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Introduction to taxation of e-commerce
E-commerce presents a major challenge for tax administrations, given the often multi-jurisdictional nature of the transactions and the potential anonymity of the parties.
This guide outlines certain key UK tax considerations for a company conducting electronic business in the UK. For e-commerce conducted by UK resident companies with UK individuals or businesses, the tax treatment is largely the same as physical business. This guide therefore looks mainly at issues relevant to cross-border e-business; for example, where a non-UK company is looking to start e-commerce transactions with UK customers or vice versa.
When will an e-commerce trader be subject to UK tax?
In the UK, taxes are imposed:
- on the worldwide income of any person tax resident in the UK; or
- on income arising in the UK of any person not tax resident in the UK.
The starting position is that a company incorporated in the UK is a UK tax resident, although it may instead be treated as being tax resident in another jurisdiction under the terms of a relevant tie-breaker provisions in a double taxation treaty (see below) with such jurisdiction.
A company incorporated outside the UK may however also be UK tax resident if it is "centrally managed and controlled" from the UK (again subject to the tie-breaker provisions of a relevant double tax treaty). This refers to the place where the business is controlled as opposed to where the main business is transacted. Provided care is taken, a non-UK trader should not become UK resident merely by carrying on UK e-commerce.
Income arising in the UK
Even where a company is not tax resident in the UK, it may be subject to UK tax on its profits which arise in the UK. If the company is trading in the UK through a branch or agency, this charge will be to corporation tax; otherwise the company will be liable to income tax.
The criteria for considering whether a trade is being carried on within the UK are derived from case law. Historically, the emphasis has been placed upon determining where the contract was formed (the "traditional test"). However, the cases also provide for a wider test: do the profits in substance derive from operations in the UK?
There is some uncertainty as to where a contract made over the internet should be treated as made. Usually in UK law a contract is made where the acceptance is communicated, but where the mode of communication is instantaneous it is treated as made where the acceptance is received. It is not clear whether internet communications should be regarded as instantaneous for these purposes.
Even where the profits derive from a UK trade, the UK will have limited taxing powers in practice unless the activities in the UK constitute a branch or agency in the UK through which the e-trade profits are earned (or, where a double tax treaty applies, the activities fall within the more limited definition of a permanent establishment– see below).
Double taxation treaties
The UK has an extensive network of double taxation treaties with other jurisdictions which seek to prevent a taxpayer from being taxed in more than one jurisdiction upon the same profits or gains. The treaties follow the Model Convention drawn up by the OECD and have as a starting point the principle that trading income should be taxed in a jurisdiction where the taxpayer has a "permanent establishment". Further details of the UK's double tax treaties are available on HMRC's website.
HM Revenue & Customs (HMRC) takes the view that a website of itself is not a permanent establishment. Nor will a server of itself be sufficient to amount to a permanent establishment of a business conducting trade through a website on that server. Other OECD Member States take the view that a server can constitute a permanent establishment.
What about UK traders conducting commerce with overseas customers?
Where UK based businesses conduct e-trade with overseas customers, they need to consider whether their activities will bring them within the scope of local taxes. Very broadly, the issues in the local jurisdiction will usually be similar to those outlined earlier for overseas traders doing business with UK customers. However, an e-trader can only be certain of the position by seeking local advice.
Can withholding tax be imposed on e-commerce payments?
Where transactions involve the supply of digitised goods over the internet there are issues concerning the characterisation of the income generated– i.e. are these business profits or royalties? The provision of digitised goods such as software or music which can be downloaded would, under traditional rules, generally be the provision of a right to use a product, and in most jurisdictions would give rise to royalties. However, if the same goods were provided in non-digitised form (i.e. sold in a physical form such as a CD-ROM), there would be a supply of goods giving rise to profits.
Withholding tax on royalties
Royalties are subject in the UK (as in many other jurisdictions) to a different tax regime from that applicable to other business profits (arising either from the supply of goods or of services).
Royalty payments may be subject to withholding tax. Where withholding tax applies, the payer is obliged to deduct or withhold an amount equivalent to the tax liability of the payee in respect of the payment. The payee receives the payment net of tax and will be given a tax credit in respect of the amount withheld or deducted. The payer must account for the tax to HMRC.
Relief from withholding tax
In practice, full or partial relief from withholding tax is given by double tax treaties provided relevant claims are made. The obligation (if any) to operate UK withholding tax will apply to the payer of the royalties - that is the customer. Non UK-traders will wish to establish whether withholding tax will be imposed on royalty payments from UK customers. UK traders who are e-trading into other jurisdictions will need to check whether there are any relevant withholding taxes on payment flows from customers' jurisdictions.
This issue of characterisation is important particularly in relation to cross-border transactions as royalties are treated differently from business profits in double tax treaties which follow the Model Convention.
The commentary to Article 12 of the Model Convention gives some guidance on the treatment of digitised products. The decisive question is what is the payment for? Revenues from selling of digitised products on-line will be characterised as business profits, rather than as royalties, even though the purchaser acquires a limited licence in the copyright to download the product.
VAT and e-commerce
Where goods or services are supplied by a UK business to a customer whether the business is obliged to account for VAT in the UK, elsewhere, or at all, will depend upon whether the supply is of goods or services, where the supply is treated as made and whether the customer is in an EU member state. The implications of e-commerce for VAT purposes can be examined in the context of three types of transaction:
- Supplies of physical goods to business or private consumers;
- Supplies of intangible goods or services to business;
- Supplies of intangible goods or services to private consumers.
It should be noted that significant changes to the VAT treatment of cross border supplies of services came into effect from 1 January 2010. However these changes did not change the place of supply of electronically supplied services.
Supply of physical goods to business or private consumers
The basic position is that in general supplies of physical goods are deemed to be made in the place where the goods are located when they are dispatched. Where the goods are merely ordered using electronic communications, this will not affect the way in which they are treated for VAT purposes. The location of goods and therefore their place of supply for VAT purposes will not be altered by internet ordering.
As VAT legislation was originally drafted in the context of goods physically being supplied, there is generally little difficulty in applying the existing regime to this type of transaction. Note however that digitised products are treated as a supply of services and not goods.
The VAT treatment of a supply of goods to a customer within the EU will depend upon whether the customer is a VAT registered business or not. If goods are sent from the UK to a VAT registered business in another member state they can be zero-rated by the UK supplier provided certain conditions are complied with, which include obtaining the customer's VAT registration number.
Where a UK business supplies goods to private consumers in another member state, the sales will be subject to UK VAT unless the business' level of sales to private customers in that member state has exceeded the distance selling threshold for that state. If it has exceeded the threshold the UK business will be required to register for VAT in that member state and account for VAT on the sales there. The UK business may voluntarily register for VAT in the other state and account for VAT there even if it has not exceeded the threshold. This may be desirable in member states with a lower rate of VAT than the UK.
Supplying goods over the internet to customers in a variety of EU member states can therefore impose significant burdens on a business in terms of monitoring levels of supply in each State and complying with the differing requirements in each state. Another potential area of difficulty in internet sales is identifying and verifying the customer's status.
Supply of electronic services to business customers
Supplies of digitised products are treated as supplies of services rather than goods. Since 1 January 2010, the basic rule for supplies of services where the customer is registered for VAT is that services are deemed to be supplied where the customer belongs. Individuals receiving supplies in a personal capacity are treated as belonging where they have their usual place of residence and businesses are treated as belonging where they have a business or fixed establishment which has the benefit of the service.
If the supplier and the customer belong in the same EU member state, the supplier accounts for the VAT. If they belong in different EU member states, a “reverse charge” procedure operates. This means that a UK supplier does not have to account for VAT when making supplies to a customer belonging outside the UK, regardless of whether the customer belongs in the EU or not. However an EU based customer must account for VAT in its member state – it is treated under the reverse charge procedure as having supplied the service to itself and so it must account for output tax and can recover input tax depending upon the extent to which it is making taxable supplies.
The reverse charge provisions also apply in relation to services supplied by a supplier outside the EU so an EU business customer may have to account for VAT under the reverse charge procedure in its member state in respect of services it receives from suppliers belonging outside the EU. For most business-to-business transactions this regime ensures a level playing field within the EU between EU and non-EU suppliers.
In the case of electronically supplied services supplied to business customers the basic rule on the place of supply of services may be overridden by the “use and enjoyment” provisions. These provide that:
- if the supply would be treated by the basic rule as supplied in the UK (because the customer belongs in the UK), but the services are to any extent effectively used and enjoyed in a country outside the EU, the supply is to be treated to that extent as made in that country (so that no VAT is payable); and
- if the supply would be treated as made in a country outside the EU (because the customer belongs outside the EU), but the services are to any extend effectively used and enjoyed in the UK, the supply is to be treated to that extent as made in the UK (so that UK VAT is payable).
Further guidance on these rules can be found on the HMRC website. Electronically supplied services include the following:
- website supply, web hosting and distance maintenance of programmes and equipment;
the supply of software and the updating of software;
- the supply of images, text and information, and the making available of databases;
- the supply of music, films and games (including games of chance and gambling games);
- the supply of political, cultural, artistic, sporting, scientific, educational or entertainment broadcasts (including broadcasts of events);
- the supply of distance teaching;
- online auction services; and
- internet service packages.
For further guidance on what is covered, see the HMRC website.
Supply of electronic services to private customers
The general rule is that supplies of services to private customers are treated as made where the supplier belongs. However, electronically supplied services supplied to private customers who belong in the EU by a supplier who belongs outside the EU will be treated as being made where the customer belongs.
Supplies to UK recipients will therefore be subject to UK VAT if the supplier belongs in the UK or belongs outside the EU. If the supplier belongs in another EU member state, VAT will need to be accounted for by the supplier in that other Member State. No VAT need be accounted for on supplies to customers belonging outside the EU. Note that the use and enjoyment rules mentioned above in relation to business customers do not apply to supplies to private customers.
As mentioned above, where the supplier belongs outside the EU but the recipient is a private customer within the EU, the supplying business will need to account for VAT. Non-EU businesses supplying electronic services can register electronically in the member state of their choice, rather than having to register each state in which supplies are received. They will account for VAT at the rate applicable in the customer’s member state on an electronic return and VAT will be distributed as appropriate to the relevant member state where the supply is consumed.
From 1 January 2015 the rules will change so the place of supply will be the place where the customer is based. The system mentioned above in relation to non-EU suppliers will be expanded to enable UK suppliers to account for VAT in the UK in respect of supplies to private customers in other member states.
Summary for UK businesses supplying electronic services
|Location of customer ||Business customer ||Non-business customer
Supply is in UK – supplier accounts for VAT in UK.
Unless use and enjoyment rules mean supply enjoyed outside the EU.
|Supply is in UK – supplier accounts for VAT in UK
|EU excluding UK
Supply is in customer's member state – Customer accounts for VAT in its member state under reverse charge procedure.
Unless the use and enjoyment rules mean supply enjoyed outside the EU.
Supply is in UK – supplier accounts for VAT in UK
From 2015 supply is in customer's member state
||Supply is outside EU – supplier does not charge UK VAT unless use and enjoyment rules mean service is effectively used and enjoyed in the UK.
||Supply is outside EU – supplier does not charge UK VAT
Summary for UK customers receiving supplies of electronic services
|Location of customer ||Business customer ||Non-business customer
||Supply is in UK – supplier accounts for VAT in UK
||Supply is in UK – supplier accounts for VAT in UK
|EU excluding UK
||Supply is in UK - Customer accounts for VAT in the UK under reverse charge procedure
||Supply is in the EU state in which supplier is based – supplier accounts for VAT in its member state.
From 2015 supply is in customer's member state ie the UK.
||Supply is in UK – Customer accounts for it in UK under reverse charge
||Supply is in the UK – Non-EU supplier must account for UK VAT – it can register for VAT in member state of its choice and account under simplified procedure