Taxamo White Paper: Standardizing Digital Tax Compliance.pdf

7/21/2019 Taxamo White Paper: Standardizing Digital Tax Compliance.pdf

http://slidepdf.com/reader/full/taxamo-white-paper-standardizing-digital-tax-compliancepdf 1/23



Standardizing International

Digital Tax Compliance

A Taxamo White Paper

November 2015

Standardizing International Digital Tax Compliance: a Taxamo white paper (November 2015) 1



Contents

1. Introduction 32. Executive summary 4

3. Challenges for digital tax legislators 5

4. Complexities created by new digital tax laws 6

4.1 Registration and filing 7

4.2 Tax calculation 9

4.3 Data retention 10

4.4 Invoicing 11

4.5 Settlement 11

4.6 Exchange rates 124.7 File formats 12

4.8 Conclusion 13

5. Technical recommendations 14

Recommendation 1: Simplify registration 15

Recommendation 2: Standardize & Simplify filing 17

Recommendation 3: Develop and introduce supporting APIs 18

Recommendation 4: Require two pieces of evidence to determine place of consumption 19

Recommendation 5: Do not require sensitive information to be stored 21

6. About Taxamo 22




1. Introduction

“Electronic commerce has the potential to be one of the great economic developments of the

21st Century.”

These 17 words combined as the opening line of an Organisation for Economic Co-operationand Development (OECD) report titled ‘Electronic Commerce: Taxation Framework Conditions’that was presented to a Ministerial Conference in Ottawa, Canada, back in October 1998. Some17 years later we are in the

midst of a revolution in howtaxation is applied to thedigital economy.

The digital economy isbecoming the economy and

tax jurisdictions worldwideare slowly implementingnew taxation measures torecoup revenue. According

to a recent Accenture andOxford Economics study thedigital economy is set to add

$1.36 trillion to the globaleconomic output by 2020.

Problems relating to a digital

service merchant’scompliance arise as tax

jurisdictions take a unilateral

approach without thought to the international context of digital taxation, and the practical impactbusinesses have in implementing conflicting logic on a single platform.

For countries to see the maximum return from digital tax rules, tax authorities need to designregulations with which merchants can technically comply. More than this, if tax authorities go tothe effort to make it easy for businesses to comply with digital regulations, they should see acorresponding return in increased revenue and a reduction in negative feedback.


https://www.accenture.com/us-en/insight-digital-density-index-guiding-digital-transformation.aspx?c=strat_digidens_10000001&n=otc_0315

http://www.oecd.org/tax/consumption/1923256.pdf



2. Executive summary

The Organisation for Economic Co-operation and Development (OECD) has taken the lead onthe issue of international digital tax compliance for merchants and have produced a series of

documents outlining recommended practices.

On October 5, 2015, the OECD confirmed their approach to the taxation of the digital economyby recommending that digital services be taxed based on the location of the consumer. They didso in their Base Erosion and Profit Shifting (BEPS) report. This report was subsequently

presented - and accepted - on October 8, 2015, to the G20 finance ministers in Lima, Peru.

Action 1 of the BEPS report focuses on the taxation challenges of the digital economy. The

report recommends that rules and implementation mechanisms be adopted to “enable efficientcollection of value-added tax (VAT) in the country of the consumer in cross-border business-to-consumer (B2C) transactions, which will help level the playing field between foreign and

domestic suppliers.”

This seminal international taxation report adds that the evolution of the digital economy has“dramatically increased the capability of private consumers to shop online and the capability of

businesses to sell to consumers around the world without the need to be physically present orotherwise in the consumer’s country.”

This lack of a requirement for physical presence is the heart of this taxation issue, and itproduces numerous obstacles for digital tax legislators.

The challenge is to implement a taxation registration, collection, and remittance system that

simplifies the taxation process for digital service merchants and does not affect the consumer’sonline transaction flow.

Taxamo provides a practical technical solution for digital merchants who wish to comply with thenew place of supply taxation rules for digital goods and services.

To date Taxamo's single integration solution is built to comply with new digital tax rules for theEU, Japan, South Africa, Norway, and the USA, with more countries currently being worked on.

Through our work in this area we have been exposed to the practical consequences

implementing a single solution which needs to comply with many of the new wave of digital tax

rules. This white paper seeks to provide feedback to tax authorities considering implementingsimilar rules so that lessons can be learned from the practical challenges faced by digital

service merchants to date.


http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/addressing-the-tax-challenges-of-the-digital-economy-action-1-2015-final-report_9789264241046-en%23page1



3. Challenges for digital tax legislators

Levelling the playing field is a common theme from the OECD. It has recommended that non-

resident suppliers register, collect, and remit VAT/GST according to the rules of the jurisdictionin which the consumer is resident. Their reasoning is that this approach will result in the VAT/GST being paid in the jurisdiction of the consumer and thereby reduce the tax advantagebusinesses can have from establishing offshore, or in low-tax jurisdictions.

The absence of an effective international taxation framework, however, complicates thisproposal.

In a recent Ernst & Young(EY) survey of senior tax

executives, titled ‘ExploringThe Possibilities’, JeffMichalak, EY Americas leadfor International Tax

Services, stated that“companies now more thanever should take action to

identify the impact of these[OECD] recommendationson their business and tax

planning. These BEPSrecommendations will likely

be followed by inconsistentand uncoordinated country

implementations, leading touncertainty for taxpayers,the possibility of double

taxation and potentialcontroversy.”

In addition the EY survey revealed that:! 83% of senior tax executives believe that the evolving taxation of the digital economy is

important to the future of overall worldwide taxation, affecting primarily nexus, permanent

establishment and treaty evolution.! Also, 27% are contemplating new operating models for digital transactions.

It is the “inconsistent and uncoordinated country implementations” that create issues for

international digital service merchants who must try to conform with a myriad of differing, andsometimes contradictory, rules.


http://www.ey.com/US/en/Newsroom/News-releases/news-ey-tax-survey-shows-beps-project-driving-major-global-tax-changes



4. Complexities created by new digital tax laws

As international tax jurisdictions implement new digital tax laws the knock-on effect is thatmerchants must deal with new systems, creating obstacles to simplified compliance.

Merchants face navigating unknown taxation regulations in relation to registration, taxcalculation and collection, data retention, invoicing, and tax remittance (schedule and fileformats). This is in addition to language barriers and foreign exchange issues.

Besides backend complexities, online businesses are tasked with coding real-time logic intotheir front-end stores to handle varying tax requirements on the fly. This includes

• ensuring that sufficient data is stored to comply with the digital TAX requirements of the

determined country of the sale,• ensuring that the correct VAT rate is calculated in real-time depending on this logic• ensuring that the correct invoice type has been issued to the customer depending on the

type of customer it is and the location of the end customer.• ensuring that the correct customer information is gathered to comply with in country B2C

audit requirements

As more tax jurisdictions, and regions - e.g. the European Union (EU) - introduce new lawsaimed at taxing the digital economy it becomes increasingly difficult for digital service merchantswith worldwide sales to understand and comply with their tax obligations locally. These

difficulties, in turn, lead to uncertainty in relation to a business’s tax compliance.

In this section we take a look at some of the most recent international digital tax systemimplementations and the differences in implementation between each. Specifically, we will take

a look at varying requirements between:

! The EU’s VAT Mini One-Stop Shop (MOSS) system, in operation since January 1, 2015

! Japan’s new consumption tax introduced on October 1, 2015! Norway’s VAT on eServices (VOES) open since July 1, 2011, and

! South Africa’s VAT on electronic services introduced in June 2014.

We will focus primarily on the EU and the Japanese implementations as they represent two verydifferent approaches and the other implementations have features of one, or other, of theseapproaches.




4.1 Registration and filing

Table 1 illustrates how digital tax systems in Europe, Japan, Norway and South Africa differ inregistration and filing requirements.

Table 1: Comparison of international digital tax registration requirements for merchants (Nov2015)

Table 1 notes:1. The Japanese threshold requirement for foreign suppliers of digital services to Japanese consumers is JPY 10 million, this

equates to circa "80,000 or $83,700 (subject to exchange rate fluctuations).

2. The Norwegian threshold requirement for foreign suppliers of digital services to Norwegian consumers is NOK 50,000, this


3. The South African threshold requirement for foreign suppliers of digital services to South African consumers is ZAR 50,000, this


4. There are upwards of 70+ VAT rates in the EU among the 28 Member States, not all of these VAT rates apply to digital

services.

Online portals

The EU, Norway, and South Africa enable digital service merchants to register via an online

portal. In the EU’s case one MOSS registration enables a non-EU digital service merchant toregister and account for all of their EU B2C supplies. On January 1, 2015, the EU created theVAT Mini One-Stop Shop (MOSS).

This new registration, filing, and settlement system enables a digital service merchant with B2Csupplies in the EU to register and file a quarterly VAT return with one Member State. The MOSSsystem requires this Member State of Identification (MSI) to send - on behalf of the merchant -

the tax due in other Member States, e.g. if a merchant registers with HMRC in the UK for MOSSthen the UK would remit the tax due on the merchant’s sales to other countries in Europe. The use of MOSS is not compulsory. The alternative to MOSS for digital service merchants is to

register directly with each EU country where the merchant makes sales.

Tax agents

Of the quartet of tax authorities focused on in table 1, only Japan requires digital servicemerchants to appoint a Japanese-resident tax agent (known as a ‘zeimu dairinin’) to completethe procedures related to Japanese tax payments (such as filing a tax return) on behalf of the

foreign digital service merchant. There are other tax authorities, such as Switzerland, who

Taxauthority

Onlineportal

Tax agentrequired

RegistrationAPI used

Filingschedule

Thresholdincluded

Taxrate(s)

E.U. Yes No No Per quarter No Various 4

Japan No Yes No Yearly JPY 10 million 1 8%

Norway Yes No No Per quarter NOK 50,000 2 25%

South Africa Yes No No Per month ZAR 50,000 3 14%




require tax agents. The requirement to use tax agents adds to the the cost of compliance for

merchants.

Registration APIs

None of these tax authorities or regions - as of yet - offer an application programming interface(API) for digital service merchants to register with an online portal and file their tax liabilities viaa third-party service (e.g. their accounting platform). APIs are now commonplace among thedigital economy enabling online merchants to link core systems together. Recent developments

in this regard include the United Kingdom’s tax authority launching an API plan promoting a‘third-party first’ software approach. This is discussed later in this white paper.

Filing schedules

Among the four tax authorities and regions there are three filing options. The EU and Norwayrequire merchants to file returns on a per-quarter basis; Japan has provided guidance that ayearly return will suffice, while the South African Revenue Service (SARS) wants digital service

merchants to file monthly returns.

Threshold levels

This is where all four tax authorities differ in their approach to the taxation of the digitaleconomy. There is no common thread. The EU has removed the threshold requirement from itsapplication of the MOSS system. This has come under much criticism from small-to-medium

enterprises struggling to adapt to the new environment. Japan’s new rate of consumption taxonly applies to merchants with a taxable turnover of over JPY 10 million (circa $83,700).Norway’s VOES includes a low threshold of NOK 50,000 (circa $6,100) while South Africa’ssystem has placed a threshold of ZAR 50,000 (circa $3,800) on foreign digital service

merchants.

Tax rates

The EU introduced the MOSS system to simplify the process of complying with these new rules.There are upwards of 70+ VAT rates in operation for a variety of goods and services across theEU. Foreign digital service suppliers with sales in Norway must charge a VAT rate of 25%. In

Japan the new consumption tax rate introduced on October 1, 2015, is 8%, while South AfricanVAT is set at 14% for supplies of digital services (referred to as ‘e-services’ by SARS).




4.2 Tax calculation

To compliantly charge and collect the correct amount of tax a digital service merchant needs toapply the correct digital tax rate to their services.

Typically, this has to be done in real-time. This is a three-step process.

Step 1: Determine the governing law of the transaction

This is done by determining where the customer is usually resident. Confusingly, differentcountries have different rules determining this.

Some countries only require one piece of evidence, often relying on billing address as a meansof identifying the location of the customer.

This is open to abuse because in most countries the billing address for card transactions are notvalidated as part of the payment process so the customer may put in whatever country they

wish.

The EU system provides most certainty of any system in place today and it requires that themerchant determine place of consumption of their electronic service based on two pieces ofnon-conflicting evidence.

Such evidence includes:

! Customer’s billing address

! IP address

! Bank details (location of bank)

! Country code of mobile phone SIM card

! Location of fixed land line

! Any other commercially relevant information (e.g. payment mechanisms or gift cardsunique to specific Member States, information from third party payment service providers,

consumer trading history details, etc.).

Step 2: Ensure sufficient evidence is collected to comply with governing law(s)

In Norway, for example, in order to comply with VAT audit requirements; the first name,

surname, and street address of the customer is required.

The merchant must code a solution so that this logic is built into its platform so that a customer

is further engaged should the governing law require information from the customer that has notalready been shared.

Additionally, the customer location proxies may indicate that more than one country’s regulation

may apply so further location evidence from the customer may be required.




Step 3: Apply the correct tax rate

Once the governing law has been established and it has been confirmed that all evidence thatallows the merchant to conduct a compliant transaction has been collected, the merchant must

then apply the correct VAT rate.

This means digital service merchants need to be aware of digital tax rate changes and rulingsaffecting the types of services covered by the governing laws.

Not only that but these merchants also need to be able to apply the correct tax rate to theservices they offer via their website(s) in real time.

4.3 Data retention

Digital service merchants with cross-border B2C supplies in the EU must - by law - store

transaction data for 10 years. The transaction data required includes information such as thetime and date of the transaction; the VAT/GST rate applied, and the amount of VAT/GSTcollected.

When filing in Japan, digital service merchants are required to retain information regarding salesin Japan. If they have any deductible tax, they will need both books and bills, etc. In principal,

books and documents related to the transactions should be retained for seven years after twomonths of the tax period in which the merchant filed (i.e. seven years and 2 months and thetime between transaction and filing).

In Norway the VOES system requires transaction data must be stored for 5 years and, at theNorwegian tax authorities' request, it must be made available electronically within three weeks.

In South Africa, the SARS requirement is for digital service merchants to store transaction datafor 15 years.

Table 2: Comparison of international digital tax data retention requirements

Tax authority Data retention period

E.U. Ten years

Japan Seven years, two months

Norway Five years

South Africa 15 years




4.4 Invoicing

A consequence of new digital tax rules is the digital merchants must comply with all the legalobligations around making a B2C sale in the country in question. This also relates to invoicing

requirements and it is another area which is inconsistent from region to region.

European Union

In accordance with EU VAT rules, invoicing varies from Member State to Member State. Indeed

a dozen EU Member States place no obligation on merchants to issue invoices.

Others do require invoicing: France, for example, requires merchants to issue an invoice for any

service supplied for more than "25.

Japan

For ‘registered foreign businesses’, when providing a Japanese business with B2C electronicservices, an invoice should state:

i. The name of the document issuer and its registration number

ii. The date of provision of the services

iii. The content of the services

iv. The payment amount

v. Indication that the registered foreign business is liable for consumption tax

vi. The name of the business (customer) receiving the invoice.

N.B.: Issuing an invoice electronically is acceptable. A registered foreign business has a duty to

issue such invoices upon the service recipient’s request.

4.5 Settlement

Every country also has its own rules on how settlement should be made, each involving varyingdegrees of complexity.

In the EU, merchants need to file returns within 20 days of each business quarter, i.e. April 20for Q1; July 20 for Q2 and so on. In Japan digital service merchants need to file returns once a

year and in South Africa, monthly filings must be made.




4.6 Exchange rates

European Union

In the EU returns need to be made in a single reporting currency. Transactions that occurred in

another transaction need to be converted to the reporting currency. The exchange rate to be

used is the European Central Bank (ECB) rate on the last day of the quarter.

This exchange rate is the mid-market interbank rate which is not achievable by any bank, let

alone any retail customer. Depending on the size of the merchant this means that the merchanthas to pay an FX fees and charges of up to 5% on top of their VAT obligation (depending on therates and fees charged by their bank).

This cost comes straight off the bottom line of the merchant. In Taxamo we have come acrosssmall non-EU businesses who have paid double the amount of tax owed in fees and bank

charges as was owed in tax in their efforts to remain compliant.

JapanIn Japan digital consumption tax returns need to be in Yen. Digital service merchants need to

convert foreign currencies using the Telegraphic Transfer Middle-rate (T.T.M.) from the day ofthe transaction. The T.T.M. is a mid-market rate issued by the banks in Japan.

This means that the merchant carries an FX risk, in some cases for up to a year, if the merchantdoes not regularly convert their tax obligations from the transaction currency back to Yen. ThisFX exposure has the potential of significant costs for even large merchants.

4.7 File formats

The file format of the settlement return is another area that, even within the EU, has alreadyproven to cause problems for digital service merchants.

In the EU digital service merchants with B2C supplies face the prospect of producing settlement

files in half a dozen differing formats. These formats range from XML to Excel & .csv.Merchants may have to code their systems to produce vastly different settlement report outputsbecause individual Member State require them to do so.

In addition there is the added layer of complexity of a lack of automation within these file uploadsystems. In many cases merchants must manually input data and then upload the correct file to

the relevant EU Member State system.

This illustrates how the aim of tax compliance simplification is still a one-sided affair. It may be asimplified system for the tax authorities, but it is cumbersome for merchants making every effort

to comply. On a once a quarter basis this may be feasible for merchants, however as thenumber of countries in which a merchant must comply increases the level of effort involvesquickly becomes unmanageable as the process is not automate-able.




4.8 Conclusion

Today, we are in the infancy of digital tax, yet already we can see through just comparing the EUand Japanese systems that differing approaches by countries to designing regulations causes

practical difficulties for digital merchants who wish to comply.

In the next section we will make some recommendations on approaches that countries couldtake which would make it easier for digital merchants to comply with their regulations.




5. Technical recommendations

The globalisation of the digital economy has led to tax jurisdictions worldwide seeking toimprove revenues by applying tax on the consumption of digital services.

However, no international digital taxation framework exists. A major obstacle to thisstandardisation is that national digital tax laws are drafted in isolation and digital servicemerchants then have tocode solutions that take

international laws intoaccount for theirplatform(s). As

documented thisfragmented approachresults in conflicts and

mismatches.

Decisions to draft andimplement legislation,

while following OECDguidelines, have beentaken unilaterally with

what seems like little orno thought given to thepotential practical impactson foreign digital service

merchants complying withvarious tax laws, each designed in isolation.

What is clear is that the vast majority of digital merchants want to be compliant. It is the job oftax authorities to assist these businesses in this desire by coding their laws with thepracticalities of compliance in mind. To this end, what is required are international standards for

digital tax compliance that encompasses registration, collection and settlement remittanceprocess for merchants. This will make it easier for merchants to code compliance solutions andmake it easier for tax authorities to design regulations.

Taxamo has been at the coalface of this changing landscape and from market feedback we

have gained valuable insight into the problems that merchants face across the world. Whatfollows are recommendation for international tax authorities to bear in mind when designing

compliance portals and in drafting regulations in this area.




Recommendation 1: Simplify registration

Here are a list of recommendations that would serve to make the task of compliance easier andless costly for a merchant.

! Registration should not require an agent.

! Tax agents cannot be automated and the level of effort and cost required for amerchant to assign a tax agent is often prohibitive. There will also typically be anongoing cost for filing. This does not lend itself to compliance.

! Registration should be simple and provided in English, along with local language.

! Registration should not look for information that is not absolutely required.

! The more effort it will take for a merchant to gather information the less likely it will

be that they will register and comply.

! Registration should include the URLs for which the business is responsible.

! Businesses change and it is useful for the taxing authority to know what URLs a

business is registered for in order to manage audit etc.! Facility should be made for businesses who wish to register and regularise their

compliance position after the initial registration period. ! Typically with the introduction of new regulations there will be an initial registration

period, in which all merchants are expected to register. From experience in the EUit is clear that the majority of businesses worldwide probably will not be compliantwithin this period. As part of the design of the registration process it should be

made clear how a business can regularise their position and become compliantafter the initial registration period. This could take the form of allowing a businessto register transactions for a previous period in the current taxing period. The

taxing authority may wish to enable this feature on a case by case basis so thatbusinesses can make good on fines or interest if they wish to avail of the service.

! The business should be able to assign filing and settlement rights to third parties

in a way that is familiar to the business. ! This is a key recommendation and it is expanded upon later. The key problem

here is that in and of itself, even when designed well, filing and settling with onecountry is somewhat of an inconvenience; as more countries bring in this OECD

recommended, place of supply rule around the world, the level of effort increasesexponentially for all digital merchants. If the tax authority makes it easy for themerchant to outsource this compliance work to a third party platform then they are

more likely to comply. To facilitate this, tax authorities need to consider howpractically a third party can easily be assigned this work.

! Registration should be available via an API so that a business can provide details

from a third-party platform. Confirmation of details and final registration and

confirmation of passwords, etc. may be done on the taxing authority’s site by wayof confirmation of registration details.




What is the idea of exposing registration via an API & enabling the merchant to easily

assign filing rights to a third party?

Digital merchants' platforms are typically a grouping of a series of off-the-shelf cloud-based

services and software combined in unique ways, harnessed to allow the digital merchant selltheir service. For example, the modern digital merchant may use a cloud-based shopping cartplatform which is hosted for them. Plugged into this may be various third party platformsincluding inventory management platforms; payment service providers; accounting platforms;

analytics providers; advertising service providers, etc. Typically digital merchants outsource allbut their core business to the myriad of providers that service this market. This is simply themost efficient way to run their businesses. Tax registration, filing, and settlement should be

viewed in the same context.

With this in mind, it is apparent that should countries make it easier for third parties to servicedigital tax on behalf of digital merchants; the market will fill the gap that the absence of an

international MOSS system represents and facilitate digital merchants to comply in all thecountries that can be supported. If tax authorities approach the support of digital tax with this inmind the levels of compliance should, as a consequence, increase.

In order to allow businesses assign filing (and possibly settlement) rights, tax authorities shouldconsider methods of assigning rights that are common among online third party platforms today.

One approach would be where businesses issue public and private key pairs (suggested size:4096 bits), and register the public keys with a tax authority, verifying the key's authenticity andreceiving a unique business ID (e.g. tax number) as part of registration. A merchant also has a

right to revoke the public key from the tax authority, in case the key becomes compromised.When communicating with tax authorities, messages are signed using private keys and the taxauthority can verify their integrity with a public key and the provided unique merchant ID. XML

messages can be used to standarize this integration even further.

External accounting software, ecommerce platforms, PSPs (Payment Service Providers), etc.

can have individual key pairs issued to the merchant that they use to register with the taxauthority. This means that in the case of a merchant ceasing to use the software, they cansafely revoke the key's permissions. The idea is that a merchant can easily assign (and revoke)registration, filing and settlement rights to third party platforms. This has the added benefit that

the number of third parties that the tax authority will have to deal with will be lower and so thecost of support should also be lower.

Making it easy for digital businesses to comply using their existing service providers will make it

much easier for digital businesses to comply with any given set of regulations.


https://en.wikipedia.org/wiki/XML



Recommendation 2: Standardize & Simplify filing

! File Format File formats should be in an easy to generate format. XML is typically one of the easier formats

that can be coded so that should be considered for support.

As described, in the absence of an international MOSS system - countries should look to third-

party platforms as the way that businesses can handle their report filing.

! Foreign exchange r ate

For small merchants the cost of foreign exchange fees to settle an obligation may constitute asignificant additional fee to the actual amount being settled to the taxing authority. This foreignexchange fee has to be borne by the merchant and represents a cost to their bottom line for

doing business in the country in question.

This cost to business can be mitigated by the taxing authority by using a reasonable rate toconvert the VAT amount from the transaction currency to the tax reporting currency. The rate

that ought to be used depends on the typical spread for the currency in question against majorcurrencies for retail customers in the major economies. This might, typically, be in the order ofbetween 2% to 5% above the interbank mid-market rate. It may be that the use of such a rate

may mean significant revenue increases for large merchants.

It may be that tax authorities could use mid-market rates, or interbank buy rates, for large

enterprise merchants while facilitating smaller merchants by offering the retail rate. This wouldreflect the comparative costs to both in complying with these rules.

! DateThe exchange rate that is used ought to be set as close to the settlement date as possible.Converting transactions at the rate of the day of the transaction should be avoided because itopens merchants up to significant currency exposure, unless the merchant converts the

transaction currency to the tax currency on a daily basis. In most cases this option is notpractical, and would add significant costs to the business.

! Frequency

The recommended tax report filing periods for digital tax returns should be on a quarterly basis.This frequency will align with international best practice as reflected in table 1, where Norwayand the European Union both require digital tax reports to be submitted on a quarterly basis.

International businesses operate to this quarterly calendar. It is in the fiscal interests of digitalservice merchants to align their digital tax reporting to these existing business best practices.

The introduction of such a timeline will mean less upheaval to existing internal processes forthese merchants.




Recommendation 3: Develop and introduce supporting APIs

An Application Programming Interface (API) is essential for a standardised internationalframework for digital taxation.

APIs will make compliance less costly as they will provide a link (a digital handshake) betweenthe merchants and the tax authorities. There is no limit to the range of APIs that could bedeveloped for the purposes of international digital tax compliance, and Taxamo would

recommend the following:

! A tax rate API

Tax authorities should have an API host which responds with tax rates when queried withdifferent product category codes (as described below).

This would mean that every tax authority would have a tax rate for every defined productcategory code (most being at the standard rate) or a default tax rate for all eServices in cases

where any specific eServices do not attract a reduced rate.

An additional feature of this service should include the ability to query the next rate change for acountry, and a request for all current valid VAT rates (and upcoming dates for rate changes) viathe API.

! International product category code definition for digital goods and services

Where a country has a reduced rate for some digital goods and services, these services should

be identified using an International Organisation for Standardization (ISO) category code.

This is so that a merchant who sells ebooks for example in one country can classify their service

as an ebook and query any given supported country with the same service identification codeand receive back the correct tax rate for that product or service.

The potential issue here is that countries would then need to define tax treatment for goods and

services against these category codes, which may in some circumstances differ from theirphysical equivalent.

The alternative to this is a digital service merchant seeking local advice in every country theysupply to in order to understand what tax bracket their product, or service, qualifies for. Thisagain would drive up compliance costs for these merchants.

! Foreign exchange rate availability The exchange rate that ought to be used by the business for filing their transactions should bemade available to merchants via an API where the business requests a rate for a date and the

service responds with the rate appropriate for that date.




! A business validation service API where a reduced rate is to be charged in B2B

transactions

Where a tax authority does not require that tax be charged to a business, the tax authorityshould make it straightforward for a business to validate whether their customer is a business or

not. A system such as the EU’s VIES should be considered.

However, any such system should have industry standard Service Level Agreements (SLAs) forservice uptime, reflecting the critical role it has in the ability of business to conduct business on

the internet. From Taxamo's experience in the EU, the reliability of such a system is critical tothe success of any merchant compliance solution.

If tax authorities impose a requirement for a business to comply with a rule there is a duty onthat tax authority to enable the merchant to comply with those regulations.

Recommendation 4: Require two pieces of evidence to determine

place of consumption

There are in effect two options to consider here:! Require one piece of evidence to determine customer location.

! Require two pieces of non-conflicting evidence to determine location.

Taxamo recommends that two pieces of non-conflicting evidence be used. The reasons arebecause such an approach:

! Reduces the possibility of fraud

! This increases certainty for merchants.

! This makes it more likely that the correct tax amount is collected for the tax

authority. ! Most evidence is not validated by a third-party so it is easy for customers to game

the system (e.g. in most countries the billing address for credit card transactions isnot validated as part of the transaction so the customer is free to put in whatevercountry they wish).

! Easier for merchants to implement

! Many merchants who wish to comply with tax rules have already put in place asystem to comply with EU regulations, so the task of looking for two pieces ofevidence will already have been addressed by merchants.

! Merchants have to code logic on how to determine the governing law for anygiven transaction. It is difficult to code logic that requires two pieces of evidencefor the EU and one piece for other countries (see text below). This will be the

position that most merchants will be in.

Exploration of current situation where both two pieces and one piece required to

determine location of consumer

Consider that any online merchant who will look to comply with a digital tax regulation will likelyalso be complying with the EU regulation.

This means that they will likely have some way of getting two pieces of non-conflicting evidence.


http://ec.europa.eu/taxation_customs/vies/vatRequest.html



Also consider another scenario, if a country has the requirement for one piece of evidence toidentify the location of a consumer then - in practice - merchants who comply with EUregulations will still look for two pieces of evidence to confirm the location of the consumer.

Let’s take the example of two countries, e.g. Mexico & Honduras, bringing in digital taxationrules requiring one piece of evidence to be sufficient to identify the location of a consumer. Let’ssay that they accept the billing country, IP address, and credit card Bank Identification Number

(BIN) as being pieces of evidence.

Let’s also suppose that the business also supports the EU regulations, so they are looking for a

minimum of two pieces of evidence where there is evidence that it may be a Europeantransaction.

Here are some additional scenarios:

In this example:

! Mexico (for example purposes only) has stated that one piece of evidence is required, for

example the billing country, or other appropriate evidence, is to be used to identify thecountry of a customer.

! Honduras (for example purposes only) has the same standard of proof, where one piece

of evidence is required, for example the billing country or other appropriate evidence is tobe used to identify the country of a customer..

! Germany uses the EU regulation requiring two pieces of non-conflicting evidence.

Table 3: Evidence scenarios used to identify consumer location

The logic table that a merchant would have to implement to determine governing tax law wouldbe something similar to above. The key things to note here are that because the EU regulationsare being complied with, and because they require two pieces of evidence, they mightreasonably trump the requirement for only one piece by the Mexican regulation because the

level of proof is greater.

For example see scenarios 1 & 2. The merchant wants to comply with EU regulations which

require that two pieces of non conflicting evidence be gathered to determine the location of the

Data Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5Billing country Mexico Germany Mexico Mexico Germany

IP Germany Mexico Germany Honduras Germany

BIN(only utilised wherethere is EUconflicting evidence)

Mexico Mexico Germany

Identified country Mexico Mexico Germany ? Germany




customer. Here the merchant picks up two pieces of evidence, one suggesting the customer is

in Mexico and one suggesting he is in Germany. In order to comply with the EU regulations themerchant looks for a third piece of evidence as their customer could be from Germany. Thisthird piece of evidence suggests they are from Mexico so the merchant identifies the merchant

as being Mexican. In effect here the business is using the “two non conflicting pieces ofevidence” rule for a country which only requires one piece of evidence.

See scenarios 1 & 3. In scenario 3 the merchant has a call to make as he has sufficient

evidence to suggest that the customer is both from Mexico (based on Mexican rules) andGerman (based on EU rules). Here the merchant must make a call and would on balanceprobably identify the consumer as being German for scenario 3 even though the threshold of

proof is met by both Mexican and EU regulations. The reason the merchant might reasonablychoose Germany as the country of taxation here is because on a practical level there is moreevidence (two pieces) that suggest that the customer is from Germany for scenario 3.

In both these scenarios, from a Mexican regulation’s perspective, where only one piece ofevidence is relevant and where the billing country of the customer is described as the key pieceof evidence, the two transactions are identical because they both identify the billing country as

Mexican. However in both cases the merchant identifies the taxing location to be different. Inthis scenario Mexican regulations are secondary to EU regulations because the standard ofproof is lower. This can cause problems when it comes to potential audit down the line and puts

the business in a position of uncertainty. The merchant may reasonably decide to not dobusiness where such uncertainty exists.

See Scenario 4. Here one can see a problem because the merchant has picked up sufficient

evidence to suggest that a customer is from two countries, with similarly low standards of proof.The merchant is put in a position of uncertainty because he has to make a call. On what basisdoes a merchant make this call? Is it based on case history within both the countries in

question? Is it based on what evidence is hardest to conduct fraud on? This leads to uncertaintyand business does not like uncertainty.

See Scenario 5. This is the two pieces of evidence regulation in play. It provides certainty andthe merchant can code this scenario relatively easily.

Recommendation 5: Do not require sensitive information to be stored

We recommend that tax authorities do not require sensitive information that identifies the

consumer be stored to comply with regulations.

Sensitive information includes the consumer’s first and last name, and their full home address.

Other location proxies may not be considered sensitive and may be stored.

Remember: by requiring businesses to store sensitive customer data about your citizens youare making these businesses targets for attack and are putting the identities of your citizens at

risk. Be sure there is a valid reason behind making business store this information becauseonce it is compromised this question will be raised again.




6. About Taxamo

Taxamo’s global digital tax solution enables digital service merchants to comply with newinternational digital tax laws.

It’s one simple integration meets the requirements of international digital tax laws on taxcalculation, reporting, and invoicing. It also offers merchants a simple, cost-effective, andreliable way to stay compliant.

Taxamo launched with an EU VAT solution in January 2015 and has since expanded to supportU.S. sales and use tax, Japanese consumption tax (JCT), and South African digital VAT, withfurther regions to be introduced before the end of 2015.

Working with international Tax Authorities

Taxamo has gained a wealth of experience and knowledge relating to the dissemination and

communication of international digital tax rules. Taxamo CEO John McCarthy (LinkedIn: https://ie.linkedin.com/in/jfmccarthy1) has actively participated in a number of industry and governmentevents, representing both the merchant community, and as a technical solution provider.

Over the past 24 months, Taxamo has worked with European tax authorities to bridgecommunication gaps and communicate directly with digital service merchants.

Taxamo has previously published a White Paper specifically on this topic (https://www.taxamo.com/white-paper-taxing-digital-services/).

Government officials and/or tax authority representatives who would like to learn more about

Taxamo's role in communicating with digital service merchants should contact Taxamo [email protected]. Emails will be brought to the direct attention of John McCarthy.

mailto:[email protected]

https://www.taxamo.com/white-paper-taxing-digital-services/

https://ie.linkedin.com/in/jfmccarthy1

https://ie.linkedin.com/in/jfmccarthy1

https://www.taxamo.com/solution/

Documents

Taxamo White Paper: Standardizing Digital Tax Compliance.pdf