Managing indirect taxes in the digital age

Digital blur: goods becoming services

As a result of digitization, items that were previously supplied as goods are rapidly becoming supplied as services; examples include printed books and CDs (goods) that are being sold as electronic books and music downloads (services).

In addition, even where there is a supply of goods, it may be accompanied by a supply of services; for example, when a game player buys a computer game on disc (goods) and then downloads additional features online (services). These changes are having a significant impact on the value chain and on the application of indirect taxes.

Key indirect tax issuesVarious indirect tax issues arise from the shift from trading in goods to trading in services, including:

• Cloud manufacturing Cloud manufacturing is a new, networked manufacturing model. Basically, in cloud manufacturing, manufacturing resources and capabilities are connected through the internet and are managed and controlled using technologies which can then be accessed, invoked and deployed through cloud computing technologies. As cloud manufacturing is basically a service or collection of services aimed at producing physical goods, the activity gives rise to the question of whether the supply should be qualified for VAT/GST as a supply of services or as a supply of goods or even as different supplies. This question is most significant for cross-border supplies or for the manufacture of goods subject to VAT/GST at a reduced rate (such as pharmaceuticals). In the EU, while the Court of Justice of the European Union (CJEU) has in the past provided some criteria for identifying the nature of this type of supply, it is worth noting that those CJEU decisions referred to different scenarios and therefore their application do not always offer the legal certainty needed for concerned businesses to act with digital tax confidence.

• 3D printing Customs duties apply to imports of goods not to imports of services (although some service elements may be dutiable as part of the customs value). The widespread use of 3D printing at the customer’s premises is likely to increase the trend towards shifting the value chain to services. In traditional manufacturing, a manufacturer makes a product and ships it as an item of goods to the customer. VAT/GST and customs duty (if applicable) are calculated on the full value of the goods. However, 3D printing changes the relationship. The manufacturer typically sells the design and knowhow (which is a service) and the end-customer purchases the raw materials to print out the item (goods), often purchased from a separate party. The value assigned to the goods is likely to be low compared to the service element. In this new environment, questions may also arise on the customs duty implications of intellectual property or design investments.

Read more in our article How could 3-D printing upend tax strategies?.

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2 Managing indirect taxes in the digital age

Key indirect tax issues (continued)• Loss of indirect tax revenues

The shift away from physical importations and the reduced value attributed to goods in mixed supplies may have a significant impact on customs revenues for some countries. Potentially, customs authorities may seek to increase the dutiable value of imported goods (see below) or governments may seek to make up this shortfall in higher VAT/GST rates or through additional internet taxes. Governments also risk suffering a loss of tax revenues if e-services are not subject to consumption tax, if cross-border services are not subject to VAT/GST, or if there is no effective way to collect the VAT/GST due (e.g., from final consumers).

• Royalties and license fees Current WTO Valuation Agreement Article 8.1 (C) states that royalty and license fees related to imported goods must be paid as a condition of sale are dutiable. Historically, in most jurisdictions, a transaction can be structured so that payment of the royalty is not a condition of the product sale. WCO Technical Committee on Customs Valuation (TCCV) — Advisory Opinion 4.15 confirms concept that “control” over the purchasing environment can create a practical condition of sale. WCO states that “each case must be considered individually.” There is no comprehensive list on elements of control which are often part of normal commercial arrangements. The latest draft of the EU’s Union Customs Code stipulates three rules with the condition of sale, which may result in more cases of royalties and license fees being included in the custo ms value of goods imported into the EU.

• VAT/GST registration and compliance obligations Vendors of digital services may encounter additional indirect tax compliance obligations that did not apply to sales of goods (because they were taxed at the border by customs). Complying with their obligations is likely to have an impact not only on their accounting systems but also on their customer contracts, pricing and customer interface. This issue is discussed in more detail later in this document.

• Different VAT/GST rules for goods and services Although supplies of goods and services generally fall within the scope of VAT/GST, different rules apply which may include the time of supply, and the place of supply for cross-border sales and even whether a supply is recognized at all (e.g., if there is no payment). Digital goods may be subject to VAT/GST at different tax rates than physical goods, even if the supplier considers them to serve equivalent purposes (for example, printed books may attract a reduced VAT rate in the EU but digital books do not). These differences may have an impact on profitability and create distortions of competition between businesses. Complying with these rules requires the supplier (and potentially the customer) to be aware of the different rules and apply them correctly for each transaction.

• Mixed supplies Many supplies now involve both goods and services (e.g. a boxed game sold with a voucher to download characters). The VAT rules for mixed supplies and for the redemption of vouchers are highly complex, which may increase the risk of errors. The VAT rules on vouchers are complex, and can vary between EU Member States, due to the absence of harmonized VAT rules across the EU. This could lead to potential double or non-taxation. The European Commission is currently in discussions with all Member States to generate harmonized VAT rules on this issue. There may be potential VAT saving opportunities for businesses that sell subscription-based products to restructure these products into vouchers.

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Business modelWe have a number of business models that are developing pretty quickly, and we have three main lines of products.

• One is the traditional box products — the typical games for either the console machines or the computer that traditionally you go and buy at the retail store. You buy the box with the DVD, install it at your console or computer and then you can play it. There are several digital aspects to this side of our business. First, players can buy the product from online shops and download it instead of purchasing it from a physical retailer. Also, various add-ons are offered online or in the game, which are transacted digitally (e.g., special characters, game enhancements). Furthermore, there is a shift from offering the game on a physical carrier, such as a Blu-ray or a DVD, to offering codes/cards in retail packaging. So instead of getting the game carrier in the retail shop, you can get exactly the same box but inside there is paper that includes instructions on how you can download the game. There is a special code, so what you are buying, basically, is a code at the retailer.

Indirect tax senior manager, interactive entertainment company

We interview an indirect tax senior manager at an interactive entertainment company about digital: the VAT challenges and advantages, the impact on indirect tax strategy, relations with tax authorities and tax transparency.

• Our second very big income stream is from games that are typically only available for computers and that are played online in a community of players. For these games, the consumer initially buys the game (installation), plus play time, and then continues based on subscription. What happens is you go to the website, create an account and purchase a product. In most cases, when you first install the product, you can buy it in a box or purchase it online and download it. But the main revenue comes from the subscription. So you can buy time to play online. You can buy tools and accessories to play online. Let’s say you buy a game and you want to level up your character so that you can play the more complicated scenarios. You do that online, and everything you purchase is an online subscription.

• The third pillar is the in-app purchases. These are offered in free-to-play games for tablets and smartphones, etc., and that’s a completely different business model. You download the game application onto your device, typically for free, but then you can buy various options that speed up your progress or enhance your game play, the so-called in-app purchases.

At the moment, our sites are restricted to certain regions. One reason is server capacity, but another is to track revenue for value-added tax (VAT), which is very complicated because of the 2015 rules, especially when it’s business-to-consumer (B2C) sales.

Three biggest VAT challenges from digitalI think that digital poses three big challenges for VAT/GST.

• The first is the speed of development of the digital world as a whole. I immediately think of the product itself, and that’s unlimited because technology is unlimited. Every day, there is a new thing that can happen and a new way of advertising and delivering product to the consumer. That has an impact for us in the VAT world. If you look at our typical box products, historically you went to a store. Now there are various possibilities “accompanying” that physical world and transposing it to the digital. So the combination of these factors is very challenging from a VAT perspective. Often the main question is what to tax and how to qualify it.

• The second thing is that the legislators are running behind digital in every possible aspect. First of all, tax authorities and governments don’t really understand how digital businesses operate. I think that’s applicable not only for businesses like ours, which is partly digital, but I think that’s true even for traditional businesses which may be only supplying goods. That’s because the way that businesses are administered nowadays has been transformed, through shared services centers, cloud computing and data analytics, for example. But VAT compliance and reporting are completely lagging behind.

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• Third, governments are struggling to find a way to tax all the money flowing digitally. All over the world, you see attempts to introduce internet taxes because there’s often no clear way to tax intangibles. This is extremely challenging for businesses because every country comes with a different approach or with different ideas of what needs to be taxed and where. In fact, there’s a huge clash between VAT and the current or even future state of corporate income taxes and transfer pricing, especially with the Base Erosion and Profit Shifting (BEPS) actions. For global businesses — and, let’s be honest, all digital businesses are potentially global — reconciling the very rapid developments in business models and the unlimited possibilities of delivering products to consumers with the much slower approach from the governments and tax authorities is a big challenge.

Advantages from digitalFrom a business perspective, digital provides new ways to make money because it provides so many more ways to bring products to the consumer. For example, we are game producers. Before — when all our games were on carrier media — we needed to have all the logistics in place to reach overseas consumers. That keeps you out of some countries just because the logistics are too difficult and costly. Nowadays, with the same products available online, there are no limits to the potential number of consumers, the range of countries and the range of markets. The possibilities are limitless.

And it’s not just digital products. Let’s talk about something very traditional, like shoes. E-commerce is expanding and disrupting traditional markets, too. Nowadays, you don’t need to travel to a place to buy shoes and only try on the styles that are available in your local stores. You can go online and see the shoes immediately from a whole range of sellers. You have an unlimited choice of styles, brands and prices, and you buy them within five minutes. So the market is so incomparably different and so much bigger, and there is so much more variety than in the past. This trend is something that some businesses will use and explore to thrive, but some businesses will lose out unless they can adapt.

The impact on indirect tax strategyHow do the changes in the digital economy tie into our overall indirect tax strategy? The main thing for me in the last couple of years is really trying to stay on top of the legislative changes. I’m trying to get informed as far in advance as possible about any changes — anything that is expected, any thoughts or movements. Of course, within the EU, that is a little bit easier with the VAT Expert Group and the VAT Forum. But for the non-EU countries, that’s very challenging.

Keeping up with VAT is a little bit easier than changes in other taxes, because whatever somebody invents in the VAT world, it is still a consumption tax. Whereas for corporate tax and transfer pricing, it’s getting really challenging. And the combination of VAT and corporate tax and transfer pricing is becoming very interesting and very challenging indeed with some of the rules that are coming.

At the same time, there are a lot of developments in the business. The beauty of being an in-house VAT person is that I’m involved in anything that will be brought to the market. The business people consult with me about the VAT treatment of new products and new business models, so I’m well aware of what we’re expecting. But I don’t have all the answers! I often have to say, “Here’s what I think we should do and then we’ll see if that’s how it will work in practice.” Trying to stay on top of the products and innovations for the business side — and of all the legislative changes and trying to put them into the system — that’s a very interesting challenge.

Relations with tax authoritiesIt is not my experience in Europe that digital technology is increasing transparency between business and the tax authorities and between business and customers. Unfortunately, in some countries, we are seeing the exact opposite trend. A good pan-European example of this was the project of the European Commission for a single VAT return, which has failed. It seems there is no way that the 28 European countries — which all essentially require the same information on the VAT return — can reach agreement as to which boxes they need and what needs to be reported. You also see it with the way the information is submitted. Even in the leading countries in this regard, a lot of stuff is still on paper, and you would be very surprised by the poor quality of the tools that are being offered for submitting forms online. Even in countries where we are registered for VAT as a nonresident company because we supply B2C electronic services, sometimes the only way to submit VAT returns is on paper.

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Currently, we are seeing a lot of tax protectionism as a result of digital activity, with each country doing its own thing. For example, we are seeing countries explicitly deciding to apply VAT to B2C sales made by overseas suppliers of electronic services because they want to protect local businesses supplying the same services. That’s fair but if you start pushing separatist and protectionist tax systems, you also risk pushing out competition and international investors. The role of organizations like the Organisation for Economic Co-operation and Development (OECD) will be very important because there has to be an agreed mechanism to allocate the authority to levy taxes between the countries. Otherwise, litigation will only grow, and that will not be good for business. For example, if you look at the EU 2015 rules, as a business, we do understand the logic. Governments want to tax consumption. That’s fair enough. But why are they putting the burden for ensuring that onto businesses?

The 2015 VAT changes cost us as a company an enormous amount of money just for the implementation, not to mention the impact of the VAT rate fluctuation. The EU Directive says that the tax applies where the consumer has its permanent address or where it is permanently resident. Who has this information? The tax authorities in the local country! They can track internet traffic, and they know who is resident there. We don’t need all these very complicated ways that have been developed to see where the consumer is located. There must be an easy way for the authorities to share this information between themselves and to get the money in the right country and to get their fair share. But they want to put all the burden on the business. They are trying to use the traditional ways to control domestic taxpayers and apply them to a completely different world, which is the world of the global internet.

I’m hoping that in the next 10 years, digital will change how information is exchanged for VAT, because that is in the interest of taxpayers and tax authorities. I think companies are fed up with compliance just for the sake of compliance. It costs us a lot of money and a lot of effort to comply with everything possible in every country. And in the digital world, it’s just losing its meaning. Legitimate businesses don’t have any interest in noncompliance. A lot of businesses are doing their best. But through the lack of unification, lack of even basic use of the digital means for tax processes, it only makes it more complicated for us and harder to get it right, and that’s unfortunate. So I’m hoping this will change.

It will be interesting to see how tax systems will change as a whole as a result of the digital revolution and the BEPS Project. Corporate tax — conceptually — is supposed to be about revenue-generating functions and assets: where are those located? Where do you have the value? So if you are trying to attract the value to where you have the consumption and tax it there, what will that mean for VAT, which is already a tax on consumption? I’m starting to think that maybe there will be a new tax which will combine both VAT and corporate tax. If I look at the BEPS actions as a whole, I see that a lot of the things are starting to merge. One example is BEPS Action 7, with the permanent establishment vs. fixed establishment definitions. Up until now, in a lot of countries, if you have a permanent establishment, then you very quickly arrive at a fixed establishment for VAT. Now it is looking like it may also go the other way around. At the very least, in the next 10 years, it will be very interesting to see how VAT and corporate tax will interact.

In Europe, we see more and more requirements and less and less effective use of the data. So in countries like that, the single tax file doesn’t make any sense because it’s very difficult to get out to the reporting systems. There is also more and more formality in the way the data is being accessed. At the same time, when you provide the data, you see a lack of technical ability in the tax authorities for them to use the data provided. And in some EU countries, we still encounter massive bureaucratic burdens. For example, it took us five and a half months to have our nonresident VAT number activated in the European system for one country because the local authorities needed to organize physical visits to our fiscal representative’s office.

Furthermore, although the submission of reports may be digital, the time that you need to invest in setting up your electronic compliance is unbelievable because you need a separate certificate and there is a separate program that you need to download for every single type of reporting. So the VAT return, that’s one program. There’s another one for European Commission sales listings. There’s another one for correcting your sales listing, one for the annual submission and so on.

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The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.

Tax transparency Legitimate businesses welcome tax transparency because reputation is very important in the global world, and now tax is a big part of that. So, from the business perspective, greater tax transparency also gives greater protection because once you’ve provided the information, it’s there for all to see and that’s as much as you can do. Therefore, I do think that, overall, companies welcome transparency, as long as it is applied across borders and it’s not every country inventing its own rules. But compliance and transparency are not always the same. What businesses really don’t want to do is provide the same information in an endless number of ways and for an endless number of reports because the compliance burden becomes tremendous and extremely expensive.

Top four priorities for managing VAT in the digital age1 I think the most important thing is to increase digital competence — and that

applies equally for people like me working in the internal tax function and for people working for the tax authorities. Increasingly, I think our function as tax professionals is to be really aware of, understand and have an increased competence in systems. Of course, we need to understand VAT and know the rules and all the case law, but, in reality, there are often gray areas and you have to make judgments. Eventually, you need to say “yes” or “no” and “it’s going to be taxed here or there, and that’s it!” in the system because these are the options that you can submit.

2 I think you need to make full use of the possibilities of the digital age — by that I mean how to use all the information you have and how you can analyze it. This is also very important for the tax authorities, and it goes along with increasing their digital competence. They could ask for so much less information than they do now, but they could do so much more with what they collect, which would reduce the burden on business but increase their efficiency tremendously.

3 I would say that staying on top of the legislative changes is really important because these are happening now quite rapidly.

4 I think it’s important to keep up a dialogue with the tax authorities and cross-border institutions. It’s important to have a mutual understanding about the underlying thought behind certain legislative changes or compliance requirements that will be put in place and what are the interests of each side. Entering into active discussions allows you to reach a mutual understanding of what’s possible and what’s realistic. I think that businesses have traditionally been reluctant to do that because talking to the tax authorities could backfire into an audit. But there are some good examples in Europe of how taxpayers can benefit from greater dialogue, with tax authorities talking to each other more to create a better internal market. The initiative for cross-border tax rulings, for example, is a great idea. I hope it will develop. Of course, this has nothing to do with the digital economy per se, but it is something that immediately impacts businesses trading internationally or going to market innew ways.

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Interview

Cloud manufacturing is a new, networked manufacturing model that depends on the spread of the internet and the development of cloud computing.1 In cloud manufacturing, an entity’s manufacturing resources and capabilities are connected through the internet, and they are managed and controlled using technologies accessed, invoked and deployed through cloud computing.

It can provide secure, reliable, high-quality and on-demand services through networked systems that control the whole manufacturing life cycle, from pre-manufacturing activities (such as design) to manufacturing and post-manufacturing functions (such as management, maintenance, dismantling, and scrap and recycling).

The EU VAT treatmentCloud manufacturing consists of services aimed at producing physical items. One example is 3-D printing,2 which produces physical goods at a remote location. This type of activity gives rise to a number of controversial questions about the correct indirect tax treatment, particularly whether the supply qualifies as a supply of services or as a supply of goods — even whether it consists of different supplies of both goods and services.

The value-added tax (VAT) consequences for the supplier and for the customer may be radically different under each of these scenarios, especially if the supplier and customer are resident in different countries. The characterization of the activity may affect whether the activity is liable to VAT, where any VAT is due and which party in the supply chain is responsible for remitting the tax.

Similar questions have been submitted to the Court of Justice of the European Union (CJEU), which has provided some criteria for identifying the nature of the supply.3 However, the CJEU’s decisions referred to different scenarios, so those criteria do not automatically apply to the services rendered in the framework of the digital economy. This may generate uncertainty for the concerned businesses.

The digital single marketThe EU Commission is well aware of the need for new rules in certain sectors of the digital economy. In its communication A Digital Single Market Strategy for Europe (Com (2015) 192 final), the Commission indicated that it will make legislative proposals in 2016 to reduce the administrative burden on businesses arising from different VAT regimes.

Manufacturing in the cloud — challenging EU VAT

1 Cloud computing has been defined as “… a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction,” National Institute of Standards and Technology of the U.S. Department of Commerce, The NIST Definition of Cloud Computing, Special Publication 800-145, September 2011, http://nvlpubs.nist.gov/nistpubs/Legacy/SP/nistspecialpublication800-145.pdf .

2 The industrial version of 3-D printing is also defined as “additive manufacturing.” www.technologyreview.com/featuredstory/513716/additive-manufacturing

3 In this respect, among others, judgment Aktiebolaget NN v. Skatteverket, C-111/05, 29 March 2007. http://curia.europa.eu/juris/liste.jsf?language=en&num=C-111/05

Contact

Yannick Zeippen+352 42 124 7362 yannick.zeippen@lu.ey.com

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Case study

Managing indirect taxes in the digital age

Are you selling goods or services?How does the digital age affect taxes on consumption, such as value-added tax (VAT) and goods and services tax (GST)? The first key point to observe is that different tests are applied to establish the VAT/GST treatment of goods as opposed to the VAT/GST treatment of services. These tests are likely to result in a different outcome, especially for cross-border sales. As a result, when you are determining the VAT/GST treatment of your supplies, one of the first questions to address is: is this a good or a service?

Most tax authorities generally consider a “service” to be something that is not a “good.” A “good” is generally a physical, tangible item. In most cases, it will be clear whether something is a good or a service (e.g., can you touch it?). However, as our world goes digital and moves toward the cloud, enabling machines to talk to each other and exchange data, the border between goods and services gets thinner and thinner.

In the aerospace industry, for example, many products now have sensors to report to the business how they are functioning and when they need replacing or servicing. As a result, many businesses in this sector are moving from selling spare parts to adopting a diagnostic subscription or maintenance service model.

The 2016 World Economic Forum in Davos4 featured the first robot delegate, “Hubo the Robot,” and confirmed that we are truly living in the age of the Fourth Industrial Revolution. By 2020, it is estimated that5 50 billion devices will be connected and communicating with one another, including people wearing clothes linked to the internet, and home and commercial appliances sending and processing real-time data.

The Internet of Things (IoT) is quietly infiltrating more and more businesses, in an increasing variety of sectors, changing how they operate. Examples include retail, automotive, health care, manufacturing, aerospace, pharmaceuticals, telecoms, media and technology.

Is your company ready for the tax and legal changes that this new industrial age will bring?

Indirect tax in the Fourth Industrial Revolution

1 Find more information here: www.weforum.org/events/world-economic-forum-annual-meeting-2016/sessions/the-internet-of-things-is-here

2 World Economic Forum, Are you ready for the Internet of everything? www.weforum.org/agenda/2014/01/are-you-ready-for-the-internet-of-everything

What is IoT? The Internet of Things (IoT) refers to the network of physical objects integrated with software and network connectivity, enabling them to connect and exchange data.

Taxation of softwareThe taxation of software demonstrates that the same type of product may be classified as a good or a service for VAT/GST purposes, depending on the exact specification. Let’s consider an example from the UK: if a consumer buys a standard “off-the-shelf” software package from a retail store, the software is generally classified as goods for VAT/GST purposes.

However, if the customer buys a bespoke or specific (i.e., nonstandard) piece of software, it changes from a tangible item (“a good”) to a service, because the buyer is effectively paying for the software provider’s know-how rather than a product. In this case, any physical form of the software (e.g., a disk) is only a medium used to carry the information, and it would generally be considered ancillary to the supply of services.

Can we apply the same analogy to the taxation of IoT? If so, what criteria can be applied to determine the VAT/GST treatment? Should we use the value of software integrated in any hardware carrier or the value of the communication services collected by IoT? How “bespoke” does something need to be for it to switch from a good to a service?

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Insight

The power of big dataWe live in a digital age, and the amount of data we produce is growing exponentially. With “datafication,” the volume, speed and variety of data are changing constantly, combined with new techniques for storage, access and analysis. This trend will only increase — things will never again change as slowly as they do today!

Impact on businessesWith the level of data and the speed of change, your business should examine a number of commercial and tax considerations:

• Ownership Who owns the data collected by IoT devices? Can data be sold to a third party, for example, to an agent? When this data is sold “as is,” with no analysis or adaptation, is it a supply of a good or of a service under the current indirect tax legislation or tax authority interpretation?

• Differences among countries While digitization and the growing amount of data are global phenomena, the speed of adoption by consumers, businesses and tax authorities differs from country to country. Where adoption by tax authorities is swift, we may see a shift in the interpretation of the difference between goods and services. How should your business monitor the different interpretations among countries? And what does this mean for your products?

• Management Can data collected by the IoT device be processed by a third party, for example, a PR company that analyzes trends in customers’ behavior? Does this affect how tax authorities would view the supply chain or the place of taxation?

The automotive sectorIn many sectors, companies are using the power of digital technology to provide new goods and services, allowing them to connect with their customers in new ways and to enter new markets. Companies within the automotive sector typify this shift from being traditional “goods” businesses to becoming “service” industry providers. Examples include:

• Supplying new services and apps (e-services) under a periodic subscription, e.g., car diagnostic services and GPS services

• Partnering with telecommunications providers on in-car phone services, broadband and media entertainment

• Switching from selling business-to-business (B2B) to business-to-consumer (B2C): moving from sales made via distributors or resellers to selling goods and services directly to the customer for the digital service element

• Changing ownership models: consumers who traditionally would have purchased a car (i.e., a good) may now choose a flexible service model, such as a “rent by the hour” or a car-sharing arrangement (i.e., services)

All these examples will result in a host of complex VAT/GST issues. How and where these activities are taxed are likely to be new considerations for operators in the automotive and other “traditional” industrial sectors.

• Storage To store the volume of data collected by IoT, will your business require increased server capacity? Does this increase the risk of fixed establishment for VAT/GST purposes or a permanent establishment for corporate tax purposes in any foreign jurisdictions?

• Taxable presence How is your business adapting to the digital age? Will it change your business model (e.g., selling directly to consumers rather than via distributors)? If so, will that increase the risk of creating a fixed establishment or a permanent establishment in any foreign jurisdictions?

• New taxes Communication services are often regulated and may face an additional “telecoms levy.” These regulations may differ from country to country. How can your business stay on top of all these requirements and whether they are “in scope” for different types of taxation, especially as your business grows and changes?

• Record retention As countries increasingly seek to tax supplies of electronic services to local consumers, they may have strict requirements for proving where the customer is and whether it is in business. For example, a customer may use a smart watch at an internet cafe in Dubai to monitor his summer house on the French coast, but his usual place of residence is the UK. Where should tax apply? Your business needs to anticipate the needs and habits of these increasingly mobile consumers, especially when onboarding new customers and gathering evidence to substantiate the customer’s “place of belonging.” But tracking the customer’s location may create a significant cost. How can you balance these demands?

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Insight

Indirect taxation and a new digital realityIoT is likely to be the next economic game changer for businesses in all sectors and in all markets. It will change the way we work and how businesses operate, and it may help optimize supply chains by making them shorter and more efficient and effective. These changes will revolutionize not just business activities but also taxation and tax reporting.

Business digitalization is already disturbing the “status quo” in financial and tax compliance reporting. The Organisation for Economic Co-operation and Development (OECD) has started to address the new digital reality as part of its Base Erosion and Profit Shifting (BEPS) Project, which was launched in July 2013. The final package of reports was issued in October 2015, followed by the European Commission drafting an Anti Tax Avoidance (ATA) Directive in February 2016. These legislative developments will shape the tax landscape for years to come.

However, if the last decade has taught us anything, it’s that technology generally evolves faster than tax legislation. Bear that in mind with your business, and keep adjusting and adopting your internal systems and process to the new digital reality. More and more, you will need to recognize the importance of keeping the tax department connected with what the business is planning in terms of innovation and new products. Bringing the tax department closer to the commercial heart of the business will help your company embrace the Fourth Industrial Revolution. Contacts

Rosie Higgins+44 20 7980 9194 rhiggins@uk.ey.com

Sylwia Dulczewska+44 12 2339 4618 sdulczewska@uk.ey.com

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Insight

We helped a multinational software company adapt its product delivery and operating model.

The challengeOur client is a multinational software company that develops programs for architects, designers and manufacturers of various products. The company has had a stronghold in the business-to-business (B2B) space for years, but it has faced a number of commercial challenges in recent years.

With the increasing accessibility and capabilities of the internet, its product delivery has shifted from shipping CDs containing the programs to making the programs available for download. Customers are also demanding new service models, such as the ability to rent a software package for a certain period while it is needed, rather than buying the software outright. These changes took the company from supplying goods to supplying services.

The widespread adoption of 3D printing has also brought changes by creating a large pool of amateur designers who have brought the company into the previously unknown business-to-consumer (B2C) market.

Lastly, the company is reviewing its original operating model (with a central company overseeing the business in Europe and interacting with its wholesale customers through commissionaires), and it may move to a model involving a network of distribution subsidiaries.

Our challenge was to help the company accommodate these changes in a cost-effective manner that would improve its compliance performance on value-added tax (VAT) and reduce risks.

What we didBased on our experience with similar structures, we supported the company with indirect tax advice and with input about the correct accounting treatment for their transactions and the setup of their reporting system.

This journey began with the design of a transaction-based reporting system that allowed the company to correctly reflect

the VAT treatment of supplies made through the commissionaires while also creating the correct accounting entries and deferred revenue recognition for the centralized principal company as the legal seller of the products. This setup was chosen to accommodate transactions in both goods and services, and to support the commercial trend toward supplying downloaded software.

The move into the B2C channel required a different approach. By creating a new company to serve B2C customers directly and registering this new company in various Member States through the Mini One Stop Shop system, the client achieved a reasonable setup for both their B2B and B2C businesses.

As the company’s business model evolves, the improvements already made to its enterprise resource planning (ERP) system should allow it to adapt quickly and cater effectively to any future commercial changes.

Software company

Contact

Marc Schlaeger+45 51 58 28 22 marc.schlaeger@dk.ey.com

12

Case study

Managing indirect taxes in the digital age

Global Director of Indirect Tax

Gijsbert Bulk+31 88 40 71175 gijsbert.bullk@nl.ey.com

Americas

Jeffrey N. SavianoNew York +1 212 773 0780 Boston +1 617 375 3702 jeffrey.saviano@ey.com

Robert S. Smith+1 949 437 0533 robert.smith5@ey.com

Asia Pacific

Adrian Ball+65 6309 8787 adrian.r.ball@sg.ey.com

Europe, Middle East, India and Africa (EMEIA)

Kevin MacAuley+44 20 7951 5728 kmacauley@uk.ey.com

Global Trade

William M. Methenitis+1 214 969 8585 william.methenitis@ey.com

Neil Byrne+353 1 221 2370 neil.byrne@ie.ey.com

Contacts

Excerpt from Managing indirect taxes in the digital age. Read the full report and access interactive content at ey.com/indirectdigital .

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About EY’s Indirect Tax servicesIndirect taxes, ranging from value-added tax (VAT) and customs duties to environmental levies, affect the supply chain and the financial system. They pose unique challenges to multinational tax functions since they must be managed accurately and in real time. These often invisible taxes can have significant impacts — on cash flow, absolute costs and risk exposures.

Thanks to our network of dedicated Indirect Tax professionals, who share knowledge and ideas, we can provide seamless, consistent service throughout the world and help you deal effectively with cross-border issues. These include advising on the VAT treatment of new and complex transactions and supplies, and helping resolve classification or other disputes and issues with the authorities.

We provide assistance in identifying risk areas and sustainable planning opportunities for indirect taxes throughout the tax life cycle. We can provide you with effective processes to help improve your day-to-day reporting for indirect tax, reducing attribution errors and costs, and making certain indirect taxes are handled correctly.

We can support full or partial VAT compliance outsourcing, help identify the right partial exemption method and review accounting systems. Our customs and international trade teams can help you manage customs declarations, audit and review product classifications, and evaluate import and export documentation. Our globally integrated teams can give you the perspective and support you need to manage indirect taxes effectively.

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