Taxation of e-commerce
This guide is based on UK law. It was updated in December
2007.
Quick links to sections within this page:
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?
Introduction
In the UK, taxes are imposed:
- on the worldwide income of any person
tax resident in the UK; or
- on income arising in theUK of
any person not tax resident in the UK.
Tax Residence
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".
HM Revenue & Customs 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?
Introduction
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 HM Revenue &
Customs.
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.
Characterisation
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
Introduction
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.
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. The basic rule where the customer is
registered for VAT is that services are deemed to be supplied where
the supplier belongs. Individuals receiving
supplies in a personal capacity are treated as belonging where they
have their usual place of residence and business are treated as
belonging where they have a business or fixed establishment which
has the benefit of the service.
However, in respect of certain classes of services, a "reverse
charge" procedure operates, whereby the supply is deemed to be made
where the recipient belongs. The E-Commerce Directive provides for
a reverse charge regime covering electronically supplied services,
which include the following:
- supply of websites or web-hosting services;
- downloaded software;
- downloaded images, text and information including making
databases available;
- downloaded music, films or games;
- digitised books or other electronic publications;
- electronic auctions; and
- internet service packages.
In such cases, a UK supplier would not have to account for VAT
whether making supplies to an EU, or non-EU business customer.
However the EU based customer would account for VAT in its member
state. For most business-to-business transactions this regime
ensures a "level playing field" between EU and non-EU.
The reverse charge provisions apply also 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.
The E-Commerce directive originally only applied for 3 years. It
has, however, been extended until 31 December 2008.
Supply of electronic services to private customers
Private consumers will generally not be registered for VAT and
therefore, it would not be practicable to impose the "reverse
charge" regime whereby such recipients would be required to account
for VAT.
The E-commerce Directive therefore provides that for
electronically delivered services, the supply will be treated as
being made in the EU if the recipient belongs there. Supplies to UK
recipients will therefore be subject to UK VAT regardless of where
the supplier belongs. No VAT need be accounted for on supplies,
whether by EU or non-EU suppliers, to non-EU recipients.
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. The E-commerce Directive provides for a regime
whereby non-EU businesses supplying electronic services can
register electronically in the Member State of their choice, rather
than having to register in 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.
Summary for UK businesses supplying electronic services
| Location of customer |
Business customer |
Non-business customer |
| UK |
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 customer's member state – Customer accounts for
VAT in its member state under reverse charge procedure |
Supply is in UK – supplier accounts for VAT in UK |
| Outside EU |
Supply is outside EU – supplier does not charge UK VAT |
Supply is outside EU – supplier does not charge UK VAT |
Further information
See:
HMRC guidance on VAT on electronically supplied services
Proposals
On 4th December 2007 the European Council reached political
agreement on the so-called 'VAT package'. This package
includes new rules which will mean a change in the place of supply
for business-to-business supplies of services from the place where
the supplier is located to the place where the customer is
situated. As has been mentioned above, the E-commerce Directive
makes the place of supply of electronic services the place where
the customer belongs and there is an obligation on the recipient to
account for VAT under the reverse charge mechanism. The new rule
will not therefore change the position for business-to-business
supplies of electronic services.
For business-to-consumer supplies of services the general rule
will continue to be that the place of supply will be where the
supplier is established. However, for business-to-consumer supplies
of telecommunications, broadcasting and electronic services, the
place of supply will be the place of consumption. VAT will
therefore be charged at the rate in force in the member state where
the customer is located.
To simplify the VAT arrangements for the suppliers of electronic
services (who would otherwise have to register for VAT in all the
member states where their customers are located and comply with the
relevant reporting and payment obligations) a 'one-stop' system
will be introduced to enable suppliers to fulfill, in their home
state, a single set of obligations for registrations, declarations
and payments. VAT revenue will be transferred from the country
where the supplier is located to that where the customer is
situated.
The business-to-consumer part of the package was very
controversial and Luxembourg (where many big e-tailers are located,
as it has a low rate of VAT) was concerned about the potential loss
of revenue. It was therefore agreed that, although the rest of the
package will come into force on 1st January 2010, the aspects
relating to electronic services will not come into force until 1st
January 2015. In addition the member state of establishment will
retain a proportion of the VAT receipts collected through the
one-stop shop arrangement until 1st January 2019. The Commission
will also be asked to report on the feasibility of the new rules
before their entry into force.
This therefore means that for business-to-consumer e-commerce
the existing VAT rules will continue until 2015. If they are
finally introduced in 2015, the new proposals should result
in a more-level playing field as the same VAT will be payable by
customers in a member state, regardless of where the supplier of
the services is situated. Despite the one-stop shop, the
administrative burdens for suppliers of electronic services to
non-business customers will be increased as a result of the new
proposals as there will be a need to verify the status of
non-business customers, in particular the member state in
which the customer resides, as this will affect the rate of VAT
that has to be charged.
Contacts
