Taxing Digital Goods: Analysis of EU, USA, and Indian Laws

Introduction:

The human civilization’s first-ever recorded practice of taxing goods dates back to Egypt in 3000 BC. The goods which were taxed, then and now are simply perceived as real, tangible, or physical commodities that we can distinguish from our senses. But with the advancement of Information and Technology, the sphere of what was called goods has further expanded and brought the concept of digital goods into the picture. Digital Goods, are tangible goods that can be stored, delivered, and used in electronic format[1].

In contrast to physical goods, digital goods cannot be touched or felt as they are accessed in the virtual world. They are delivered electronically to the consumer who can then download it or access it through an e-mail link. Some examples of digital goods are media files containing music files and movies, e-books, online games, social media sites, mobile applications, cloud storage services, etc. At present various countries have their well-defined tax system for collecting taxes from goods, but when it comes to taxing digital goods, it is quite complex and ambiguous as the idea of collecting taxes from these virtual goods is itself new and many developed and developing countries around the world are still figuring out how to formulate an effective tax system for them.

Taxation in EU[2]

The European Commission Taxation and Custom Unions in its policy on telecommunication, broadcasting, and electronic services[3] have defined digital goods as “ Services which are delivered over the Internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology.” The member countries of the EU follow a very complex taxing process when it comes to digital goods where they charge VAT or Value Added Tax on digital goods. VAT is a consumption tax placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale[4]. A consumer pays VAT on the cost of the product and not on the cost of materials used in the production of the goods (that has already been taxed). Consumption tax is a form of tax that is imposed on the consumer rather than the seller. The rate of EU VAT charged is not uniform and varies from 17 – 27 % in all the member countries.

One of the most important questions to be determined by a seller is when to charge VAT on digital goods. The EU lays down two important factors to look upto. They are :

1. The location of the customer.
2. The nature of transaction ( whether B2B or B2C).

The Location Of The Customer

While selling digital goods, it is very important for the companies or individual sellers to firstly determine the location of the customers in order to decide the amount of VAT to be charged from them. This is a most important step and a slight mistake puts the onus on the sellers to pay required taxes from their own pockets. In order to determine the location, the seller must collect the following information to confirm the location of the buyer. They are :

1. The billing address[5].
2. Location of the customer’s bank[6].
3. Country which issued the credit card[7].
4. The IP address location of the buyer’s device[8].
5. Country of the SIM card (in cases where the purchases were made by means of a mobile)[9]. 

Any European business selling below € 100,000 in a cross-border sale of digital goods every year, among the EU countries only needs to collect one piece of evidence of the location of the customer but the piece of evidence must be collected from a third party and not from the buyer directly. The third-party can be a bank or an IP address. The evidence of the location of the consumer has to be kept with the seller for a period of 10 years and which is used as a proof of the fact that the seller pays his taxes and does not evade them.

Nature of the Transaction (B2B or B2C)

The seller selling digital goods in his own country does not need to worry about the VAT charges but the same changes when the transaction is made with any other EU country or non- EU country and thus, it becomes important to determine the nature of the transaction accordingly.

1. B2B Transaction

B2B transaction are those transaction that takes place between two businesses. For example, transactions between a manufacturer and wholesaler or between wholesaler and retailer[10]. When selling to a buyer belonging to another EU country, if the transaction is of a B2B type, then there is no need to impose any VAT charges. Here another process called the reverse charge method is applied where the buyer pays the VAT to their own country[11]. This process facilitates the seller to sell his products easily within any EU member country without any need to file a separate tax return in every country where the sale is made. The seller needs to retain a VAT number from the buyer in order to verify the service of VIES from the European Commission.

VIES or VAT Information Exchange System is a process of transmission of information relating to VAT registration of companies registered under the provisions of the European Union through electronic means.

2. B2C Transaction

B2C transaction involves the direct sale of goods and services by sellers to the consumers or the end-users of the goods or services. This transaction charges VAT from all the buyers of the digital products. But the rate of VAT which is charged depends upon how much sale is made within the EU. If the sale is below € 10,000 in cross border sales of digital goods per year, throughout the EU[12], then the rate of VAT charged is in accordance with the country of the seller and if the sale is above € 10,000, then the rate of VAT charged is in accordance with the country of the buyer.

For non-EU countries, the same rule applies in the case of B2B or B2C transactions.

Taxation in US

The concept of digital goods is also new in the US despite being one of the leading countries in digital infrastructure and digital economy. The rate of sales tax charged in the US varies from state to state and the country lacks uniform tax legislation. This creates a new set of problems for the sellers or businesses to identify the states which charge taxes on digital goods and states which do not. In the US, each state has discretion to decide:

1. Whether or not to charge a sales tax[13].
2. The sales tax rate[14].
3. How digital goods will be taxed[15].

One of the distinctive features of this taxing system is that the sellers are required to collect sales tax only in the states where they have “state tax nexus.[16]” Nexus is the legal connection a state has with a vendor that gives the state the right to compel the vendor to collect sales tax on behalf of the state[17]. Nexus analysis looks closely at a customer’s location, the location of an actual sale, delivery details, ownership elements, and the vendor’s location (including their servers or other technology)[18].

US does not have a common definition defining digital goods, instead the definition of digital goods varies from state to state.

Based on the definition of digital goods, the states in the US are classified into three types :

1. States which have their definition of digital goods. 
2. States which do not have any definition for digital goods.
3. States which use standard definition as given under SSUTA.

The Streamlined Sales and Use Tax Agreement (SSUTA) is an agreement that was implemented in an attempt to create harmonized sales tax across the United States[19].

It provides several definitions for taxable goods, which includes digital products[20]. At present, this agreement is binding on 23 states who accept the definition given by SSUTA.

Many attempts have been made by American legislators to simplify the taxation of digital goods. An attempt in the same direction was made in 2011, where the US Congress passed the Digital Goods and Service Tax Fairness Act to provide a federal framework for digital taxes[21] but proved to be an unsuccessful venture.

Taxation in India

India as a developing nation has its challenges when it comes to taxing digital goods. Before implementation of GST (Goods and Services Tax) on 1 July 2017, service tax was charged on the digital goods. After 2017, GST at the rate of 18% is taxed on all digital goods. India defines digital goods in terms of Online Information Database Access and Retrieval or OIDAR which is a category of service provided through the medium of the internet without having any physical interface with the supplier of such service[22]. India’s definition of OIDAR is similar to the definition of digital goods given by the EU. OIDAR as defined under the Integrated Goods and Service Tax Act (IGST Act) is “a service whose delivery is mediated by information technology over the internet or an electronic network and the nature of which renders their supply essentially automated involving minimal human intervention.”

The examples of services as provided under OIDAR as follows :

1. Online advertising[23].
2. Cloud-based services[24].
3. E-books and streaming content such as music, movies, software, and other intangibles[25].
4. “Providing data or information retrievable or otherwise to any person in electronic form through a computer network”[26].
5. Digital data storage[27].
6. Online gaming[28].

To pay digital taxes via GST, firstly it is required that the sellers register themselves and foreign business or non-taxable suppliers can easily do so under the Simplified Registration Scheme.

Location of the Customer

Whenever a sale of digital goods is made it is essential to determine the customer’s location to verify whether the customer is based in India or not. In order to confirm the customer’s country of residence, the following information is essential :

1. The home or office physical address[29].
2. The credit card or debit card is issued by India[30].
3. The customer’s billing address[31].
4. IP Address of the device[32].
5. The address of the bank used to pay for the service[33].
6. The country code of the customer’s mobile phone SIM card[34].
7. The country code of the customer’s landline phone[35].

Identification of the Customer

For taxing, it becomes very important to determine whether the transaction with the customer is B2B or B2C.

In the case of B2B transaction, the reverse charge mechanism is implemented where not the supplier but the buyer has to pay GST on digital goods. The supplier or seller needs to confirm that the buyer is a GST registered person by collect their GSTIN and verifying it with the help of the GST Portal.

In the case of a B2C transaction, where the transaction directly takes with the customer, the GST rate of 18% is imposed on the sale of digital goods.

Conclusion

The advent of Information Technology has not only changed the lifestyle of people around the world but has also changed the method and the way government collects taxes especially by recognizing digital goods as taxable goods. Legislators are realizing the need to regulate the sale and purchase of these goods looking into the day to day rise in the sale of these goods and increasing internal and external demands. Many countries accordingly are making subsequent amendments in their taxation laws and policies in order to accommodate digital goods but still, a lot of progress has to be done to effectively and efficiently facilitate the collection of taxes on digital goods and create a common ground to simplify the complexities related to taxation of such goods. 

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References:

[1] Vangie Beal , Digital Goods, WEBOPEDIA ( Feb 5, 2021, 06:40 AM), webopedia.com/definitions/digital-goods/#:~:text=In%20electronic%20commerce%2C%20digital%20goods,or%20download%20from%20the%20Internet.

[2] European Union

[3] Annie, What is a Digital good, anyway?, QUADERNO (Jul 16, 2020, 07:11 AM), https://www.quaderno.io/blog/digital-good-anyway .

[4] Julia Kagan, Value- Added Tax (VAT), Investopedia (Feb 28, 2020, 03:13 PM),  https://www.investopedia.com/terms/v/valueaddedtax.asp .

[5] The Ultimate Guide to EU VAT for Digital Taxes, QUADERNO (Feb 5, 2021, 04:12 PM), https://www.quaderno.io/resources/eu-vat-guide.

[6] Ibid.

[7] Ibid.

[8] Ibid.

[9] Ibid.

[10] James Chen, Business to Business (B2B), Investopedia (May 29, 2020, 04:40 PM), https://www.investopedia.com/terms/b/btob.asp.

[11] Supra note 5.

[12] Ibid.

[13] Are Digital Products Taxable in United States, ASD GROUP (SEPT 24, 2020, 07:38 PM), https://www.asd-int.com/en/are-digital-products-taxable-in-the-united-states/

[14] Ibid.

[15] Ibid.

[16] Victoria, Sales Tax for Digital Goods in the US, QUADERNO (Aug 13, 2020, 08 : 35 PM), https://www.quaderno.io/blog/sales-tax-digital-products-us#:~:text=Sales%20or%20purchases%20of%20’digital,a%20reduced%20rate%20of%201%25.

[17] Should you charge customers sales tax on digital goods?, AVALARA (Feb 5, 2021, 08:42 PM), https://www.avalara.com/us/en/learn/whitepapers/the-taxation-of-digital-goods.html .

[18] Ibid.

[19] Supra note 13.

[20] Supra note 13.

[21] Supra note 16.

[22] Tax on sale of Digital Products and Services in India/GST on OIDAR, CHARTERED CLUB (Feb 5, 2021, 10:34 PM), https://www.charteredclub.com/gst-digital-oidar/

[23] Annie, GST in India for its burgeoning digital economy, QUADERNO (Jun 18, 2020, 10:52 PM), https://www.quaderno.io/blog/saas-businesses-indias-online-service-tax.

[24] Ibid.

[25] Ibid.

[26] Ibid.

[27] Ibid.

[28] Supra note 23.

[29] Ibid.

[30] Ibid.

[31] Ibid.

[32] Ibid.

[33] Ibid.

[34] Ibid.

[35] Ibid.