New e-commerce VAT directives

By Tafadzwa Brian Mukwende

Current developments in the South African Value Added Tax (VAT) regime consist of new digital tax reforms in comport with the principle of fiscal neutrality. Application of the underlying principle of fiscal neutrality inherent in the common system of VAT requires equal treatment of similar goods and services supplied by taxable persons, which are in competition with each other, see Grattan PLC v Her  Majesty’s Revenue & Customs [2013] UKFTT 488 (TC) at paras 25 – 27 and 38; Fischer v Finanzamt Donaueschingen [1998] ECR I-3369 at paras 27 – 30; Schmeink & Cofreth AG & Co. KG v Finanzamt Borken and Manfred Strobel [2000] ECR I-6973 at paras 55 – 59. These fundamental tax changes have a colossal impact on e-commerce and also play a pivotal role in aligning current tax laws with contemporary developments in the field of e-commerce.

Transition of the Traditional Value-Added Tax System

VAT in the South African context is defined as an indirect tax charged on the supply of goods and services by a vendor in the course or furtherance of any enterprise as a statutory precondition that lies at the heart of the VAT system as contemplated by s 7 of the Value-Added Tax Act 89 of 1991, (the Act), as laid down in KCM v Commissioner of South African Revenue Services (Tax Court) (unreported case no VAT 711/14-8-2009) (Van Oosten J) at para 8. Vendors collect output VAT on behalf of the state for taxable supplies of goods and services from consumers or end users in terms of s 7(1)(a) of the Act. Vendors can claim input VAT for supplies acquired or imported from other suppliers subject to exceptions in s 17 of the Act. In some tax jurisdictions, a similar form of indirect or consumptions tax is charged for taxable supplies such as Sales and Use taxes in the United States (US) and Harmonised Sales Tax or Goods and Services Tax in Canada. 

Revenue rule

The present day challenges of collecting digital taxes levied on electronic products from technology companies established in foreign states finds substance in the common-law doctrine of the revenue rule, which has evolved over time. The common-law doctrine of the revenue rule in the international sphere recognises that the revenue laws governing a foreign state have no legal force in other sovereign nations, originated from English courts as illustrated in Holman v Johnson 98 Eng. Rep. 1120 (KB. 1175) at 1121 per Lord Mansfield. In Ben Nevis (Holdings) Limited v Commissioners for HM Revenue and Customs [2013] EWCA civ 578 at paras 51 and 53, the England and Wales Court of Appeal ruled that the revenue rule can be abrogated by way of international treaties that allows tax collection on behalf of the South African Revenue Services (Sars) by the United Kingdom (UK) Her Majesty’s Revenue and Customs tax authority party to the bilateral tax treaty with South Africa.

Economic presence test 

Among the major changes of the common-law principles governing VAT regimes is the inevitable gradual shift from the prevailing residence-based and source-based system of taxation to the economic-based system. The US Supreme Court in Quill Corp. v. North Dakota 504 US 298 (1992) at 306 – 307 (Quill) cited the case of Burger King Corp. v. Rudzewicz 471 US 462 (1985) at 476 where it was held that a foreign corporation purposefully avails itself to the state in personum jurisdiction even if it has no physical presence in the state. However, the US Supreme Court of Appeal in Overstock.com Inc v New York State Department of Taxation and Finance et al 987 N.E. 2d 621, 627 (N.Y. 2013) at 25, overruled the New York’s Court of Appeal decision to hold Overstock.com Inc liable for New York sales and user internet taxes based on the economic-effects test. The US Supreme Court of Appeal found that the rationale based on the economic-effects test deviates from precedent set in Quill at 306 – 307, that physical presence not merely economic contact is the touchstone of the state’s taxing authority under the commerce clause.

Digital reforms

The European Commission (EC) passed Council Regulations (EC) No.1777/2005 on 17 October 2005 (CR), which codify the provisions implementing measures for the Sixth Council Directive 77/388/EEC on the common system of VAT. Article 11 of CR regulates intangible electronically supplied services such as software, music downloads, ringtones, films, e-journals, virtual classrooms, websites, webpages and digitised book contents among others. Article 12 of CR provides for tangible electronically processed products in the form of CDs, floppy disks, CD-ROMs, audio cassettes and games on CD-ROM. South Africa adopted a similar digital tax model imposing VAT on electronic products supplied by vendor’s based in export countries as governed by the Electronic Service Regulations passed by the National Treasury during 2014.

Supply of electronic services

In the new European Union (EU) VAT system as from 1 January 2015, the place of supply of electronic services shall be taxed where the consumer has a permanent establishment rather than where the supplier is established as contemplated in art 58 of the amending Council Directive 2008/8/EC.

VAT grouping

Parent companies and subsidiaries which have financial, economic and organisational links are treated as a single taxable person and identified as members of the same VAT group for VAT purposes according to art 4(4) of the Sixth VAT Directive (see Ampliscientifica Srl and Amplifin SpA C-162/07 at para 19).

Online VAT compliance procedures

Compliance with tax reporting and disclosure procedures through e-filing of VAT returns is not a smooth transition from the conventional paper-based method to the electronic system. The court in LH Bishop Electric Co Ltd v Revenue and Customs Commissioner [2013] UKFTT 522 (TC) at paras 921 – 924, interpreted regulation 25A of UK VAT Regulations 1995 (SI 1995/2518) governing non-compliance with online filing of VAT returns as disproportionate and subject to exceptions, citing exemption of categories of disabled persons, older persons, computer illiterate citizens and those living remotely from internet access.

Aligning international tax protocols with the digital tax model

The United Nations Commission on International Trade Law (UNCITRAL) was tasked with the mandate of developing Model Laws as standard international guidelines on e-commerce in the wake of global digitisation brought about by technological changes in modern business models. UNCITRAL set internationally accepted rules of conducting commerce through electronic means in the Model Laws on Electronic Commerce (MLEC), which was adopted on 12 June 1996. The EU Sixth VAT Directive formulated by the European Commission in Brussels contains a set of rules regulating the VAT rate; place of supply; the tax point; taxable amount; the scope and special schemes. On 1 January 2007, it was replaced by Directive 2006/112/EC.

Implementation of the common VAT system on intangible digital products supplied through the ‘borderless’ internet by technology companies without a physical presence in the forum state dealing at arm’s length remains a complex issue see HMRC v Secret Hotels2 Ltd [2014] UKSC 16 at para 1. Recently, the Court of Justice of the EU in Skandia America Corp. (USA), filial Sverige C-7/13 at para 39, ruled that the cross-border supplies of Information Technology (IT) services made by the parent company based in America to a branch company that is a member of a VAT group established in Europe is subject to VAT at the standard rate. Supply of services by intermediaries shall be taxed at the place where the underlying transaction is supplied in accordance with art 46 of the amending Council Directive 2008/8/EC. Trademarks, trade names, customer lists, customer data and propriety market are characterised as intangibles for accounting purposes for transfer pricing according to art 9 of the Organisation of Economic Co-operation and Development (OECD) Model Tax Convention formulated by the OECD an international fiscal monitoring organization established in 1961 (as outlined in OECD Guidance on Transfer Pricing Aspects of Intangibles Action 8 at 32).

Global perspectives on the digital economy

In a concerted effort to close and tighten loopholes in technology regulations and cyber related laws the South African National Treasury in collaboration with the Sars, saw the imposition of VAT on online digital products supplied by sources from export countries. Some of the products governed by these new regulations are educational services (reg 3), games and games of chance (reg 4), internet-based auction service (reg 5) and subscription services (reg 7) among others. These Electronic Service Regulations came into operation on 1 April 2014 as the date prescribed by the former Minister of Finance, Pravin Gordhan, by proclamation in the Government Gazette, which published the regulations prescribing electronic services for purposes of the definition of ‘Electronic services’ in s 1 of the Act.

Whereas in the US, the Internet Tax Freedom Act of 1998 (ITFA) introduced a three-year moratorium on internet taxes commencing from 1 October 1998 and ending three years after the date of enactment as contemplated by s 1101 of the ITFA. During the 110th Congress of the US, Congress assembled to amend the ITFA in order to extend the moratorium from the beginning of 1 November 2003 and ending on 1 November 2014. On 18 March 2010, the Foreign Account Tax Compliance Act (FATCA), a US Federal law, was enacted by the US Congress in order to combat tax evasion and the under reporting of foreign financial accounts and off-shore assets owned or controlled by foreign financial institutions (FFI’s) including other financial intermediaries. 

In the UK, there are two specific category definitions for ‘UK VAT’ for the Union schemes and non-Union schemes. Under the Union schemes ‘UK VAT’ is defined as VAT in respect of supplies of scheme services treated as made in the UK as contemplated in para 38(1), Part 1 interpretation of Schedule 22 of the Finance Act 2014 (FA). In terms of para 10(2)(e), Part 2 of Schedule 22 of the FA, ‘UK VAT’ in relation to non-Union schemes means VAT, which a person is obliged to pay either in another member state or in the UK in respect of qualifying supplies treated as provided in the UK at a time when the person is currently or was previously a registered participant under the special scheme. Elsewhere, Canada’s digital tax model is basically regulated by the Uniform Electronic Commerce Act (1999) as the primary legislation. Consumers in Canada residing within British Columbia are charged Provincial Sales Taxes for online sales such as acquisition of software or taxable services in terms of s 8 of the Provincial Sales Tax Act, SBC 2012. In contrast, online digital products imported by a recipient in South Africa are subject to VAT in terms of reg 2(2) of the Electronic Service Regulations. 

Conclusion

It is my recommendation that when reforming the common VAT system tax legislators, bearing economic considerations in mind, should incorporate the economic presence test that has gained momentum. Where the incidence of tax being the privilege of deriving economic benefit from markets in a forum state where the recipient receives taxable supplies see Tax Commissioner of West Virginia v MBNA American Bank, 640 S.E.2d 226 (W.Va.2006) at 18 – 24. In view of the evolving commerce the US Supreme Court in landmark cases adopted the substantial economic nexus test when taxing remote out-of-state retailers trading in intangible products online such as trademarks see Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (1993) at 16 – 19 and intellectual property licensed through franchisees see KFC Corp v Iowa Department of Revenue 792 N.W.2d 308 (2010) at 15. Model inter-governmental tax agreements such as the internationally acclaimed US Federal tax legislation, FATCA, is a bold step towards the right direction in future digital economic integration.

Tafadzwa Brian Mukwende (LLB) UP is a candidate attorney at Locketts Attorneys in Nigel.