The Convergence Of Digital Services And Indirect Tax In APAC

As economies evolve and businesses adopt the use of disruptive technologies to drive commercial value, tax regimes have been playing catch up in how to apply...
Worldwide Tax
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As economies evolve and businesses adopt the use of disruptive technologies to drive commercial value, tax regimes have been playing catch up in how to apply indirect taxes to services consumed domestically that have been supplied from nonresident entities abroad. The Asia Pacific region is no different, as it is currently seeing the broadening of VAT and GST application on the supply of cross-border digital services.

However, to understand what the changes are and why they have come about, it is important to also understand the indirect tax landscape in the Asia Pacific region.

Indirect Tax in the Asia Pacific Region

Based on our experience, there are four key observations that reflect the current landscape of indirect tax in the Asia Pacific region. These are:

  • Territorial regimes, differing in legislation from country to country.
  • Government fiscal policies increasingly relying on VAT and GST to achieve budgetary strategy.
  • Overarching taxable classification for many supplies.
  • Renewed audit and controversy activity.

In relation to territoriality, the Asia Pacific region is unique in that it is not a single trading bloc or institution like, for example, the European Union. Therefore, each country in the region has its own VAT and GST regime and this can result in different indirect tax treatment of supplies, including digital service transactions, from market to market. It also means that companies engaged in cross-border activity often do not have the entitlement to claim any VAT or GST credits incurred in overseas markets, which may lead to indirect tax leakage. Therefore, operating in the Asia Pacific region can involve multiple VAT and GST registrations and diverse indirect tax implications in cross-border transactions.

Creating Tax-Based Revenue Streams

Evidently, indirect tax regimes in the Asia Pacific region are also being used to generate government revenue and incentivize business activity. Practices in Indonesia and Vietnam are just two examples. Indonesia recently passed a law which saw the VAT rate climb to 11 percent from 10 percent in April 2022, with the rate to become 12 percent by 2025. This is directly aimed at reducing Indonesian fiscal deficits. On the other hand, Vietnam had seen COVID-era lockdowns hamper factory activity. As a result, the government has instituted a regulation that provides a temporary reduction of VAT liability by from 10 percent to 8 percent. The broadening of VAT/GST to cross-border digital service supplies is also a method by which Asia Pacific governments are seeking to increase tax-based revenue streams.

Separately, in the Asia Pacific region many jurisdictions have a default taxable classification on transactions. Therefore, supplies that in other regions such as the EU or United Kingdom are zero rated are typically taxable for indirect tax purposes unless proven otherwise. This is true for China, Indonesia, Thailand and Vietnam.

Finally, local tax authorities in the Asia Pacific have returned back to work post-COVID, often back to physical office premises. We have therefore seen an increase in audit activity aligning with the return to work. This is true for Japan, Thailand and Indonesia where VAT audits and controversy had bottlenecked during COVID but now have cleared as authorities attend physical premises for reviews. As a result we are continuing to assist our clients as they respond to local tax authority queries in the indirect tax environment, including in the context of cross-border digital services. 

With all the changes abounding, it is clear that the paradigm for VAT and GST in the region has changed. Regimes are broadening their tax base and increasing the importance of VAT and GST as a revenue raiser. Indeed, the application of VAT and GST on digital services is an example of this.

VAT/GST Is Not a Digital Services Tax

It is important to distinguish between VAT/GST on digital services and a digital services tax (DST). While many discussions are occurring at a global level regarding VAT and DST, these are fundamentally two different tax types. VAT is a broad-based consumption tax. It is borne by the end consumer and will typically require a business establishment in the jurisdiction in which the tax applies. 

Comparatively, a DST is applied on services where users create the value. Registrations are determined based on revenue thresholds. Currently no markets in the Asia Pacific region have implemented a DST. Australia and New Zealand have separately discussed potential implementation (with New Zealand even introducing a DST bill into its parliament) but both countries currently have decided to withhold on further application of a DST. 

Therefore, when we refer to VAT or GST on digital services it is in reference to the application of indirect tax to cross-border supplies of services using digital means by nonresident entities (i.e., those entities without a presence or physical place of business in the market). It is not a DST and it is not relevant for domestic supplies of online or digital transactions that will be captured by existing VAT and GST rules and regulations.

Cross-Border Digital Services

From China in the north to Australia and New Zealand in the south, almost all Asia Pacific markets have implemented or legislated that VAT or GST will apply to digital services. While each jurisdiction will have its own regulation and guidance, in general a digital service can be defined to be cross-border supplies of streaming of music, films, apps and games, the provision of e-books, subscription-based media, listing services in an online marketplace, online support services, and web, cloud and storage services. While not an exhaustive list, it can be noted that any cross-border service that relies on information technology or the internet to facilitate its provision will need to be considered in the context of these evolving VAT and GST rules. 

Many regimes in the Asia Pacific region are concerned with the supply of cross-border digital services to consumers — that is, to nonregistered individuals or parties located in the country in which the VAT or GST applies. That is not to say that supplies to local businesses are not captured, but often the complexities in VAT or GST treatment occur when supplies are made to consumers. To exemplify the difference, we can look at the rules in Singapore, which may require nonresident entities to register for GST if they supply digital services to local consumers (subject to turnover thresholds). If these same services are supplied to a GST-registered business in Singapore a reverse charge mechanism will apply which mitigates the need for nonresidents to register when making these supplies.

A key takeaway from this example is the requirement of nonresident entities to register for local VAT or GST and charge, collect and remit VAT or GST to local authorities. In many Asia Pacific markets, simplified VAT/ GST registrations are available. It is thus seemingly easier for nonresidents to register in foreign jurisdictions but this often restricts their ability to claim any local input tax, and so there is only tax outflow and no tax inflow. While the requirements to register and the registration application process may differ between countries, one thing is for certain — entities providing cross-border digital services face an additional indirect tax compliance burden as well as pricing pressures from having to charge local VAT or GST to customers.

The Way Forward for Businesses

In light of all these changes, what does it mean for businesses adopting technology as part of their service offering? There are key practical considerations to keep in mind. 

First, are contracts for services signed by cross-border entities? Indeed, it is the cross-border element that is the driver for many of these VAT and GST outcomes. Localized transactions will be captured by prevailing VAT and GST rules and regulations (i.e., as domestic taxable supplies). 

Second, who is the recipient of the supply? It is above mentioned that the requirements to register and VAT/GST outcomes may differ according to who the recipient is. Therefore it is critical to understand whether supplies are made to registered entities (that is, registered for VAT or GST) or to local consumers. An interesting point to consider is whether the increased registration requirements will trigger a permanent establishment (PE) status for corporate income tax purposes. While some markets such as Australia, Malaysia, Thailand and Vietnam have explicitly stated that PE status will not be triggered, it is to be seen whether the registration for simplified VAT or GST by nonresidents is an element that local authorities consider when they assess PE. 

Finally, given that VAT or GST may be required to be charged to end consumers, it is important to understand whether current pricing models will be affected by the imposition of indirect tax. That is, if VAT or GST needs to be charged on cross-border supplies, do underlying contracts contain necessary gross up clauses?

A Case With Multiple Registration Outcomes

As a recent example, we assisted with assessing the VAT registration requirements of a Vietnamese domiciled app creator in the Asia Pacific region. This client had two business models for going to market. One business model relied on third-party platforms to sell and distribute its apps to consumers. The other business model encompassed selling and distributing apps directly to business customers without the third-party platform. In other words, the latter business model operated with direct business-to-business transactions. Importantly, the entity supplying the apps was the Vietnamese entity only. The client had not registered or incorporated local entities in other Asia Pacific markets.

There are key characteristics that resulted in different registration requirement outcomes depending on which business model was assessed. For example, model one relied on a third-party platform and sold apps to consumers that were typically not registered for VAT or GST in their local market. The other model was a direct-to-business model where the business was a VAT/GST registered business.

Overall, the model selling apps to consumers triggered VAT and GST registration requirements. This was due in part to the supply being made to consumers. Interestingly, however, in certain markets such as Australia and Taiwan (PRC), for example, the third-party platform was responsible for registration and not the Vietnamese app creator. 

The client's direct-to-customer model did require further analysis in Malaysia and Indonesia, for example, as these regimes also include business-to-business transactions to be considered for overseas vendor VAT and GST registrations.

A&M Tax Can Help

In summary, we are clearly seeing a broadening of VAT and GST regimes in the Asia Pacific region, but this is not necessarily an impediment to doing business. Rather, it means we need to consider whether registration requirements will apply and what this means for the compliance profile in overseas markets where our clients are operating. Importantly, we can assist our clients by analyzing their cross-border digital services to determine VAT and GST implications across the region. 

Originally published 12 June 2024

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.

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