Digital transformation is drastically changing how people and businesses interact and conduct commerce. It is transforming social, business, and economic norms and changing the way we interact, consume and do business. This facilitates e-commerce in both existing and emerging markets and allows for more products to be delivered digitally. New opportunities for growth exist as new ways of business gain pace and levels of connectivity increase. These rapidly developing modern technologies pose innumerable challenges and questions for governments and tax authorities. With many governments under unprecedented fiscal strain and with digital activity accelerating, tax authorities are grappling with the consequences of this shift for the sustainability of their tax bases and the efficient administration and collection of taxes.
Taxing the digital economy, e-commerce and digital trade presents unique challenges for policymakers and tax administrations. The challenges associated with developing new mechanisms and frameworks for taxing goods and services in the digital economy are increasingly acute, but not new. It is timely to revisit such issues and analyze the prospects and possible advances to determine the impact of the digital economy on tax systems. Significant changes to business models and value creation have implications for taxation, offering opportunities for both the private sector, by expanding potential markets, and governments, through a potential increase in revenues from new sources of taxation. However, it also raises a need for governments to consider how to adapt their tax systems to the growing role of e-commerce and digital trade.
E-commerce and the process of digital transformation also pose a threat to government revenues through tax base erosion, primarily because of the unique mechanisms inherent to e-commerce and digital delivery of products. Digital platforms and online marketplaces facilitate numerous transactions between buyers and sellers. However, this abundance of online interactions and transactions on platforms gives rise to concerns regarding the clarity and assessment of tax responsibilities and the methods used for tax collection. These challenges can impede the accurate recording and traceability of both transactions and taxpayers. Governments need a comprehensive understanding of how to adapt their existing taxation systems, including with regard to indirect taxation.
Tax controlling and auditing online transactions can be challenging. There is uncertainty concerning the nature of the relation (nexus) between jurisdictions, potential taxpayers and businesses for transactions, which can be either domestic or cross-border. Tax increasingly has to be collected from millions of end-users rather than from a small number of intermediaries for “traditional commerce”.
Digital trade, which involves digitally ordered and/or digitally delivered products across borders, confronts tax administrations in all countries with new challenges. One of the key impacts is the possibility for non-resident vendors to offer their goods and services without a permanent or fixed establishment in the territory of the buyer. However, the administration of indirect taxation in the form of value added tax (VAT) or goods and services tax (GST) is not easy, especially when imposed on non-resident vendors. This is especially pertinent for digitally delivered services that, in contrast to digitally ordered goods, do not pass through customs administrations.
Developing countries are increasingly implementing new rules for e-commerce, but at different speed and with significant diversity in their implementation. A balance needs to be struck between securing tax collection while ensuring that collection processes are neither overly complex nor discriminatory. There is no “one-size-fits all” policy or legislative approach. Responses and areas of reform may depend on the market size, technological capacity, the role of the informal economy, as well as other social, economic and legislative considerations. While some developing countries have already adopted a strategy to regulate e-commerce and to address the main indirect taxation issues, others are still only at the beginning of this process. Administrative flexibility is also important to ensure that adjustments and improvements can be adopted across the entire tax system.
The multiplicity of options induces a potentially complex environment where foreign sellers may avoid paying or remit taxes due and/or where the compliance costs may deter firms from becoming digital, certainly evidencing a need for harmonization.
The main experiences and solutions explored in this study cover the potential role of digital platforms and marketplaces at the core of the system and the initiatives and rules to monitor and manage non-resident vendors. Interestingly, all these solutions can contribute to improving a major shortfall of digital trade commonly observed beyond the taxation issues, namely the lack of reliable data and information about the users and transactions performed online.
Role of the marketplaces at the core of e-commerce
- Online marketplaces intermediate large numbers of transactions between multiple buyers and sellers, often across borders. This makes them central nodes in the e-commerce system and in turn useful as potential tax collectors and sources of information.
- As tax collectors they may play a role for both domestic and cross-border transactions.
- As a source of information, they may provide information that can enable revenue authorities to implement proper risk management from huge quantities of data centralized and shared.
- Relying on digital platforms to collect indirect taxes can be an opportunity to tax the unregistered economic operators (informal sector) doing business through e-commerce platforms.
VAT registration for non-residents
- Simplified registration and compliance regimes can provide an effective solution to collect VAT on cross-border services in business-to-consumer (B2C) transactions. The last stage of VAT collection mechanism is the weakest link of this tax, since final consumers are not VAT registered. This weakness is exacerbated when vendors are non-tax-resident. Their VAT registration aims at reducing the risk of revenue losses at this stage.
- Developing countries are increasingly adopting regulations requiring non-resident vendor to register for VAT with multiple different scenarios. A growing number of developing economies have also implemented a simplified registration and compliance regime for non-resident suppliers.
Withholding and reverse charge mechanisms (business-to-business (B2B) e-commerce only)
- Some countries have implemented withholding tax mechanisms to extract VAT/ GST on payments to non-resident vendors.
A withholding tax mechanism is typically introduced through banks or a financial intermediary. Beyond VAT, it aims at protecting countries against tax planning and avoidance that may occur more often in the context of digitalization. However, Double Taxation Agreements (DTAs) may limit the application of withholding tax mechanisms.
- Reverse charge mechanisms shift the responsibility for paying VAT or GST from the supplier to the buyer.
This mechanism may be viewed as a special case of the withholding instrument. While in a traditional VAT system, vendors generally charge VAT on their supply of goods or services, collect tax from the customer, and remit it to the tax authorities. Under the reverse charge mechanism, it is the customers that are responsible for paying VAT due on a transaction directly to the tax authorities.
Although most developing countries are implementing new taxation rules at the country level, a regional approach may have many benefits. A regional approach to addressing the challenges of indirect taxation of e-commerce may be specifically relevant for developing countries because:
- many developing countries belong to a regional economic community (and some even to a customs union), and a regional approach to taxation could foster economic integration;
- the bargaining power of individual countries remains limited against multinational digital platforms, and regional cooperation may reinforce their position; and
- regional cooperation may secure revenue and reduce compliance costs by avoiding multiple disparate registration processes.
Despite remaining challenges, developing countries are making meaningful progress towards taxing the digital economy. Challenges with the taxation of the digital economy have led to tax reform initiatives that could significantly alter current tax systems and accelerate the taxation of the digital economy. As of June 2024, 101 countries had enacted indirect taxes on transactions in the digital economy, with the aim of enhancing efficiency. The evolution of digital administration responses to the challenges of digitalization are not restricted simply to tax policy and legislative changes. Many developing countries are also adopting technological solutions to improve their own tax administrative processes related to tax collection and compliance. Moreover, new communications and information approaches are being considered to interact with taxpayers under a new framework, in which a mutual exchange between transparency and certainty with them can be established. What is fundamental is a dual focus on enforcement and facilitation, which will underpin a range of desirable reforms to achieve modest, but consistent, revenue gains in developing countries. In turn, countries can make meaningful progress towards effective, equitable and accountable tax systems.
Source: United Nations Conference on Trade and Development (UNCTAD)