As of January 1,
2015, there are significant changes to the European (VAT)
Value-Added Tax rules. The new rules, which were approved
in 2008, will apply the tax rate on digital services such as
cloud storage and movie streaming services based on consumer
location. This tax change will impact the large U.S.
digital medium service providers including Netflix, Amazon,
Google, Apple, and Microsoft.
Previously, the tax rate
was based on where the company selling the product had its
central headquarters. Under that system, large digital
service providers benefitted from conducting central operations
in tax favorable countries such as Luxembourg. There, the
tax rate was as low as 3 percent for certain purchases.
Other countries, like Britain, charge up to 20 percent for
similar purchases. Such differences in tax rates provided
a tax advantage to consumers and larger enterprises that could
benefit from location planning. All that will change
however with the new regulations.
In order to comply with
the rule, businesses selling digital goods will be required to:
Charge the VAT rate based on
the consumer's location
Validate the consumer's
Report VAT to each
corresponding consumer EU country
Proponents for the new
system argue that it will add up to $1 billion in annual tax
revenue for the European Union. The rule change aims to
spread revenue from digital goods more evenly throughout member
countries. Nonetheless, not all countries will be affected
Some smaller countries
with lower populations consume disproportionate amounts of
digital services. Take France, for example, although the country
has a population of 64 million which accounts for only 12 % of
the larger European Union, the country generates nearly 50% of
all European Union Netflix sales. Of course, Luxembourg
will be affected the most. In order to make up for the
lost revenue they will increase the value added tax on
non-digital goods from 15 to 17 percent.
Before the rule change,
many large digital service providers, like Amazon and Netflix,
utilized bundled pricing (including transaction taxes) in order
to keep things simple for the customer. These companies
have indicated that for now this practice will continue.
The initial reaction of large service providers is to maintain
bundled pricing and absorb the higher tax levels. This
however is troublesome for large service providers because the
net profit margin in high VAT countries is going to be
substantially reduced. It remains to be seen how they will
respond long-term. Once these digital service providers
achieve desired market penetration, some possible options could
be unbundled VAT changes or raising the overall bundled price.
The new European VAT
charge comes at a time when all of the major U.S. digital
content providers are expanding in Europe and the rest of the
world. A billion in new revenue is attractive to
government tax authorities and we expect other countries to
closely follow the European experience.