VAT Kicks In, Headaches Begin

A new law taking effect Tuesday asks U.S. merchants to pay the European Union’s (EU) version of sales tax on digital downloads. But word hasn’t gotten out to a whole bunch of e-tailers, while a lot more are asking, “How’s the EU gonna find me to collect?”

The new regulation, passed in May 2002, radically changes the way the value-added tax, or VAT, is charged for digital goods.

The law covers only digital products like software, movies, games and e-books that are offered to consumers as paid downloads.

Previously, digital content sellers outside the EU enjoyed quite an advantage. Before the law took effect, a European buyer could get a cheaper price on a software download, for example, by buying it from a company in the U.S. rather than the U.K., because U.S. businesses aren’t required to charge or pay sales tax on e-commerce transactions.

Merchants in the EU had a double handicap. Not only did they have to pay the VAT tax on sales within the EU while foreign merchants didn’t, they also had to pay the tax on sales they made to consumers outside the EU.

The new statute bases the VAT on the buyer’s location instead of the seller’s. Now, the VAT tax is based on the laws of the country where the purchase is used, rather than where it originates. It also lets EU-based e-tailers off the hook for the VAT on sales made to consumers who don’t reside in the EU.

As of today, merchants selling digital goods online are supposed to follow the VAT regulations of the various EU countries where their customers live. Foreign companies with European branches already pay the appropriate tax levied by the host country, and many large digital merchants are prepared to comply.

“We manage VAT-related issues for clients operating on our merchant account,” said Richard Mitchell, general manager of the London office of Minneapolis-based e-commerce outsourcing company Digital River in April.

Additionally, a lot of smaller companies aren’t aware of this law. Many don’t see how they can comply.

“Technically, the EU has no control over us as a corporation,” said Matthew Feldman, CEO of Versaly Games, a mobile content platform and content wholesaler. “How could they possibly police us if we sell into the EU?”

Versaly wholesales digital content to mobile phone companies in the Netherlands and Spain. In those cases, Feldman said, it’s no sweat.

“They collect the revenue and when they send us our royalty, they withhold the VAT tax.”

However, Versaly’s is a website that sells ringtones, images and games directly to consumers. The company also hosts San Francisco-based CNET’s Cell Phone Zone, which offers paid downloads.

Feldman said that it’s not always possible to know where a site user is coming from.

“Not only is it difficult for us to gather that info,” he said, “it’s going to be impossible for the EU to police U.S. companies,” he said. CNET did not return calls for comment.

The European Union’s initiative may also have an inverse impact on American companies and put them at a competitive disadvantage in the expanding EU marketplace.

Karen Myers, an Electronic Data Systems (EDS) executive, told a Senate Foreign Relations Committee’s Subcommittee on European Affairs panel last week that, while not opposed to the application of VAT to electronically delivered goods and services from abroad, U.S. industry believed the EU’s approach would place unfair obligations on non-EU companies.

“In trying to level the playing field, the European Commission has created a trading environment that discriminates against U.S. and other non-EU businesses,” said Myers, who testified on behalf of the United States Council for International Business (USCIB), a pro-trade group.

Adapted from

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