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Introduction to taxation of e-commerce

This guide is based on UK law. It was updated in February 2016. 

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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?

Introduction

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.

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.

Even if 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 (HMRC) takes the view that a website of itself is not a permanent establishment (PE). Nor will a server of itself be sufficient to amount to a PE of a business conducting trade through a website on that server. Other OECD Member States take the view that a server can constitute a PE.

Following concerns about the avoidance of tax by multinationals, the Organisation for Economic Cooperation and Development (OECD) has recommended changes to the international tax system. Changes to the definition of PE have been proposed to prevent arrangements that artificially avoid PE status.

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 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.

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.

It should be noted that the place of supply of electronically supplied services changed with effect from 1 January 2015..

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

From 1 January 2015 the rules for the place of supply of electronic services to private customers changed so that the place of supply is where the customer is based. Before this time, the place of supply was where the supplier belonged. The new rules apply to broadcasting, telecommunications or e-services, for example video on demand, downloaded apps, music downloads, gaming, e-books, anti-virus, software or online auctions where the service is automated.

The place where the customer is normally resident will be the member state where VAT on the digital services supply is due. For some services (such as those supplied throguh a telephone kiosk or a Wi-Fi hotspot the supplier can make a presumption about the place where the supply is to be taxed. In other cases the supplier will need to obtain supporting evidence of the place the customer normally resides.

For cross border supplies of digital services there is no registration threshold and VAT is charged at the rate due in the consumer’s country.

Under the Mini One Stop Shop (MOSS) system, businesses supplying electronic services can register electronically in the member state of their choice, rather than having to register in each EU state in which their customers are based. 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.

The system is administratively burdensome for very small businesses who would not have had to account for VAT under the old rules.  

No VAT need be accounted for on supplies to customers belonging outside the EU. However, non-EU businesses supplying electronic services to  private customers in the EU will be required to account for VAT.  Note that the use and enjoyment rules mentioned above in relation to business customers do not apply to supplies to private customers.

HMRC has produced a useful flowchart as to when the new rules apply

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.

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 customer's member state. Supplier accounts for VAT in the relevant member state or in one member state under the MOSS system

Outside EU

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

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 UK -  Customer accounts for VAT in the UK under reverse charge procedure

Supply is in customer's member state ie the UK – supplier accounts for VAT in UK.

Outside EU

Supply is in UK – Customer accounts for it in UK under reverse charge

Supply is outside the EU – no  VAT