As policymakers are increasingly taxing everything and everyone (see Proposition 1), the tax treatment between the 'traditional economy' and 'digital economy' is not always aligned; certain trends and actions have, in fact, led to a skewing toward taxing something sold in the digital space even though a special treatment is applied to similar products and services in the traditional economy. This could be because policymakers consider the two types of supplies not to be equivalent, or it could be the result of policymakers struggling to adapt their rules to create parity between digital economy business models that are competing with the traditional economy.
One of the first examples of this disparity is the application of reduced VAT rates to e-books and similar products (e.g., newspapers, magazines, etc.). Several countries apply a reduced VAT rate to books, newspapers, and magazines to foster education and culture, among other things. However, the same rate is not automatically applied in all jurisdictions to e-books and the like. In 2015, the ECJ ruled that Member States were not allowed to apply a reduced VAT rate to e-books as the EU VAT Directive allowed only for the application of a reduced VAT rate to physical books.49 Further, policymakers initially argued that e-books are not akin to paper books because they often include additional features such as links to websites, videos, or audio content. These concerns could have been addressed by limiting the application of the reduced VAT rates to e-books that have the same (or substantially the same) content as paper books. Rather, it took the EU Council until October 2018 to finally agree to allow Member States to apply the same VAT rate to e-books as physical books.50 Since then, countries have slowly started amending their laws to apply the same VAT treatment.51
Another recent example arose in a case heard by The Hague Court of Appeals in the Netherlands, where a virtual sports platform offering subscription-based access to workout videos was unable to make use of a reduced VAT rate otherwise applicable to gyms and other sports facilities (except during a period when special COVID-19 policies were in place) because they did not make use of physical sports facilities.52
The COVID-19 pandemic has only exacerbated these inconsistencies. While employees who could work from home discovered virtual meetings, certain industries had to shift to a “remote” business model as well: education shifted to online remote teaching, healthcare embraced more telemedicine, and even live performance of events such as concerts and theatre started live streaming. While COVID-19 did not create these remote business models, the pandemic was certainly a propellant, and these business models will continue in a post-COVID world as they constitute an additional avenue to generate revenue by reaching a broader audience and providing consumers a convenient means of using the service. Current VAT laws can be an impediment to such business models because they treat the same transactions carried out in the digital economy differently than those in the traditional economy.
For example, imagine a US university in the summer of 2020 had already admitted students to start their curriculum in the fall. By Fall 2020, most universities did not allow for in-person classes and had shifted to remote learning (either through live streaming of a course or offering previously recorded courses). All foreign students admitted to the program could not enter the US territory by the Fall 2020 and had to participate in the curriculum remotely, thus exposing such universities to potential foreign VAT obligations. While most countries exempt educational services from VAT, the exemption is not always available to foreign providers. Many jurisdictions narrowly define education to cover only K-12 type education, a degree-granting education program, or education providers authorized by the local ministry of education.53 The same reasoning is sometimes applied to telemedicine when healthcare should, in principle, be exempt, but the exemption often does not apply to foreign providers because the exemption is often tied to a local licensing agreement.
From a policy perspective such restrictions may be defended as the state wanting to ensure that only persons with appropriate qualifications provide education or healthcare to the citizenry. However, these restrictions were usually drafted in an age before the internet, making the disparate VAT treatment an inadvertent consequence of timing. The question is whether policymakers will start addressing these discrepancies as they have done for e-books or whether they will use regulatory requirements to provide a competitive advantage to local providers by adding VAT to services provided by non-resident providers of the same service in a digital form. Updating these regulatory requirements to consider the change in services offered, delivery models, and consumer needs is a daunting task that does not likely sit high on the priority list of policymakers. Perhaps this would present an opportunity for policymakers to review the application of special VAT treatments such as reduced VAT rates and exemptions and repeal some of them, as suggested by the OECD.54 In the meantime, businesses transitioning from the traditional economy to the digital economy should carefully review their global VAT footprint.
Another area where neutrality among providers of similar services is proving to be increasingly challenging is in financial technology (FinTech) services, which lay at the intersection between two sets of VAT rules. The FinTech industry uses technology and innovation to challenge and provide alternatives to the traditional financial services industry. Examples include online payment processing, online banking, online lending, e-wallets, stock trading applications, and crowdfunding in addition to the various forms of crypto assets discussed further below.
Traditionally, most jurisdictions exempt financial services from VAT for socio-economic reasons and because calculating the value added on non-fee based financial services can be complicated.55 As FinTech companies include a financial services component and a digital services component, policymakers face the challenge of determining whether FinTech services should be treated as VAT-exempt financial services or as taxable digital services. For instance, in many mature VAT jurisdictions, most payment processing services would not qualify as VAT-exempt financial services because they would likely not fit within the strict definition of the exemption. Even in the EU, which has broader VAT exemptions for financial services, the VAT Committee reached the same conclusion in one of its working papers relating to certain payment processing transactions.56 However, payment processors are now an essential part of the digital commerce ecosystem and in the eyes of the average consumer they fulfill the same functions as traditional financial services providers (even though that is not always the case behind the scenes); as a result, policymakers will likely have to review in detail the scope of the VAT exemption for financial services. This review becomes even more critical as technology tools become essential and critical in the supply of many financial services (e.g., trading of stocks, investment decisions, and lending decisions) and traditional definitions of financial services may no longer apply.
The ECJ seems to have acknowledged this as it opened the door for certain software services to fall within the VAT exemption for the management of special investment funds, which until recently was not conceivable.57 Until policymakers address the evolving technology and the differential VAT treatment, FinTech services will unfortunately be subject to greater levels of indirect taxation than competing services in the traditional economy.
In our view, the problem in this area is not with the VAT rules for digital services. Rather, the area that needs to yield is the traditional VAT rules for financial services. As we have argued previously,58 the VAT exemption for financial services represents a historical anachronism. When the design of banking, insurance and trading businesses is such that: (a) they intend to (and profit from) a customer’s daily interactions being almost invariably digital; and (b) they have shifted away from margin-based products to more fee-based products, the existence of broad VAT exemptions for financial services is no longer justified.
As we can observe, the decision to tax transactions in the digital economy is undoubtedly both necessary and appropriate to achieve neutrality with transactions in the traditional economy. However, having made this bold move, policymakers now need to take steps to reform the VAT treatment of the traditional economy to restore neutrality.
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Senior Manager, Global Indirect Tax Services, KPMG in the US
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49 Reuters, France, Luxembourg lose lower VAT rate battle on ebooks (5 March 2015).
50 European Council, Reduced VAT rates for electronic books, newspapers and periodicals.
51 For instance, Moldova just recently exempted e-books from VAT. Moldova - Moldova Applies VAT Exemption of Electronic Books and Periodicals (19 April 2022), News IBFD.
52 Judgment given on 25 May 2022. See:https://uitspraken.rechtspraak.nl/inziendocument?id=ECLI:NL:GHDHA:2022:947
53 See e.g.., Charlene Hu & Philippe Stephanny, INSIGHT: Online Teaching in Higher Education—Indirect Tax Considerations, Bloomberg Law (19 June 2020).
54 OECD, The Distributional Effects of Consumption Taxes in OECD Countries (10 December 2014).
55 The scope of the exemption varies greatly between jurisdictions, with EU countries exempting more services than jurisdictions that have introduced VAT more recently (e.g., China or New Zealand).
56 EU VAT Committee, Working paper No 1038 - Digital payment services – Selected issues in e-commerce (e-wallets, marketplaces and “Buy Now, Pay Later” offerings) (25 February 2022).
57 ECJ, BlackRock Investment Management (UK) Ltd, Case C‑231/19 (2 July 2020).
58 See Wolfers, L “Indirect Taxes: Looking Back and Looking Ahead”, published in International Tax Review as “Future of VAT: Continued Evolution and Increasing Significance,” December 2019.