Working paper regarding qualification as electronically supplied services for VAT purposes
The European Commission (EC) on November 19, 2024, published Value Added Tax (VAT) Committee Working Paper No. 1090 regarding the qualification as electronically supplied services (ESS) for VAT purposes of sales of “skins” (i.e., digital items that change the appearance of a character or item without affecting gameplay) in the secondary market. The Working Paper presents a detailed step-by-step analysis by the EC VAT Committee of how to determine when a service qualifies as ESS for VAT purposes.
ESS are defined as services delivered over the internet or an electronic network, when the nature of the service makes its provision essentially automated and involves minimal human intervention. These services cannot be ensured without the use of information technology. The VAT Implementing Regulation provides an indicative list of services that qualify as ESS, emphasizing their automated nature and reliance on digital technology.
ESS are always taxable in the country where the customer is located. In case of business-to-business (B2B) transactions, the customer is liable to self-assess VAT under the reverse charge mechanism while for business-to-consumer (B2C) transactions, the seller (even a nonresident) must register for, collect, and remit local VAT. However, for B2C services that do not qualify as ESS, the transaction is in general sourced at the location of the seller, unless another sourcing exception applies. Therefore, it is essential for businesses to determine whether their services qualify as ESS or not.
This interpretation has become more important with the rise of cryptossets. The VAT Committee has been discussing the implications of non-fungible tokens (NFTs), which in a previous Working Paper it determined to qualify as ESS. The EC believes further discussion is necessary to determine if the sales of skins in the secondary market qualify as ESS under EU VAT legislation. Indeed, while the initial sales of skins generally are considered as ESS, resales of these skins by players are not necessarily automated as required by the VAT Implementing Regulation and therefore it could be argued that they do not always qualify as ESS.
The Working Paper outlines the following steps to determine if a service qualifies as ESS:
1. Check if the service is listed in Annex II of the VAT Directive or Article 7(2) of the VAT Implementing Regulation or its Annex I
2. If the services do not fall under (1), verify if the service is excluded under Article 7(3) of the VAT Implementing Regulation
3. If the services do not fall under (1) and (2), assess if the service meets the criteria in Article 7(1), which includes being delivered over the Internet, being impossible without information technology, and being automated with minimal human intervention
According to the VAT Committee, the supply of skins, whether in the primary or secondary market, is not explicitly mentioned in Annex II of the VAT Directive or Annex I of the VAT Implementing Regulation. However, the VAT Committee recommends considering their inclusion under Article 7(2) of the VAT Implementing Regulation, which provides an indicative list of ESS, including "the supply of digitized products generally."
However, neither the EU VAT legislation nor the Court of Justice of the European Union (CJEU) have provided any clarity of the term “digitized product.” Based on the VAT Committee's analysis, "digitized products" must be understood as encompassing products or services based on digital technology existing in a non-physical form. Therefore, skins, being digital products, could be seen as covered by Article 7(2) of the VAT Implementing Regulation, qualifying them as ESS. Further examinations under the second and third steps are deemed unnecessary if the service is already covered by Article 7(2).
As an alternative, the VAT Committee offers an interesting analysis under step 3 as they dismiss the application of step 2 in this case. In this respect, the VAT Committee considers that skins must be considered as (1) service delivered over the internet or an electronic network and (2) their provision is impossible to ensure in the absence of information technology. However, the VAT Committee highlights that the involvement on the side of the seller is essential to determine whether the services meet the last criteria (i.e., whether the nature of the services renders their supply essentially automated and involving minimal human intervention) and therefore a case-by-case determination may be required. In this respect, the VAT Committee provides several examples of secondary sales of skins. If the secondary sale is automated, the transaction likely qualifies as ESS. However, if the seller is involved in the secondary sale (e.g., the seller is tasked with accepting, refusing or making a counteroffer to the offeror) the secondary sale does not qualify as ESS.
The Working Paper provides helpful guidance on how to determine whether a transaction qualifies as ESS. With respect to the secondary sale of skins, the initial conclusion reached by the VAT Committee offers a practical and straight forward approach for businesses and tax authorities. The alternative would require businesses and tax authorities to perform complex analysis taking into consideration each “manual” step the seller performs. It would also open the door to argue that certain transactions do not qualify as ESS and thus circumvent the requirement to collect VAT on B2C transactions by simply adding some “manual” components. It would also potentially result in different tax authorities taking different positions on the sufficient level of involvement of the seller to consider as service not qualifying as ESS.
Unfortunately, the VAT Committee has not yet addressed the obligation of platforms facilitating the resale of skins. Under EU rules, platform operators facilitating the sale of ESS are considered acting as an undisclosed agent and thus performing a buy-sell of the ESS to the end-consumer (thus shifting the VAT collection obligation from the seller to the platform operator). If the secondary sale of skins qualifies as ESS, this would mean that in principle platform operators facilitating these sales are liable to collect VAT on these sales.
However, the CJEU held recently in Credidam (case C-179/23) that the general undisclosed agency rules on which the platform liability rules are based are not applicable when the underlying transaction is outside the scope of VAT. As highlighted by the VAT Committee in a previous Working Paper, the resale of skins may be performed by private individuals that are not performing economic activities (and thus are considered outside the scope of VAT). Therefore, the question arises whether platforms facilitating the resale of ESS are still liable for VAT or not based on the Credidam case. Read TaxNewsFlash
Philippe Stephanny| philippestephanny@kpmg.com