INTERNET LAW - EU VAT Rules for Electronically Delivered Services

Council Directive 2002/38/EC of May 7, 2002, is the Community law directly addressing and clarifying the VAT basis for assessment to electronically supplied services.  This Directive was introduced to eliminate the then-existing discriminatory tax treatment for electronically supplied services.  Before 2002, electronically delivered services within the EU were subject to VAT whereas those from non-EU Members were not.  Thus, this Directive created a harmonized VAT system for electronic services and a competitive advantage for EU businesses. 

Directive 2002/38/EC defines electronically supplied services as those rendered in electronic form through a network.  Annex to the Directive provides examples of electronically supplied services and include services such as software; website supply; web hosting services; video games, gambling games, including games of chance; cultural; artistic; sporting; scientific; educational and distance teaching services; entertainment; supply of images and information and similar services such as databases; and computer services generally, including distance maintenance of programs and equipment. E-mail communications between supplier and customer does not render a service an electronic one within the meaning of this Directive. Once it is determined that a particular services is considered as supplied electronically, the next important question is to decide the place of taxation for such service for VAT purposes. 

Principles to determine the place of taxation for electronically supplied services constitute the most significant adjustment introduced by Directive 2002/38/EC.   According to this Directive, businesses rendering services electronically should consider the following four principles to determine- for VAT purposes- the place of taxation of such services,

(a) When an EU operator provides electronic services to a business in another EU Member State, the place of supply is the place where the business customer is established.  Germany would be the place of supply for VAT purposes, e.i., in the case of a UK e-commerce business selling e-books to a Germany customer.  

(b) When an EU operator provides electronic services to a private individual in the EU or to a business person in the same Member State, the place of supply continues to be where the supplier is located. 

(c) When a non-EU operator supplies electronic services to an EU customer, the place of taxation, according to the Directive, is within the EU and therefore those services are subject to VAT.  For instance, a US e-commerce software company electronically delivering services to an Italian individual or business is subject to VAT because the place of taxation is deemed to be within the EU.  For this purpose, the foreign supplier must register with a tax authority in one EU Member state to collect and remit the VAT every three months. Yet, an important distinction exists when non-EU operator supplies electronic services to an EU company (not a final customer), this transaction may not be subject to VAT under the "reverse charge mechanism."  Since the EU company will collect VAT when making the final product sale, the non-EU operator sale is exempted from VAT payment.    

(d) Finally, when an EU operator provides electronic services to a non-EU customer, the place of taxation is the place where the customer is located; thus, this transaction is not subject to EU VAT.   Indeed, electronic services rendered by a UK video company to an Argentinean individual or company are not subject to VAT because the place of taxation is outside the EU. 

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