Today’s economy is becoming increasingly digital, and so are businesses. Where companies used to be geographically limited in terms of customer base, today any company can start selling products or services online and reach millions of customers in every country. Governments are struggling to keep up with all the new ways of doing business, and are trying to find ways to secure their tax revenues.
Historically, governments used to simply apply direct and indirect taxes—like corporate income tax, VAT/GST, and similar taxes—to businesses that had a physical presence in the country. But with digital services, service providers are rarely present in the consumer's country, making it hard for authorities to tax them.
Specific tax rules for digital services
As a result, in the past few years, many countries have introduced specific tax rules to ensure they’re able to tax the services provided to their citizens, regardless of where the service provider is established. The basic idea is the same—taxing foreign service providers on the digital services they provide is now seen as a necessity. However, the way each country approaches this is different.
That means companies—large and small—providing digital services are facing an abundance of increasingly more complex tax rules to comply with. But how do you know which rules in which countries apply to you, and whether your services are digital?
What are digital services?
To understand the tax obligations your company may have as a service provider, you first need to determine if you’re offering digital services.
While every country has its own rules and regulations, the definition of digital services is usually similar and reads something like:
“Services that are supplied by electronic means, requiring little or no human intervention.”
In other words, any service rendered electronically through the internet or that involves telecommunications or broadcasting might be considered a digital service.
As digital services require little human intervention, this means they’re highly automated: the end consumer receives the service with no manual work done by the service provider.
Examples of digital services are:
- Software and Software as a Service (SaaS)
- File sharing and cloud storage
- Web hosting services
- Online gaming
- Online membership programs, giving access to content, workshops, etc.)
- Marketplace services, such as app stores, e-commerce services, etc.
- Intermediary platform services (ridesharing, home-sharing, delivery, etc.)
- Digital media subscriptions and on-demand services
Once you have established whether your company is providing digital services that could be subject to tax, you need to understand which rules in which country apply to you. That is usually determined by the location of your customers.
However, establishing your customers’ location (for tax purposes) can be hard. Different countries use different rules to determine whether a service is consumed on their territory and to verify the consumer’s location.
Common factors that determine consumer location for tax purposes include:
The billing address provided by the customer
- If a service is provided through a customer’s telephone landline, the location/country of the landline
- The Mobile Country Code (MCC) of the SIM card used by the customer
- The Internet Protocol (IP) address of the user’s device, or different geolocation methods used by the customer
- Bank details, such as the location of the bank account used for payment, or the address of the customer’s bank account
- Any other form of relevant information or evidence of customers’ location
Every country defines the hierarchy and importance of these factors differently. For some governments, having one piece of evidence on the above criteria may be enough to establish the customer’s location, while for others, multiple points of evidence must be gathered. Needless to say, collecting this information can result in a lengthy signup process and lower conversion rates. This creates a challenging situation: failing to collect all necessary information might be penalized by local tax authorities while requesting all of it upon signup might lead to customer dissatisfaction.
Once you know the location of your customer, the next step is to determine your customer’s taxable status. For tax purposes there are generally two different categories: your customer might be a business or a consumer (non-business).
In most cases, you are only required to charge tax to your (non-business) end consumers and are not required to charge and collect taxes like VAT/GST, etc. from business customers. Your business customers may need to pay taxes, as defined by their local tax rules and regulations, but that’s their responsibility, not yours.
But in order to make the decision if your customer indeed is a business entity, you need to verify their business status and keep proof of it.
There are different ways to determine if your customer is a business or a consumer. For many companies, verifying this with the least amount of friction is crucial for commercial reasons. This can be hard, however, because the exact evidence you need to collect differs per country.
For example, the following documents might serve as proof that your customer is a business entity:
- Chamber of commerce certificate or business identification number
- Tax registration certificate
- Tax identification number (TIN)
If a business customer provides you with a valid tax identification number for its business, in most cases, this is sufficient. But you have to make sure the tax identification number is valid and belongs to that business. In many countries, you can call the local tax authorities to validate a number. Language barriers may make this hard. Luckily, sometimes the local tax authorities allow you to manually verify tax numbers on their website. But doing this at scale is unviable. Services like Fonoa Lookup offer a scalable solution by providing an automated tax identification number validation (through an API).
Registration and remittance
Once you have determined the type of your services, your customer’s location, and your customer’s taxable status, you’ll be able to figure out if and what (local) taxes you need to charge.
If you do need to charge tax, you need to know the rate, and whether you can charge tax on top of your pricing, or whether it has to be included in your shown prices. Unfortunately, governments have different rates for different services, and rates change over time. It can easily become a burden to manually keep track of this to ensure you are charging the right amount of tax to your customers.
To ease the compliance burden on small businesses, some governments have introduced rules around thresholds for small businesses, which means that you do not have to charge tax until you reach a certain sales threshold in that country. Often this is based on revenue coming from that country, but sometimes it can be based on the number of customers, or on your global revenue.
And if a small business regime applies to you, you have to make sure you’re calculating your threshold correctly. Some countries look at calendar years, others at the year till date, or at the last twelve months, or at rolling twelve-month periods. For many businesses, this creates a lot of administrative work and risk.
Once you have completed all these steps, for all countries that your company has customers in, you are ready to proceed with registering in the countries that require it and start charging and remitting taxes. This also means you will have a periodic tax return filing obligation there.
A positive trend can be observed: many countries by now have made attempts to streamline this process and allow you to register and file your tax returns online, in English. Unfortunately, this is not the case everywhere. In some countries, registering for tax purposes comes with the obligation to appoint a local tax representative, typically a local accountant or tax advisor that will help you with your filings.
Failure to comply
Taking all the above into account, it’s clear that compliance obligations for companies providing digital services globally are serious. However, it is important to ensure your company does this right: Failure to comply has serious consequences.
Not charging and remitting the correct amount of taxes will mean your company will at some point receive a tax bill on your past transactions, potentially with an interest rate attached to it. And in some countries, not complying means tax authorities will impose high penalties and fines in addition to the original taxes due.
If your company plans to continue doing business in these countries in the future, you’ll need to settle your tax bills earlier rather than later. There are many examples of governments closing down companies (small and large) that are not compliant or refuse to comply with their tax rules. What’s more, in many countries the company’s directors might be personally liable and face the risk of criminal prosecution in case of non-compliance.
At Fonoa, we have developed a platform that allows digital service providers to meet their tax compliance obligations across the world in a plug-and-play manner. With our Lookup tool, you can automatically or manually validate tax numbers from your customers and suppliers in different countries. Our tax engine easily integrates with your existing systems (API) and automatically calculates the correct amount of tax you need to charge your customers, anywhere in the world. And with our invoice generator, your transactions will always be accompanied by a locally compliant tax invoice to your customers. In their language, in your house style.