Getting real taxes out of virtual services – VAT fraud going online
Benjamin Franklin once wrote in a letter: “[…] in this world nothing can be said to be certain, except death and taxes.” With the digital revolution spinning through our society, some things, which we got used to, have gotten a little twist. While death is indisputable, we can no longer be sure with taxes in times of online services.
We talked to Prof. Rolf J. Langhammer about China’s role as an exporting country of digital services and how the EU is having trouble finding a proper solution.
GESblog: Prof. Langhammer, in December 2016, the president of the German Federal Audit Office Kay Scheller called the internet a tax haven. What did he mean by this statement?
Rolf J. Langhammer: Traditionally, when we talk about the value added tax (VAT) on imports, we have a trade of physical goods in our minds. That is the classic model, which makes it relatively easy to tax imported products because they get imported via roads, railway, ship or planes. If we look at the digital services that many people consume nowadays, they are harder to track and thus more likely to remain unrecorded by the taxation institutions.
GESblog: What kind of digital services fall under this tax issue?
Rolf J. Langhammer: There are various services, just take the streaming and downloads of music for example, or software, movies, video games or even payment and communications services. What happens is that local importers and consumers do not report their overseas purchases to tax authorities, and thus evade the import VAT for services.
GESblog: What amounts of money and services are we talking about?
Rolf J. Langhammer: Looking back at 2013, the VAT revenues in Germany accounted only for EUR 28 million, while the market itself is expected to be a “billion euro market.” Moreover, that was four years ago, and the market has grown significantly since then.
GESblog: What role does China play in this issue?
Rolf J. Langhammer: The digital services represent the bulk of unreported trade today, and, reportedly, an increasing amount of tax evasion related to this trade originates in China. One reason is that Chinese internet traders such as Alibaba or Tencent have gained market share in the EU at the expense of eBay and Amazon. The second reason is that many sellers who advertise “VAT-free” transactions reportedly operate from addresses in China while selling via Amazon and other sites to EU customers.
GESblog: If this issue is known, what makes it so difficult to tackle this fraud?
Rolf J. Langhammer: To put in simple terms: The digital environment is the problem. Customs authorities lack the digital equipment to identify tax evasion. They are also rather demotivated to sue traders who do not pay the VAT on imports. Moreover, China is a particular case. Chinese VAT rules exempt services that are entirely consumed outside of China. Foreign customs authorities fail to record the VAT exemption for Chinese exports of such services, which generally serves as the basis for levying the import VAT. Furthermore, VAT registration in China usually requires a company’s physical presence and involves much paperwork. Businesses in the digital economy, therefore, fall through the cracks in the regulatory systems.
GESblog: That sounds like many tax revenues go missing in those cracks.
Rolf J. Langhammer: Indeed, approximately 55 percent of all VAT revenues is not properly accounted for in China according to the OECD. Also, this problem may become more severe in the near future due to the rise of companies like Alibaba, the Chinese giant in cross-border online trade. Alibaba’s payments system Alipay is offered by a growing number of retailers and other service providers in Germany and other EU countries as a mode of payment since it provides access to China’s consumer market via Chinese tourists for whom digital payment is the rule rather than the exception.
GESblog: What can authorities of other countries do about that?
Rolf J. Langhammer: Certainly, the current system of labeling figures for expenditures for service imports from China as “uncertain” – as you find it in the German trade statistics – is a poor way of handling this situation. The most clean-cut solution would be abandoning the destination country principle and to charge the VAT at the source of production. This means you would charge the products at the point of export from China. The similar level of VAT in China and Germany (17 percent in China versus 19 percent in Germany) would make this sound reasonable.
GESblog: That sounds almost too easy for a solution to such a complex topic.
Rolf J. Langhammer: Well, of course, it would involve many changes, both for the tax systems in China and Germany, since a large number of exceptions from the standard VAT in China would likely raise fears of unfair tax competition in Germany. Furthermore, abandoning the destination country principle is not even feasible within the EU, whose member states have widely differing tax rates and systems of taxation.
GESblog: So we are facing here a fundamental problem of the digital revolution: laws and regulations don’t adapt quickly enough to keep up with the speed of the development of digital trade and transactions.
Rolf J. Langhammer: That is a massive problem, indeed, and it this case it literally means losing huge amounts of VAT if the authorities don’t find a way to force non-EU suppliers to report their trade and pay the tax as soon as possible. The European Commission is, therefore, working to create clear rules for a digital single market within the EU, as well as for digital trade with non-member countries such as China. The Commission’s calendar envisages the introduction of a so-called One-Stop-Shop (OSS) for digital service imports not earlier than 2021. The hope is that this mechanism will help to report digital service imports and that it creates incentives for traders to register by offering them a fast-track customs mechanism. Without an overhaul of the Chinese VAT rules on digital service exports, however, the incentives to sell cross-border digital services without reporting the VAT will continue to exist. That would be an invitation to traders and consumers to elevate tax evasion to the status of a rule. It should remain an exception.
Rolf J. Langhammer is a Professor of economics, former Vice President of the Kiel Institute for World Economy and expert on China’s economy. An opinion piece by the author on the same topic was first published on the Mercator Institute for China Studies’ blog “European Voices on China”.