Exploring The EU VAT E-Commerce Reforms

Liz Armbruester, Avalara’s senior vice president of global compliance, discusses the recent EU VAT e-commerce reforms and their impact on businesses and consumers worldwide.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: VAT update.

On July 1 the European Union’s sweeping reforms to the value added tax took effect. The changes, which most notably affect online purchases in some EU member states, were delayed six months due to the COVID-19 pandemic.

How are businesses in the EU reacting and adjusting to these new VAT rules? How will the reforms affect customers in both Europe and the United States?

Here to talk more about this is Tax Notes legal reporter Kiarra Strocko. Kiarra, welcome back to the podcast.

Kiarra Strocko: Thanks, Dave. It’s great to be here.

David D. Stewart: You’ve been covering this issue for Tax Notes. Could you tell us some background on why these reforms came about and their significance?

Kiarra Strocko: Of course. The VAT e-commerce package was adopted by the EU Council in December 2017 with the aim of reducing administrative burdens affecting intra-EU trade while also reducing VAT fraud. These new rules also aim to place EU and non-EU businesses on an equal footing, which promotes fair competition.

As you mentioned, the rules were originally supposed to come into force on January 1, but, due to recent challenges this year, they were postponed to July 1. These rules are significant because they reflect the rise in cross-border e-commerce and will impact most businesses around the world.

The new measures include a rule that will make online marketplaces that facilitate cross-border sales responsible for collecting and remitting tax on deemed supplier transactions. Also, their forms eliminate the VAT exemption for the import of low value goods, so now all goods imported to the EU are subject to VAT.

These new rules are very important because under traditional rules, businesses that sold online goods needed to register an account for VAT in the member state of the consumer when the sales exceeded a certain threshold. But now businesses can register and file VAT in a single member state.

David D. Stewart: Now, you recently spoke with someone about this. Can you tell me about your guest and what you talked about?

Kiarra Strocko: I spoke with Liz Armbruester, who’s a senior vice president of global compliance operations at Avalara. She provided insight into the nuances of the EU VAT system and the overall effects of the changes that were implemented. We thought it was interesting that the EU VAT system was last updated in 1993 and now these VAT changes are occurring amid the slowdown of the pandemic and talks for an agreement on a two-pillar global tax reform plan.

We also discussed the why behind the VAT reforms, its potential to close the e-commerce VAT gap, and the overall VAT gap in the EU of €140 billion that was reported in 2018. We also focused on the implications for large and small businesses and whether non-EU and EU businesses are truly prepared six months later to handle the new changes.

It was nice because Liz provided examples of when online marketplaces may become the deemed supplier and apply the change to different business scenarios. She also provided an overview to the VAT One-Stop Shop (OSS) and the Import One-Stop Shop (IOSS) system, and discussed lessons learned from the Mini One-Stop Shop (MOSS) that was launched in 2015 and addressed any challenges we might face ahead.

David D. Stewart: All right. Let’s go to that interview.

Kiarra Strocko: Welcome to the podcast, Liz. It’s so great to have you here. What a perfect time to be discussing EU VAT reforms and their implications with the new rules coming into force at the start of this month. It’s the calm before the storm potentially from an implementation perspective.

Liz Armbruester: Thanks, Kiarra. Great to be here with you today and talking about this really significant change that is going to impact a variety of sellers around the globe.

Kiarra Strocko: As a result of some of the EU VAT reforms like the introduction of the VAT One-Stop Shop scheme, EU companies are now allowed to declare and pay VAT in a single member state. What implications does this have for e-commerce sellers? Does this mean that some sellers will now be put at a disadvantage?

Liz Armbruester: I think it’s a great question, and I think saying, “Hey, listen, we haven’t had this significant of a change in overhaul since 1993,” really speaks to the implications of how fast commerce is changing. It’s taken the EU reforms and the regime a bit of time to pick up the pace, recognize that, and really get everybody back on a level playing field.

But when we think about the One-Stop Shop and the Import One-Stop Shop, commonly known as OSS and IOSS, it is important to recognize first and foremost that when you hear those terms, that’s actually not what’s creating the disruptions themselves. Right? Those are the methods. Those are the tools, if you will, that sellers will be able to utilize to help simplify the changes that are coming as a result of the reforms that go in to effect on July 1.

When I think about that prior to July 1, one thing, first of all, that comes to mind is the distance selling thresholds. Right? Those existed and were basically in effect to require foreign companies to VAT register once they exceeded a selling threshold specific to that country, which ranged. They were $35,000 to maybe all the way up to $100,000.

Beginning the first of July, the VAT package actually withdraws those distance selling thresholds. Cross-border sellers have to charge the VAT rate of the customer’s country of residence at the very first sale and remit it to the foreign tax authorities. On first glance that looks like, “Wow. That’s a huge compliance burden for sellers. They have to go out and VAT register everywhere that they’re selling.”

But the reform package says, “Nope. We’re actually going to create some simplification there.” That looks like an extension of the single VAT return. It is that one-stop shop to e-commerce, cross-border selling, distance selling of goods. That replaces that obligation to VAT register in every country where the sellers are making sales to EU consumers. It creates, again, a simplification, and that existing obligation to register in all the countries is then removed. That’s a big change.

Kiarra, this can be really complicated for sellers to try and absorb. I think a key call out here, and you highlighted it in the introduction, is to really think about who this applies to and what transaction types really fall under that OSS and IOSS simplified scheme.

The first one is business-to-consumer [B2C] sales of goods shipped within the EU, and then there’s business-to-consumer sales of goods shipped from outside the EU. If you have those B2C sales shipped from within the EU, that’s again where the benefits of OSS come into play. If you have B2C goods shipped from outside the EU, that’s where IOSS comes into play. It makes it easier to register and remit VAT.

One key callout, if you fall into that latter category, you’re outside the EU, you have to consider the necessity of an intermediary, and that is a representative established in an EU state. It’s kind of similar to fiscal rep requirements that exist in many EU member states today. I don’t know if there are any U.K. sellers potentially listening, but there are some real complications right now with whether that intermediary applies to U.K. businesses or not. So, just to key callout to those folks that are still working through whether that applies or not.

But last, and an aside kind of from OSS and IOSS, there’s one other piece of consideration with this reform that will impact sellers, and that is around deemed marketplace. Those reforms, of course, hit the first of July as well. In this particular situation, the marketplace deemed supplier rules apply to a marketplace that are established outside of the EU, or they’re bringing goods into the EU.

Under those rules, the marketplaces will be responsible for handling the VAT reported for sales made by third parties on their platforms. It’s a lot of change all intended to do the things that you mentioned, which is reduce fraud and create the level playing field as well. But for businesses, even with the models of simplification, it can still be a heavy lift.

Kiarra Strocko: Another major change is that now, like you said, online marketplaces that facilitate cross-border sales will be responsible for collecting and remitting that on deemed supplier transactions. Could you provide us with a short overview of this change and any implications of this from a non-EU perspective?

Liz Armbruester: Sure. Happy to. The marketplace deemed supplier rules apply to marketplaces that are established outside of the EU or bringing goods into the EU. Under the rules, the marketplaces are going to be responsible for handling the VAT reporting for sales made by third parties on their platforms.

Once that marketplace is determined to be the deemed supplier, the sale that happens between the seller and the customer in effect is now treated as two separate transactions for VAT purposes. The first part looks like the seller selling the goods to the marketplace. It’s the simplest way to explain it. That becomes a business-to-business tax exempt sale and no EU VAT is due.

The second part of the transaction is when the marketplace sells the goods to the customer, and that becomes a business-to-consumer sale with the marketplace now being responsible for collecting the VAT that’s due based on the customer’s country of residence. Kind of that destination sourcing idea that a lot of folks in the U.S. are well versed on.

Here’s an example, just to kind of help cement that for the audience. If a U.S. merchant is selling goods to a French and a German customer through an online marketplace prior to the reform, the seller has to be VAT-registered in France and Germany in order to charge the 20 percent VAT to the French customer and 19 percent VAT to its German customer.

Effective first of July under the new rules, the seller becomes basically the underlying supplier and the facilitating marketplace becomes the deemed supplier. They purchase the goods from the seller. They resell them to the EU customer. They collect the VAT. They report the sale through either the local VAT registration or the single EU import OSS for those sales.

What’s important for the marketplaces is, of course, they have to keep detailed records of those sellers’ transactions to show that the VAT has correctly been accounted for. They have to electronically maintain those records for 10 years per the rules.

Also, I think important is the marketplace will not be held liable for underpaid VAT if the seller fails to provide the correct information required for the VAT calculation, and the facilitating marketplace can reasonably show that it wasn’t aware of the error.

There’s some really important nuances to make sure that the seller takes care of in this two-part transaction if they’re selling goods through the marketplace and deem supplier is the methodology that’s used.

Kiarra Strocko: Thanks so much, Liz. That seems like a very complex part of the new rules. It seems like businesses are genuinely trying to stay compliant. Do you think they’ve been given the adequate resources to facilitate a smooth implementation? I know the commission has issued explanatory notes and has provided detailed outlines on the changes, but is this enough?

Liz Armbruester: Well, I think based on the number of businesses that are compliant today, I would say this is a heavy lift for businesses. I think the tools are there with the simplification of how do you report.

But if we go back in time and think about the fact that these reforms changed the way that businesses invoice a customer, when and how they calculate the tax, and not only how they remit it, it’s, like I said, a big lift for businesses to try to figure out how to do. They have to set that correct tax calculation, and that can be a change within their system today.

For importers who didn’t have an import threshold, who now do and have the model of IOSS to be able to facilitate these imports of low value goods, they now have this obligation that they have to calculate tax at the point of sale. Again, that’s different.

It’s hard to say whether they have the tools in place or not because it does go back all the way up the supply chain to the point in time where the transaction happens. It’s not just about when the business has to go out and report their transactions.

Setting tax calculations to be accurate. No. two, ensuring the pricing of the accuracy of the online goods for those sellers who will be under the obligations of IOSS. Those sellers, again, have to charge the VAT at the time of the transaction. Getting that rate right on a country-by-country basis, they may have the tools in their system to do that today. They might not from a how-do-you-do-it perspective around the rules.

Yes, I would say they have the tools to do it, but the actual implementation of that for a business could be really, really tough.

Downstream of that, do they have the tools to understand the reporting requirements? Do they have the models to be able to consolidate transactions and get that data where it needs to be? I would largely say yes, but it is a heavy lift.

I would go on to say that I think maybe for some businesses that are out there, the impact could be that the complexity of these rules may guide them to a place of saying, “Hey, I don’t even want to sell into the EU any longer because of the complexity.” I’m not saying that’s a large number of businesses, but I do think it’s a consideration because not only is it complex to understand, but the actual costs to do it.

If you go back to my example of you have to get the tax rate right at the point in time that you’re doing the sale, there might be some compliance costs there. There might be a lift for that business to ensure that they can get those right rates done. If those compliance costs are too high, it might not make sense for that business to continue with those types of sales.

If that checkout process doesn’t include the right cost and they get it wrong, the customer at the end of the day, who is now in the EU, might face additional costs. They might refuse the product. The business now has to deal with a return. In some cases, some sellers might not want the administrative hassle for those direct sales. Maybe those businesses might choose to only sell through marketplaces.

Your question, I think, can go in so many different directions. As I’ve just said, it really depends on the perspective. I think the rules, yes. The understanding, I think we’re getting clarity. I think the implementation of that for many businesses can actually be pretty tough and it’s going to take some time for businesses to get compliant.

That’s not unlike what happened in the United States with regard to Wayfair. It’s taken a while for businesses of all sizes, not just the small ones, but for a business of any size to actually be compliant with the new economic nexus.

Kiarra Strocko: Thanks, Liz. Absolutely. Do you have any recommendations for businesses, especially smaller ones? You were talking about compliance costs and the burdens, and if you have any insight on what could be useful for businesses to utilize in this scenario.

Liz Armbruester: Well, without a doubt. I mean this level of lift for businesses of any size can be significant. And just the manual nature of trying to deal with tax complexity seems a little bit crazy to me when you’ve got digital technology that can work in your favor.

There are a variety of automated solutions that can address the entire VAT compliance life cycle, including the registrations, calculations, and reporting, and businesses can certainly benefit and tap into that. I think technology in this particular instance is really a friend to business. It becomes an essential component to help businesses not just get compliant, but remain compliant.

Because that’s one of the most challenging nature I think of tax in and of itself is that it’s not static. It’s going to change just as much as this reform is representative of that. There will be reasons why we’ll see tax reform in the future. We know that there are upcoming changes that will impact future sales into the EU. So, again, leveraging automated solutions, leveraging technology to help a business not just get compliant, but remain compliant with future changes can really be a significant lift.

Why I think that’s so helpful for this period of time is for the reasons that I had stated before. Businesses have to manage the checkout process now in a way that they very likely haven’t had to do previously for these low value goods that are being imported into the EU. You want to make sure that a business can get those taxes calculated accurately because at the end of the day, if they do it wrong, not only do they have a compliance issue, but they might have a customer satisfaction issue. That’s what drives business. They want to make sure that they’re retaining their customers, they’re selling more, et cetera, et cetera. If they put that at risk, then they’ve got a whole different issue to deal with aside from just making sure that their tax compliant.

Kiarra Strocko: Speaking of technology, I like that point you made about how the One-Stop Shop and Import One-Stop Shop are the methods and tools that sellers will use. I was wondering if you foresee any technical issues arising or any problems in the transmission of that returns and back paid via the secure communications network?

Liz Armbruester: Yeah. Any time that new technology comes in into play, we might be subject to a little bit of disruption and a little bit of normalization around the processes. That can be said of really any technology; the way in which that it’s implemented, it’s used, the data is transferred, et cetera. There might be a few bumps in the road, but I think the more that we see adoption increase, we begin to see those issues start to smooth out.

You’re going to see a rapid adoption, I think, over the course of the next six months with more and more businesses coming online to do this. I think those points in time where we’ve got technological issues or issues of other kinds, where the business doesn’t fully understand how to be compliant, let alone how to use the technology in and of itself for the reporting mechanism. I think those will smooth out.

With the institution of any net new change comes even some unforeseen issues. It’ll take a little bit of time to work through those.

Kiarra Strocko: Yeah. That’s really interesting. Are there any lessons to be gained from the implementation of the optional VAT MOSS  scheme?

Liz Armbruester: I think again, as you think about it from the government’s perspective, the adoption rate, right? It’s how transparent can we be with the information with the change? How easy can we make it for businesses to actually adopt? In theory, sometimes you can imagine sitting in a room with a bunch of people, you come up with an idea and you’re like, “Yeah, this sounds really simple.” But in practicality, the implementation of it sometimes can be really tough. I’m not just talking about tax here.

I think alongside with that, what a lot of businesses and the government saw was on paper it looks really good, but in practicality, maybe we had some unforeseen hurdles. Some of those have been worked through as they expanded MOSS into OSS and IOSS, and that came around the information share. How much information was available out there? How much lead time was available? As we said, there was a bit of an extension here for known reasons.

But I think all of that led to getting the word out and helping businesses understand how they can be compliant and utilizing tools that really in effect actually can do the things that the EU reform was intended to do. What I don’t think anybody yet completely has wrapped their arms around is just how long it’s going to take.

I mean, again, if I flip back to the marketplace facilitation laws, now we’re on the third anniversary of Wayfair. I would imagine that most people said in June of 2018 that it would take probably a year, maybe two, to get a large margin of our businesses online and being compliant. I don’t think that anybody expected even at the third year out from Wayfair that there’s still a significant number of businesses who are not compliant.

I think that might be the case here. I think the expectation of how fast businesses will comply probably won’t meet the expectations of what the governments would like. I think they’d like it to be sooner. I think it’s going to take a little bit longer. But I do think that again, some lessons learned along the way have helped facilitate that.

If businesses can be out-leveraging technology to help them get on board with these changes, and then kind of future-proof, if you will, the next round of changes that will happen and keep them compliant as their business grows, they’ll be in better shape.

Kiarra Strocko: Absolutely. Another big change was to eliminate the VAT exemption for the import of low value goods. The €22 VAT exemption effectively allowed sellers to under declare the import value of goods. My question is: Do you think this was a smart move to eliminate the low value consignment VAT exception?

Liz Armbruester: Let’s take a look back first to answer that question. What did it look like on prior to July 1? As you said, any package value below €22 would have passed through customs without the collection of import VAT or customs duties. From the EU’s perspective, I think that exemption encouraged noncompliant traders to misrepresent the value of their shipments to avoid inspection to get the packages through. Now, items of any value should be subjected to import VAT and inspection, but that elimination, the abolishment of that threshold does create disruption for sellers that have benefited from that low value consignment exemption previously.

That’s why IOSS got introduced. We’re going to abolish the threshold. It might inflict a little bit of pain, but here’s the remedy for that. July 1, that imported sale of consignments that don’t exceed €150 will be liable to import VAT at checkout instead of at the customer’s point of import. Sellers or facilitating marketplaces do have that ability to use the IOSS return to report those transactions.

Because they don’t have to go through the inspection process, I do think overall it will push more businesses to be compliant. It’s just getting over that first hurdle of, “OK. How do I have to register? Do I need an intermediary? And then how do I do this on a month-to-month basis?” A little bit of pain upfront for those sellers, but in the long run, I think it actually will benefit them.

Kiarra Strocko: My next question is on the why behind these reforms. Another objective is to combat abusive VAT practices and tax revenue losses. What impact might the VAT reforms have on closing the e-commerce VAT gap that was reported at approximately €5 billion and the overall VAT gap in the EU of €140 billion that was reported in 2018? Or are there other issues at play here that were not necessarily addressed in the new rules?

Liz Armbruester: Great question. First of all, I think that the aim is to combat fraud. I think it’s also to boost cross-border online trade. We talked about at the beginning of this interview the fact that commerce has changed. How we sell, to whom we sell, the rules that we had in place were old. They weren’t reflective of the new commerce model that we have, the new business models that we have today, including drop shipping and internet sales, and even how we advertise products that are out there like across social media. All of that has led to changes in cross-border trade.

The element of leveling the playing field, of course, has to be considered here as well, where brick-and-mortar stores were facing a different landscape in competition with the remote online sales. When you think about it from a business’s perspective and the environment in which they’re selling, I don’t think anybody really has set out to be intentional about being fraudulent and not compliant.

I think that the way the rules have been created, again, aren’t reflective of how businesses sell today. I do think that this reform will drive significant change in compliance and ultimately in combating fraud because the methodology that they have used aligns to how businesses go to market.

If that’s the thought process, then businesses can fairly easily see — I wouldn’t go so far as to say easily see — how they can be compliant because there is complexity there. But I think it aligns with how they go to market, and therefore, have an improved opportunity and increased chance at really getting it right and remitting the tax obligations accurately and timely to the tax authorities where they’re due.

If the consideration of the EU had gone a different route where it really was not well aligned to how businesses go to market, whether that’s through marketplace, through e-commerce, through the consideration, of course, of brick-and-mortar, I think it wouldn’t be as effective at combating fraud. But because they have taken that really into consideration, I think the chances of reducing the significant VAT gap that exists, has existed over the past several years, will see a positive change.

Kiarra Strocko: Absolutely. That kind of leads me to my next question about some statistics that were in the commission’s impact assessment. They said that the new VAT rules would reduce compliance costs by 95 percent for companies selling goods remotely to multiple EU countries and will raise €7 billion annually in VAT revenue. I was wondering if you thought that these statistics were ambitious or are these numbers attainable?

Liz Armbruester: Well, again I think the answer is from the perspective of the business. There’s, of course, my perspective as well. As I look out across the business landscape, maybe for smaller businesses a reduction of costs? I don’t know. We talked about the fact that some sellers may see this as too burdensome and the compliance costs being too high. It won’t make sense for them to continue to do the type of sales that they do today.

They risk not having the tools in place, maybe not being able to deliver the level of customer satisfaction that they want to. That just may be too much for smaller businesses. I think overall when you look at the landscape of medium and large, where businesses are selling and to whom, and where their compliance costs are going to come from, I do think actually that in the whole the cost should come down. 

The reforms’ intention is to reduce the compliance cost and reduce compliance obligations overall. If you can limit the number of registrations, limit the amount of reporting that ultimately has to happen. Yes, I would say that while it might be a little bit ambitious, I do think that over time those compliance costs will come down.

But as I said earlier, I think there’s a bit of a lift that we have to get over first. It’s a climb, and then it’s a bit of a downhill, and therefore, overall I think that the cost for most businesses should be a bit less while also promoting trade into and within the EU.

Kiarra Strocko: Thanks, Liz. That’s great insight. Since the rules were implemented at the start of July, I thought it would be appropriate to discuss how we arrived at this effective date. Do you think that the delay in the implementation dates from the January 1 date was necessary for member states? I know that there seem to be a varying degree of how hard the pandemic hit different EU member states and the U.S. as well. Do you think that this was a necessary and welcomed setback, so to say?

Liz Armbruester: Yeah, I think I would say for most businesses’ perspective, the delay was probably welcome. When you think about the overall impact of the pandemic, it was different for every business. Some handled a little bit better than others. Some struggled to even stay in business. Having a very significant tax reform hit them — and for all the reasons we’ve talked about with cost of compliance, understanding the rules, et cetera. Yeah, I think it was a bit of a welcome breath of fresh air to say, “I’ve got six more months before I have to go ensure that I’m compliant with these changes.”

I think also quite frankly, it actually gave a bit of time for some of the member states to provide some clarification. To some degree, we’re still working on that clarification.

As I mentioned, specific to the U.K., if there were U.K. sellers here listening, I think it’s important when you talk about whether they need an intermediary or not, some of those rules are still being worked out.

I think not only maybe was it a bit of a relief for the businesses to have that delay, but I also think sometimes in some regard, some of the member states’ governments actually needed a little bit more time to make sure that they had firm policies, guidelines, et cetera, to ensure that businesses knew how they could be compliant with these new rules.

Kiarra Strocko: Thanks, Liz. Now, I have to ask this question. There’s so much attention on the OECD’s efforts to reform international corporate tax rules to address the digital economy. Speaking of VAT work, do you think the OECD’s work in the VAT space has been successful? Could they call its VAT work a win regardless of whether countries can agree on pillar 1 and pillar 2?

Liz Armbruester: I’m going to have to decline to answer that question because I don’t have data on that.

Kiarra Strocko: I really appreciate your time today. It was such a pleasure getting to talk to you about all these very, very interesting and important topics.

Liz Armbruester: Thank you. It was a pleasure to be here.