However, while the world of commerce is moving online at lightning speed, the global tax system appears to be lagging behind. The vast universe that is the internet is virtually impossible for any taxing authority to oversee, resulting in numerous exchanges of value going undetected. This movement has the potential of severe knock-on effects, since consumption taxes, like Value Added Tax (VAT), are a primary and vital source of revenue for many states. The intention of these taxes has always been to generate revenue for a state by taxing final consumers for their personal expenditures. However, many developing countries – Kenya included – have not yet fully tapped into systems which make it easier to track online commerce, meaning that businesses are still taxed where they have a physical presence as opposed to an online presence, thereby seemingly growing the hole in the taxman’s pockets.
Moreover, while it is extremely difficult (and some would argue, impossible) to regulate the online customer’s virtual market, this difficulty does not mean that the issue should be ignored. Indeed, many states and trading blocs have taken heed of the danger in form of reduced government revenues, and so have taken matters into their own hands.
Developments
The starting point in determining payment of VAT on cross-border transactions are guidelines that govern the place of payment, which is either the ‘destination principle’ or the ‘origin principle’. Under the destination principle, VAT is paid on a transaction where the ‘supply is consumed’, i.e. where the transaction ends. This is common in business-to-consumer (B2C) transactions where the place of consumption of cross-border transactions, and thus the place of payment of VAT, is the jurisdiction in which the recipient of the good or service has their usual residence. The approach is also taken in business-to-business (B2B) transactions where VAT is paid in the jurisdiction where the recipient’s business presence is located. Under the origin principle on the other hand, VAT is paid on a transaction where the supplier ‘has a fixed establishment’, i.e. where the supply begins.
Neville March Hunnings, in his article Casenote on Debauve and Coditel published in 1980, compared the sale of a Financial Times newspaper from London to Frankfurt by post and by fax. He posited back then – and was proved correct many years later – that the means of transportation should not make a considerable difference in the legal consequences attached to the sale, being highly critical of old-fashioned lawyers dealing with modern technologies. Hunnings went on to say:
“…we are faced in reality with two different forms of transportation …The end result is exactly the same: the physical object in London has been transported into the hands of the recipient in Frankfurt. The conceptual blockage which prevents this equivalence being acted upon is the lawyer’s reluctance to move from Newtonian physics to quantum physics, an inability to attribute physical characteristics to anything that cannot be held and thus an unwillingness to accept that one can ‘import’ electronic signals. This reluctance is likely to have more serious consequences than that of cable television”.
However, the above propoundments notwithstanding, one of the first major developments in the field came about many years later in 1998 with the OECD Ottawa Electronic Commerce Taxation Framework Conditions (OTFC Guidelines). The OTFC Guidelines were set to apply to cross-border supply of services and intangible property by suppliers who are not registered or required to register, in the destination jurisdiction under existing mechanisms. In a bid to avoid double taxation or unintentional non-taxation, the OTFC Guidelines stipulated that cross-border trade of services and intangible property should be taxed in the jurisdiction where consumption takes place i.e. the destination principle. The OTFC Guidelines went further to encourage all member countries to amend their national legislation to comply with this principle.
This call for unification was then picked up a few years later by the European Commission when, as per its 2015 Communication, it listed the completion of the “Digital Single Market” as one of its top priorities. This was directly complemented with the coming in to force of the EU Directive 2008/8/EC on 1 January 2015 (EU Directive). Before this date, services supplied to private individuals i.e. B2C supplies were taxed at the supplier’s place of establishment, as per the origin principle, resulting in some companies taking advantage of tax planning opportunities and setting up shop in countries where the most preferential VAT rates apply, and registering all their European sales there. The EU Directive thus sealed off the tax loophole used by these multinationals by providing that digital services provided to a non-taxable person (i.e. a private individual) were to now be taxed at the place where the customer of the good is located, following the approach under the OTFC Guidelines.
Difficulties
While the above mentioned efforts by the likes of the European Commission and OECD in the field of VAT for online commerce are hailed for being progressive and a step in the right direction, there are still hurdles that the implementation of an international tax system has to overcome. For instance, uncertainty in the classification of supplies poses difficulties for suppliers. This was exemplified in the cases of Commission v France ECLI:EU:C:2015:141 and Commission v Luxembourg ECLI:EU:C:2015:143, where the European Court of Justice denied affording digital books the same VAT status as afforded to physical books (for which member States were permitted to apply a reduced VAT rate). The Court held that the reduced rate of VAT is applicable to supply of physical books, and while support is also required to read an electronic book (such as a tablet or computer), such support is not included in the supply of electronic books. Thus, such a classification of the supply as made by the European Court of Justice is likely to increase the administrative burden for companies and may even affect how companies price their supplies, as different rates will apply depending on the classification, albeit for the same product.
Another issue with the proposed VAT models, is that they do not contribute to legal efficiency as they complicate the applicable tax provisions. Whether looked at on a global scale or even a smaller scale such as within the European Union, one will notice that virtually every state has differing laws governing VAT and applies different rates. Therefore, in cross-border supplies, it is not only the provisions of one of the jurisdictions that will affect a supplier, but normally the VAT provisions in two or more jurisdictions. These complex rules increase the compliance costs for supplier companies, thereby affecting the legal efficiency of the tax system, and even carries the risk of double taxation which could raise consumer protection issues.
The issue is further aggravated by the fact that there is no international consensus on digital taxation, resulting in individual states taking unilateral action to prevent possible double taxation or unintentional non-taxation. For instance, India has placed an ‘equalisation levy’ on online revenue earned by non-resident companies, and in New Zealand businesses selling to customers online within their jurisdiction now must register for Goods and Services Tax (GST). These legislative advancements, while evidence of the enthusiasm of tax authorities to pave their way towards what they see as their rightful share of the tax-take, further complicate matters for the sale of products across international borders.
Going Forward
The foregoing brings to light the fact that many tax authorities are aggrieved by, or face an imminent threat from, the significant amounts of tax they are unable to collect from businesses operating within their jurisdiction without a physical presence. It is therefore evident that international coordination is not only desirable, but necessary, in order to improve tax collection efficiencies particularly on online cross-border sales. This coordination means that principles need to be agreed upon on three levels: a policy level, so that jurisdictions effectively agree upon where cross-border supplies are to be subjected to VAT; a legislative level, so that agreements between nations are effectively transformed into legislation that courts and tax authorities can refer to and apply; and finally an interpretive level, so that courts and tax authorities alike do not alter the intended outcome of legislation through divergent means of interpretation.
