The Organisation for Economic Co-operation and Development (OECD) released guidelines on applying Value Added Tax (VAT) and Goods and Services Tax (GST) to international trade transactions.
Officially called the “Recommendation of the Council on the Application of Value Added Tax/Goods and Services Tax to the International Trade in Services and Intangibles,” the guidelines are aimed at addressing issues that arise from the uncoordinated application of national VAT systems in international trade. Specifically, the guidelines include recommended approaches for collecting VAT on cross-border sales of digital products.
The guidelines highlight that VAT is designed to tax final consumption in the jurisdiction where it occurs — that is, according to the destination principle. The guidelines note that implementing that principle for trade in services and intangibles is more difficult than for trade in goods. For services and intangibles, VAT systems must have mechanisms to identify the jurisdiction of consumption. These systems are necessary for business-to-consumer (B2C) and business-to-business (B2B) supplies, which are often different from each other.
For B2B supplies, the place of taxation rules should focus on two factors:
- Where the business customer will use its purchases to create the goods, services or intangibles that final consumers will acquire, and
- Facilitating the flow-through of the tax burden to the final consumer.
For B2C supplies, the rules are used to predict the place where the final consumer is likely to consume the services or intangibles.
VAT imposes compliance costs and burdens on businesses and administrative costs and burdens on tax authorities. Examples of costs associated with VAT compliance include the following:
- Administration (costs related to employees, collection, and recovery),
- Infrastructure (costs associated with establishing systems and processes, including making software changes), and
- Finance (cash-flow costs and bank guarantees).
According to the guidelines, foreign businesses shouldn’t be disadvantaged or advantaged compared to domestic businesses. Foreign businesses shouldn’t incur irrecoverable VAT if this is considered “unjustified discrimination” compared to domestic businesses.
A number of approaches can be used in this situation, such as direct refunds to foreign businesses, refunds through a domestic registration procedure, or making supplies VAT-free. Consult with your tax professional, who can help you decide how to proceed.