Electronic interfaces, platforms and marketplaces form a key layer in the digital infrastructure behind e-commerce, serving as gatekeepers between consumers and producers of digital content or digitally sold products.
These gatekeepers offer third-party companies access to a global market by providing their own infrastructure. It is therefore not surprising that their growth is often driven by a strong influx of third-party companies, which can expand internationally with their products and content without having to build their own technological infrastructure.
An increasing number of online retailers use such platforms for their e-commerce businesses, which has made these platforms an integral part of compliance procedures.
The EU VAT reform
On July 1, 2021 there was a big change in the European Union’s Value Added Tax (VAT) law, impacting online retailers, marketplaces and their e-commerce businesses across the EU. Since 1993, the VAT law in the European Union concerning cross-border e-commerce was in large part unchanged and was originally introduced for mail order businesses that used catalogues.
But EU member states realized a few years ago that EU VAT law was no longer on track with the developments taking place in the e-commerce ecosystem.
In the worst case, non-compliance with these regulations will mean that VAT will not have been paid for thousands of transactions.
This has led to many problems for marketplaces like Amazon, as they have a significant number of third-party merchants based outside the EU. For example, third-party merchants account for about 50%-60% of Amazon Germany’s revenue, and more than half of these merchants based in China.
The VAT problems that arise from this led to enormous tax losses in the past, because third-party merchants, especially those from China, did not declare the VAT that was actually due in the EU, giving them a huge market advantage over the EU merchants. The EU has recognized this and initiated the VAT reform, which primarily places responsibility on the marketplaces.
The EU VAT e-commerce package, under specific circumstances, can make online sellers and marketplaces liable to pay VAT and leads to certain challenges and risks.
Since July, it has been key for marketplaces to determine the VAT due for every transaction and establish related processes such as VAT rate determination, invoicing, filing and reporting. This is applicable to marketplaces when they are liable to pay tax on transactions by sellers not based in the EU or for distance sales from non-EU countries.
Marketplaces have to be aware of additional indirect tax regulations to avoid massive tax and financial risks. Not adapting to the new regulations can result in paying VAT and interest retrospectively for the sales made on the platform. In Germany, this would mean paying 19% VAT on the net sales, with fines and interest added on top. In countries like Italy, the surcharges can reach up to 240%.
Broad range of VAT rates across the EU
It is not only necessary for online merchants to determine the VAT rate for their products, but marketplace operators, being liable for VAT under certain circumstances, also have to ensure the application of the correct VAT rate in every EU member state.
As rates vary widely from country to country, this is a complex task that involves high risk. Firstly, marketplace operators have to determine which VAT rate is applicable. Then, they have to review whether some of the reduced VAT rates are applicable to their product groups and in which member states.
Greater VAT filing complexity
Filing reports has become more complex. Marketplace operators are now liable to pay VAT, and different procedures and the new Import One Stop Shop (IOSS) policy co-exists alongside local VAT registration procedures.
Both the One Stop Shop (OSS) and IOSS policies are simplification mechanisms. Generally, without OSS/IOSS, every online merchant had to register to pay VAT, file VAT returns, etc. in every member state where a good is sold to an end customer, resulting in an enormous amount of bureaucracy.
The OSS/IOSS mechanism allows taxable persons to only file one VAT return per quarter, but that should include all distance sales. Furthermore, VAT is paid to only one tax authority, which then distributes the VAT to the respective member states in which VAT is due.
Marketplaces that are treated under the new regime can also use OSS/IOSS to avoid bureaucracy burdens. While using the OSS/IOSS mechanism, most of the former VAT registration obligations became widely unnecessary.
Joint liability for unpaid VAT
In the last few years, several European states have adopted the concept of joint liability for unpaid VAT for e-commerce. This means that under certain circumstances, marketplace operators will be liable for unpaid VAT resulting from transactions carried out on their platform. Independent of the e-commerce package, Germany recently adopted such a regulation, as did France, Austria and Great Britain.
These various regulations come with extensive recording and validation obligations for marketplace operators to ensure that merchants selling their goods in a certain country fulfill their tax obligations.
Risks and consequences
The outline of the legislative changes that came into effect on July 1 shows that the reform impacts merchants and marketplace operators enormously.
Here are some risks they face in case of non-compliance with the new rules:
Financial and reputational impact
In the worst case, non-compliance with these regulations will mean that VAT will not have been paid for thousands of transactions.
This can result in (a) huge financial impact due to the subsequent payment of VAT (e.g., 19% in Germany), including potential fines and interests depending on the member state (e.g., 6% in Germany, or up to 240% in Italy), and (b) the risk of criminal proceedings due to non-compliance with tax obligations.
Effects on compliance processes
Marketplaces have to act immediately to avoid severe consequences from a compliance perspective. As explained above, it is essential to determine the correct tax rates to pay. Marketplaces must ensure the correct tax determination on the transaction level to declare whether the online merchant or the marketplace itself is responsible for paying tax.
Overall, marketplaces face two major challenges: Determining the right amount of taxes to be paid on an individual transaction level and determining tax rates. In both cases, marketplaces are dependent on the information they receive from merchants.
To tackle this, platforms can implement an automated VAT determination solution that covers the following:
- Automated real-time VAT determination on the transaction level to decide who is liable to pay VAT on a sale.
- Determining VAT rates for products being offered on the marketplace.
- Provide invoicing to the end customer.
- Reporting and recording obligations.
OSS should bring relief, but the opposite is the reality
The EU reform should remove the last barriers of the single market — which seeks to guarantee the free movement of goods and services within the EU — for the digital economy in terms of VAT. But companies that rely on the latest logistical technologies in e-commerce face big challenges, as seen above.
Thus, the EU reform does not do justice to modern e-commerce. Online retailers also face higher risks, such as double taxation, if taxes are declared incorrectly.
Furthermore, the OSS only supports limited transaction types, which is far from the reality in the e-commerce ecosystem.
So far, only a few types of transactions can be declared via the OSS, such as distance sales to end customers and electronic services to end-customers. Therefore, B2B transactions and some local transactions still have to be declared via the traditional, decentralized (national) VAT filing regime.
Businesses therefore have to maintain at least two different VAT compliance schemes (traditional and OSS). In practice, we expect that many online traders will declare and pay double VAT on some of their sales due to a lack of compliance mechanisms in place.
Unlike before, the marketplaces now stand to become tax debtors. For VAT purposes, these marketplaces were previously only service providers used by online retailers, but due to the reform, they are treated like a common online trader.
As a result, marketplaces can no longer benefit from their pure service provider status and have to fulfill all VAT obligations that previously were the seller’s burden.
Special rules for VAT reform could be mapped technologically
All these aspects that could be implemented without any problems by simply leveraging technology. I understand that the EU member states are currently not prepared to hand over comprehensive competencies to the EU on the subject of taxes and thus bring about a truly consistent simplification of VAT processing for online sales.
It could still be years before such a simplification is achieved. For the time being, online retailers should continue to implement more technology in their e-commerce processes, and marketplaces should address compliance requirements to act in conformity with the law.