration in the EU would only prompt foreign firms to register in the lowest tax jurisdiction with the EU.
One solution to the problem was pushed under the auspices of the French presidency of the EU. Several European finance ministers had proposed that business-to-consumer transactions require non-established sellers to register for tax purposes in all 15 EU member-states. But the disagreement over how the VAT ought to be assigned based on the location of a good's point of entry into the EU or in which member-state a seller chose to register proved problematic.
Taxation Commissioner Frits Bolkestein characterized the proposed changes to VAT as "giving business security and certainty as to its obligations under the EU VAT system." EU officials explained that they want to make collection of the VAT easier on outside companies.
Despite several different proposals on the actual collection and distribution of tax revenue, a prominent European tax source said consensus has built around the idea of allowing foreign-based companies or vendors to register for tax purposes within one member-state, and establishing a revenue-sharing mechanism with the other 14 member-states — an approach favored by the Swedish delegation, which now holds the EU presidency.
Working groups established under the purview of Europe's economic and finance ministers are attempting to devise a method for splitting among EU members any revenue collected under such a system. So far, the plan heads in the direction of letting companies break down their tax returns to 15 countries without having to file in 15 countries. They would file only in one country.
They are "looking at the idea of a single point of contact for non-established trade — but a reallocation of revenue for the country where the consumption actually takes place," one EU official said.
Potential Revenue Loss Drives Debate
Not surprisingly, EU tax authorities are eagerly watching the U.S. debate over e-commerce taxation. They likened the collection of VAT to the application of U.S. sales taxes because EU members depend on the VAT for a large part of their national revenue and stand to lose much of their revenue as commercial transactions move online.
The problem with the VAT is simple, says Jonathan Winer, a lawyer with U.S.-based Alston and Bird. "It's an extraterritorial tax," he said, adding that the burden of complying could be costly and is essentially a tax burden that the United States does not have. Winer noted that companies possibly could resign themselves to paying the VAT, but they do not want to have to pay in each EU region.
"It's not a particularly onerous burden," an EU source argued. "What we are attempting to try and avoid is make someone register with 15 separate administrative [bodies] and submit 15 separate tax returns."
EU officials point to technology as a potential solution. "Software will do it for [companies]," a source said. "It will compute ... the final sales price" based on tax and revenue sharing.
The working groups have yet to reconcile the issue of enforcement. In practice, the VAT requires something of an honor system. "The first line has always been ... voluntary compliance," one EU official said. "That's the underlying principle."
E-commerce-related revisions to the VAT are among many proposals to update tax rules to add stability and coherence to the EU market and to take advantage of the ease of electronic communication for things like invoicing taxes. Once final amendments to the proposal are worked out and approved, the VAT rule changes could take effect as early as June and would provide about a year to 18 months for EU member-states to ratify the changes.
Time For Global Tax Reform?
U.S. officials, while technically unable to do much about the situation, often have voiced concerns over long-term implications. In a speech before tax lobbyists last summer, then-U.S. Deputy Treasury Secretary Stuart Eizenstat outlined the Clinton administration's problems with the measure.
Specifically, he noted that proposals could treat goods, such as software, differently depending on whether they are delivered physically or electronically. Eizenstat repeatedly urged EU officials to wait for specific recommendations from the Organization for Economic Cooperation and Development, which is mulling the issue.
Similarly, the application of different standards of enforcement could be worse than little enforcement. One congressional source close to tax policy noted that there is a question about unequal enforcement of the VAT policy by each EU member. Should some enforce it more then others, the United States could review the matter from a trade perspective and possibly look to the World Trade Organization for a ruling.
But the source also noted that the advent of digital goods means more than simply contending with strong regulations from abroad. "There is going to be a tax of something on the Internet all over the world before this thing is through. This moratorium is not going to last forever," the source said. The answer is "fundamental tax reform. It's clear that we have a tax system that is out of sync with the rest of the world ... and it's hurting us."
- by Maureen Sirhal
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