UK: The Application Of VAT To E-Commerce In The European Union

Last Updated: 1 March 2001
Article by Tim D. Wilkie

Co-written by Peter Jenkins (Ernst & Young)

A Commentary On The EU Draft Directive On Digital Goods & Services


The advent of e-Commerce – business transactions taking place through the electronic transmission of data over communications networks such as the Internet – has altered the business model in important respects, by creating new sources of revenue, new and much less cumbersome routes to market, new alliances and synergies between businesses, new and different supply chains and fulfilment models. It has also altered the traditional ways of valuing businesses, placing a premium on growth of the customer database and the potential of new ideas and technology, rather than more solid measures of profitability, though this may now be changing. Also it has created huge uncertainty about taxation, both sides of the Atlantic, particularly in the area of consumption taxes, which is the subject of this article. Can the existing tax base be maintained, particularly given the difficulty of tracking B2C sales over the Internet? Can offshore/out of State on-line providers of goods and services be made to account for consumption taxes? Can they be collected some other way?

Underlying this debate is a growing realisation among tax collectors that perfection in this area is just not attainable in the real world – there is no paradigm solution to all the problems. In the end, there are bound to be a series of compromises or trade-offs between the need to ensure "bricks and mortar" businesses do not lose out to unfair competition from the 'dot-com's and the need to maintain the revenue yield without placing wholly unrealistic compliance burdens on the new businesses whose concern is with growth and markets, not with paying taxes. There is also a strong concern to ensure that the basic integrity of the existing taxes is maintained, which means that whatever new rules are put in place have to be credible and realistic, that is to say enforceable in practice, at least against the bigger players. It is already the case that no consumption tax can be enforced and collected 100% or anything like it – the variable is always the relative size and competitive distortion caused by those choosing to trade in the black economy.

The Perception Gap Between The US And The EU

Perhaps the easiest way of describing this gap is by pointing out that, while in the US the debate is still about whether to tax the Internet and the new business it generates, in the EU it is purely about how to do so. The questions of jurisdiction, nexus and legitimacy that are still the subject of furious debate and proposals and counterparts in the US Congress are not regarded as open questions needing resolution in the EU. As the EC Commission put it in the working paper presented to the Council of Ministers on 8 June 1999 on the VAT aspects of e-Commerce:-

"Any long term business strategy which assumes on-line sales can be made in the Community without regard to VAT would be most injudicious."

In the EU, VAT is seen as a broadly based consumption tax on all types of consumer expenditure which is not specifically relieved by exemption and unlike most sales taxes, it applies equally to goods and services. Overall it raises one fifth of all tax revenues, and nearly half of "own resources" in the EU, making it a most important revenue earner for the Member States. All pleas for a moratorium on infant industry or other grounds against the application of VAT have been rejected from the beginning – as have proposals for replacing VAT on Internet sales with some other method of taxation (for example a bit tax).

The assumption has been that, with whatever adaptations are needed, VAT will be successfully imposed on e-Commerce sales, even those services which are supplied digitally on a B2C basis for downloading by the consumer in his own home. It is recognised that securing the cooperation and compliance of the greatest number of offshore operators may well require carrots as well as sticks, though a stark warning note is sounded:-

"For an operator, even one located outside the EU, to risk exposure to significant and unresolved tax debts in the world's largest market place cannot be considered prudent business practice…. The presence of such a liability is hardly likely to assist in access to legitimate capital or funding resources."

The US Position

In the US, the scene was set by the Internet Freedom Act of October 1998. This provided for a three-year moratorium on Internet Access taxes, unless these taxes were in effect before 1 October 1998, and a similar three year ban on multiple or discriminatory taxes on electronic commerce. The Advisory Committee on Electronic Commerce was set up by Congress to conduct "a thorough study of Federal, State and local and international taxation and tariff treatment" of Internet transactions and access to it. Although the ACEC, chaired by Governor Gilmore has come up with simple majority resolutions in favour of extending the moratoria and prohibiting taxation of sales of digitised goods and products, these do not have force. By contrast, the approach favoured by Utah Governor Leavitt is to approach the issue on lines more familiar in the EU (how, not whether):-

"The debate is not about new taxes on the Internet, but how the states will collect taxes already on the books and whether those states will remain sovereign in the right to collect those taxes."

His proposals include the development of uniform tax base definitions for e-commerce, accepted and uniform sourcing rules and uniform audit procedures, tax returns and use of technology (e.g. electronic filing). These proposals have been taken up in Congress by would-be reformers of sales and local taxation (SALT) whose belief is that a streamlined and standardised version of such taxes can be made to work. Three bills on these lines encouraging States to reach "compact agreements", clearer rules to determine State jurisdictional nexus and simplified sales and use tax rules and procedures are currently under consideration in the Judiciary Committee of Congress and its Sub-Committee. The potential trade-off between streamlining and reform of SALT and effective rules to require remote sellers to collect tax on consumer sales into a state is recognised as a promising way ahead: but it still has many opponents inside Congress who continue to argue for a permanent extension of the moratoria on Internet Access taxes and on new multiple and discriminatory taxes.

The underlying difference in the US is that State and local tax collectors already have a huge difficulty in collecting sales and use taxes from sellers (whether conventional mail-order or on-line) who supply consumers from out-of-state locations and have no presence there sufficient to create nexus. This arises from a fundamental conflict between the principle in the US Constitutions 14th Amendment (which gives a State the right to impose its tax powers on a person who "purposefully directs its business activity into a state") and the Commerce Clause which prohibits a State from extending its tax jurisdiction to persons that do not have a "substantial nexus" with that State – which the Supreme Court has established means the taxpayer must have physical presence in that State. The case of Quill v. North Dakota in 1992 established that businesses are not responsible for collecting a use tax unless they have a physical presence or nexus in a customer's home State. Where there is still room for debate is how far the Quill tests – derived from mail-order transactions – read across to Internet sales, where the presence and use of www sites accessible to persons in the State, the use of ISP's and servers located in the State, and the use of service providers for transmission of information and of local affiliates for marketing and sales raise new points which will sooner or later be put to the test as States try to defend their tax base. However, new Federal law on this whole subject, whether on the basis of a trade-off between simplicity/reform and compliance or some other basis seems a long way off. As the October 2001 Internet Moratorium deadline approaches, the newly convened 107th Congress will want to find some way of resolving these issues – which boil down in the end to those which exercise the tax collectors in the EU, how to collect consumption taxes on remote "no substantial nexus" transactions with final consumers.

The EU Position

However, the issues still outstanding in the EU VAT context are far more narrowly defined than is the case with US SALT. Fundamentally the issue boils down to the narrow (but not easy) issue of how to enforce VAT collection on supplies of digitised products from remote (i.e. non-EU) on-line sellers to final consumers resident in the EU where the supplies are down-loaded on their home PC's or other equipment. This is because supplies of goods, being physical events requiring an importation into the EU, and B2B supplies of services do not raise nexus or enforcement issues of the kind raised in the US.


In the case of physical goods, it makes no difference if the Internet is used to trigger a mail-order delivery: tax will be collected, if necessary from the delivery agent and by him from the customers, when the goods pass the frontier on importation, the only exemption being postal deliveries under a threshold (which varies from EUR 22 in some Member States to only EUR 10 or even nil in others, especially for mail-order sales). In any case those trying to set up and operate "remote" mail-order businesses from outside the EU soon find they run into severe practical and logistical problems, and end up having to set up at least one local distribution centre.


In the case of B2B supplies of services, the EU answer is simple – apply the reverse charge so that the responsibility for remitting the tax passes from the supplier to the tax registered business customer, who treats it like any other intermediate transaction in the supply chain (i.e. he deducts the tax as a credit and passes it on to the next person in the chain – only suffering a restriction if he makes "exempt" supplies, e.g. financial services or healthcare). The problem at present is that "reverse charging" does not apply to the full range of services which can potentially be provided via the Internet, so the first change to the existing VAT rules needed is to widen the scope for reverse charging, making it in effect co-extensive with Internet deliveries. The other more practical requirement is to deal with the question of identification of business customers – how can the on-line service provider determine that the person he is dealing with really is a business customer and not a final consumer masquerading as one to obtain a VAT-free delivery? The Commission's answer is to recognise the need for an on-line 24 hour verification system to check the existence and validity of VAT registration number, the assurance being that if the supplier makes the necessary check before completing an on-line transaction, his liability will be at an end, and tax will be collected by self-assessment from the business customer.

One criticism with this approach is that by removing the need for compliance in the case of B2B suppliers, the EU is placing a psychological bar in the way of compliance for B2C supplies, particularly if they are in the minority.

So far as B2B supplies are concerned, therefore, the main problem identified in the EU is widening the scope of the reverse charge to cover the potential range of services and products capable of being delivered via the Internet, at the same time putting in place the on-line systems needed to enable the supplier to distinguish between business and non-business customers.

In the case of services, there are also problems of nexus to be resolved when the supplier is offshore. The basic rule in Article 9(1) does require the supplier to have his seat of business or a fixed establishment in the EU before VAT can be applied. For certain types of supply, for example those in Article 9(2)(e), the VAT liability will rest with the customer under the reverse charge where he receives a supply from a supplier based in another country, but only if he is in business. This is precisely the problem at present – while most B2Bsupplies can in practice be picked up under the reverse charge principle, so that VAT is accounted for by the customer, B2C supplies from third country suppliers of on-line services cannot effectively be taxed.

Supplies within the EU between the Member States will be treated broadly as now – B2B will be VAT-free from the Member State of export, but subject to the reverse charge in the hands of the business customer at the rate in his own Member State, and B2C supplies will be taxed in the Member State of origin, the supplier charging the customer his rate of VAT and paying it over to his taxing authority. The preservation of these intra-EU arrangements in the e-commerce environment is of some importance – it is also implicitly under threat.

The core of the EU's current legislative proposals is therefore intended to deal with the problem of B2C supplies of digitised products to final consumers in the EU.

The Commission has recognised that any system of self-assessment based on a reverse charge system extended to final consumers would lack any credible means of enforcement and would bring the tax swiftly into disrepute – exactly the problem experienced with use taxes in the US, where taxpayers have persistently failed or refused to recognise their obligations, and with GST in Canada. The Commission has also rejected ideas put forward for an alternative avenue of collection, for example a withholding tax collected by the banks issuing payment cards and/or by the clearing and payment systems used to manage these transactions, because of the lack of tax critical information available, the sheer practical difficult of distinguishing between taxable and non-taxable transactions, and dealing with multiple VAT rates. The only alternative, inevitably, is to "lasso" in the off-shore on-line supplier, by compelling him to register and account for VAT on his sales to EU final consumers, even if he has no "substantial nexus" with the EU (in the sense of the presence of people and equipment) but only a website accessible to those consumers.

The Proposed Draft Directive

The Commissions' proposals, in the form of a draft Directive amending the Sixth Directive published on 8 May 2000, recognised that to achieve this objective in the real world would require a good deal of persuasion and cooperation as well as legal certainty (largely lacking under the existing rules) and means of practical enforcement. In short, carrots as well as sticks. The Commission's scheme had three main carrots on offer:-

  • A single place of registration enabling the operator to discharge all obligations for EU VAT with a single administration. This would normally be the first Member State where the first taxable supply is made – it would not require a fixed establishment to be present.
  • An exemption from registration for non-EU businesses whose annual level of sales within the EU is below EUR 100,000
  • The facility of completing electronically all procedures in relation to registration and making of tax return, together with electronic invoicing.

Under the EU legislative system, the Commission alone can propose legislation, but the Council of Ministers representing the 15 Member States must agree unanimously (in the case of tax) to adopt it before it can be implemented in the domestic law of the Member States. The Council can, to an extent, modify the Commission's draft in order to reach an acceptable proposal. In this particular case, the modifications since May 2000 have been extensive – and involve the removal of the most important carrots, while leaving the sticks. In particular under a "compromise" proposal drawn up by the French Presidency, the single place of registration idea has disappeared altogether, leaving a requirement that an on-line service provider should register and account for VAT in all the Member States in which he trades – subject to a much reduced registration threshold of only EUR 5000 per Member State (that is up to only EUR 75,000 in the EU as a whole).

Belgium, supported by the Commission, has proposed an alternative formulation of the earlier proposal – central registration in a single Member State with breakdown of receipts on a macro-economic basis between those Member States where actual consumption of services from that operator takes place.

This harks back to earlier ideas put forward by the Commission for a single place of registration for EU business with a clearing system to direct tax receipts to the Member State of consumption. This was rejected by the Council of Ministers as impractical and open to abuse; there is little reason to believe a lesser version of this rejected idea for non-EU operators would be likely to achieve unanimous approval.

So what is the great concern? It has to be remembered that VAT rates vary from as low as 15% in Luxembourg to 25% in Denmark and Sweden, and the higher rate Member States fear that third country operators will contrive to register in mass where the rates are lowest, and may even opt for the special status of registration in Madeira, where the rate is only 12%. Such registration would give them, in effect, "Community privileges", i.e. the right to supply final consumers all over the EU at the rate of VAT in the Member State in which they now have their base – leading to feared loss of revenue and "unfair" competition.

Lowest Standard VAT Rates By EU Jurisdiction


VAT Rate



















At risk in this debate is the survival of the intra-EU place of supply rules for all e-Commerce supplies in the EU, not just the third country ones. The high rate Member States would clearly like to remove the "arbitrage" advantage that on-line service suppliers already based in the EU enjoy – by moving to a general "place of consumption" test. Fortunately this would require a change to the long-established place of supply rules in the Sixth Directive, which is unlikely to win unanimous support from the Member States.

It is important to remember that the proposed changes only affect certain supplies of services delivered by electronic means – wider reform of the place of supply rules for other services (which is clearly necessary as the rules are over-complex and lead to confusion and anomalies) is promised as the next step in the Commission's programme to modernise the Single Market's VAT system. The affected services are:

  • Cultural, artistic, sporting, scientific, educational and entertainment services
  • Supplies of software
  • Data-processing
  • Information
  • Computer services (such as web-design and hosting)
  • Satellite broadcasting

The proposals do not affect these services if delivered other than by electronic means, genuinely "free of charge" services such as free downloads or free access to information, or supplies of other types of services such as basic telecommunications and use of the Internet just as a means of communication between parties.

How soon are the changes likely to be adopted? Given that the most controversial aspect put forward by the Commission – the right to register in only one Member State – has disappeared under the compromise proposal drawn up by the French Presidency, the proposals arguably have a greater chance of early adoption than before, and the French Presidency is pressing hard for agreement on adoption of its compromise proposal at the 27 November 2000 Council of Finance Ministers (ECOFIN) with a view to early implementation. At present, the betting is against this, because of the difficulty of getting unanimous agreement, but much will depend on how far the VAT authorities see their revenues becoming genuinely threatened by third country suppliers over the coming months.

Finally, on the question of registration in one Member State, non-EU on-line service providers should keep one important point in mind. If they want to "come out of the cold" and register for VAT in the EU, they can already do so by setting up a fixed establishment in one Member State of choice and conducting their EU trade from there – they will then have the Community privileges already referred to. Although this will require putting people and technical resources in place – as well as careful consideration of the direct tax effects of having such a permanent establishment – it may well be a better option than registering separately in each Member State once the EUR 5000 threshold has been exceeded, and Madeira, with its Treaty of Accession protected 12% VAT rate and much improved business infrastructure may be an attractive option for an EU 'dot-com' headquarters.

Madeira, a full EU Member State, has many benefits in addition to the VAT rate. As well as having good communications, labour and transport infrastructure, it also has preferential tax regime as part of a EU State Aid funding structure. This was approved by the EU to stimulate inward investment and reduce Madeira's dependency on tourism. As part of this financial commitment by the EU (which also includes a programme to increase the GDP per capita), the EU recently provided, through the EUREGIS and Cohesion funding, the financing structure for the new Ł300 million rebuilding of the airport which can now handle Boeing 747's and 3.5 million passengers a year.

The days of buying a shelf company in an offshore tax haven location (or any location) and putting up a brass nameplate have finished. An operating presence, with the management powers is a necessity for the Tax Authorities to accept that the company is resident in that location. On the 11th April 2000, the Director of the UK Inland Revenue's International Division, Gabs Makhouf, said in his Lisbon speech:

"In the UK, we take the view that a web site of itself is not a Permanent establishment. And we take the view that a server is insufficient to constitute a Permanent Establishment of a business that is conducting e-commerce through a web server.

We take that view regardless of whether the server is owned, rented or otherwise at the disposal of the business".

Permanent Establishment is the rule that Governments use to decide where companies should be taxed. It is not, therefore, a viable proposition for a UK company to set up a server in Madeira, Luxembourg or the United States, whilst effectively managing the business from the UK, as the basis of operating in a low VAT EU jurisdiction or outside the EU. Similarly, setting up a server in the Cook Islands does not solve the problem unless substance and management can be demonstrated in that jurisdiction. As a guidance, the EU Commission announced on the 28 June 2000 and new aid scheme IP/00/670 as a State Aid under Article 87 of the Treaty. This was in the form of tax-free allowances. An eligible firm (who would receive tax-free allowances) was defined as requiring to have, amongst other matters, their registered office, centre of management or stable establishment in the jurisdiction to which this State Aid applied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.