International Tax Panorama

Background: 

Today more than 20% of non-food retail spending in the UK now takes place online. The increased retail sector is mired by the simultaneous increase in VAT fraud. The basic problem is that as third party sellers on UK online marketplaces, overseas businesses can sell goods to UK consumers in circumstances where the goods are in the UK (in a storage facility or “fulfillment house”) at the time of sale. The sales therefore attract UK VAT. However, as the seller is based overseas, it is easier to evade the correct payment of VAT and duty.Hence significant VAT revenue is lost, and the overseas fraudster is able unfairly to undercut businesses trading lawfully in the UK.

The assessment of real time impact of the online VAT fraud by a parliamentary report in UK revealed that online marketplaces – including Amazon and Ebay – are profiting from online VAT fraud while the HMRC fails to use the full extent of its powers for a crackdown. The Public Accounts Committee found that online marketplaces allow overseas sellers or businesses to sell goods while dodging the 20 per cent VAT which has serious repercussions towards undermining UK-based traders. 

HMRC estimated the cost to the Treasury to be around GBP1bn (USD1.25bn) a year, with many of the non-compliant overseas retailers said to be based in China. On the other hand the cross-party committee’s report said the HMRC was “too cautious” in cracking down on fraudsters, and that the potential amount of tax funds the public is missing out on as a result could be higher than the tax authority’s estimate of £1.5 billion.Such report comes a huge shock in the midst of huge jump in retail sales. Thus Online marketplaces are accused of double standards, saying they have taken such little action to date despite the companies’ commitment to removing fraudsters. Such form of behaviour unfairly undercuts businesses trading in the UK that play by the rules, abuses the trust of buyers and deprives the government of significant revenue that funds vital public services.

Under current tax laws, traders based outside the EU selling to UK customers must charge VAT if the items are present in the UK at the time of sale. Many fail to charge the 20 per cent tax despite the goods being stored in up to 3000 fulfilment warehouses around the the country. The committee warned this would only get more complicated given the uncertainty over customs arrangements when Britain leaves the EU. The committee also called for much more urgency from HMRC, which has not named and shamed non-compliant traders and so far has not prosecuted a single seller for committing online VAT fraud. 

Analysis of series of measures in UK:

The UK was one of the first countries in the world to introduce tough powers to tackle VAT evasion by overseas sellers in September 2016, which has led to the removal of over a thousand non compliant overseas businesses from selling goods online in the UK and to motivate thousands of others to register for VAT. The powers, which came into force in September 2016, were aimed at addressing the unfair advantage overseas retailers had over UK-based retailers by not charging VAT on internet sales.

Under those rules, HMRC can force overseas retailers to appoint a UK-based VAT representative or provide a financial guarantee. If the overseas retailer fails to comply, the online marketplace they use to sell their goods could be held liable. Additionally, HMRC will start to accept registrations for the Fulfilment House Due Diligence Scheme from April 2018, which will oblige fulfilment businesses in the UK to register with HMRC, keep certain records and carry out robust due diligence checks on their overseas customers. In 2016, HMRC saw a ten-fold increase in VAT registration applications from internet retailers as a result of the change.

Then, in the 2017 Autumn Budget, the UK decided to bolster the new regime by introducing joint and several liability for online marketplaces and introducing a new obligation requiring sellers to display their VAT numbers online.

What does the new law talks about? 

Current law for joint and several liability is in Section 77B of the VAT Act 1994 (VATA94). These changes were effective from 15 September 2016 by Section 124 of the Finance Act 2016.

Legislation will be introduced in Finance Bill 2017-18 to:

• amend Section 77B of VATA94 by removing references to ‘UK-established’ in subsections (1) and (12) and omitting subsection (10)
• amend Section 69 of VATA94 to enable a penalty to be applied where the online marketplace is in breach of the requirement relating to displaying sellers’ valid VAT numbers

In particularly Clause 38 of the Finance Bill 2017-18 provides for an anti-fraud / non-compliance measure with the following features:

1. Broadening of scope: It extends the scope of existing joint and several liability rules for online marketplace operators to include sales of goods of both UK and non-UK sellers to UK consumers. (previously just non-UK sellers). An online marketplace operator can be held jointly and severally liable for VAT payable by any person selling goods through the platform who fails to comply with any requirement imposed by VATA 1994, Sch 1A.
2. Time threshold: If an online marketplace operator allows an unregistered non-UK business to continue to sell goods through its marketplace 60 days after it knows that it should be registered, it will be held jointly and severally liable for the unpaid VAT. The liability will cease from the point that the non-UK business complies with its obligation to register under VATA 1994, Sch 1A.
3. Substantive requirements: It introduces a new test for online marketplace operators in relation to non-UK sellers; where the online marketplace “knows, or should know” that the seller is in breach of its VAT registration requirements.
4. Formal requirements: It requires online marketplace operators to (a) display VAT numbers of all sellers and (b) take reasonable steps to verify the VAT number is valid, when they are provided with one, to help buyers make an informed choice about buying goods from a VAT-registered businesses.This is part of a package of measures designed to clamp down on businesses who sell through online marketplaces but fail to pay VAT. The scheme will require businesses that store imported goods for or on behalf of overseas sellers from outside the EU to keep certain records and perform certain checks on the goods they are storing.
5. Burden of proof: The operator will be responsible for ensuring the validity of all the registration numbers provided to it and take steps to remove any invalid ones.They will also be required to ensure that VAT numbers displayed on their website are valid to ensures that fictitious and hijacked VAT numbers are not displayed.
6. Consequences for non-compliance: The legislation only applies to those businesses who are not compliant with their VAT obligations and HMRC will only issue notices to online marketplaces where it is satisfied that a business is non-compliant.This could lead to fines and recovery of future unpaid tax by those sellers.

These measures will help to level the playing field between sellers who comply with their UK VAT obligations and those who do not. Marketplaces are also encouraged to help online sellers to understand the tax rules.

The new rules go further to strengthen and develop HMRC’s operational response to online VAT fraud and error from both UK and overseas businesses.The HMRC also believes that the new measures will help protect around £1 billion of tax revenue by 2023.

Criticisms: 

Effectiveness of Procedural formality: 

Several VAT experts voiced their concerns over the new rules. Peter Dowd (Lab) welcomed the move to make online marketplaces jointly liable for the sellers’ VAT on their websites. But he was concerned that the wording seemed to imply that joint liability would not be presumed in law but would happen after HMRC had undertaken an investigation. Further, the government had not stated the value of the penalty that an online marketplace would incur if it refused to co-operate with HMRC. Nor had it specified a time framework for an online marketplace to comply with HMRC and remove a seller’s goods if it failed to pay VAT.

The Brexit effect: 

As ever in VAT, the devil is in the detail. What would, at first glance, be the easiest measure for marketplaces to adopt, is the displaying of a seller’s valid VAT registration number; assuming the marketplace is given one. Under this measure, the marketplace is expected to check the validity of the number given. But to do so, HMRC needs to ensure that the VIES database is up to date, and identifies all UK VAT-registered business, particularly where the seller may be an individual member of a VAT group and only the VAT group’s representative is identified on the database. 

HMRC expects leaving the EU to pose four big challenges to the department as a whole: customs; indirect taxes, particularly VAT; data sharing with other EU countries; and the welfare state (with respect to treatment of EU citizens). 

Administrative challenges: 

The new measures also address UK sellers using an online marketplace. Here it is envisaged that the first contact will be between HMRC and the non-compliant seller. According to a recent study, there are now over 700,000 small UK business owners selling via online marketplaces. If even 10 per cent of these businesses are identified by HMRC as not being VAT-compliant, online marketplaces face the onerous administrative challenge of contacting and removing these sellers from their platforms within a tight timeframe.

Enhanced tracking & monitoring of stocks through HMRC assistance: 

Another challenging aspect for online marketplaces relates to tracking and monitoring stocks of overseas sellers. Under the new measures, an online marketplace will face a joint and several liability notice if it ‘knew, or should have known’ that the non-UK business should be registered for VAT in the UK. The marketplace will have 60 days to contact or remove the non-compliant seller from its platform if it wishes to avoid a joint and several liability notice. However, without some assistance from HMRC, marketplaces may struggle to know what stock is held by the seller in the UK; the value of a seller’s sales in the UK; or even if the seller has been compliant in filing VAT returns; particularly if the seller is using several different platforms.

More often the marketplace has no idea where stock is held or what your total turnover is (apart from the bit on that particular marketplace). Amazon of course know exactly where your stock is if it’s in FBA, eBay frankly haven’t got a clue as they don’t hold your stock and don’t get to see you tax affairs so it’s tough for them to be held to account. Of course as soon as HMRC notify them of a suspicious account that may be dodgy we expect them to take action, but they appear to have been more than willing to do this.

eBay reported in September this year that they had only received a paltry 77 Joint and Several Liability Notices from HMRC resulting in blocking 184 sellers. Amazon have acted on 416 notices from HMRC (Unlike eBay, Amazon have a strict one account per retailer on their platform so we can assume they’ve blocked 416 accounts). It’s worth noting that from their own internal efforts eBay blocked a further 893 accounts with no input from HMRC. Thus such figures suggest a joint effort of HMRC with online market operators to reduce the huge insignificant administrative burden on market operators to remain compliant with the law. 

Effectiveness on filling the VAT gap: 

The Chancellor identified that ‘online VAT fraud costs the taxpayer £1.2bn per year’; however, the Budget papers show that the new measures will only generate £145m, in total, by 2023, which suggests that, although marketplaces are themselves already doing a lot to clampdown on online VAT fraud, more needs to be done.

The ‘knew or should have known’ test

The measure enables HMRC to hold online marketplaces jointly and severally liable for any unpaid VAT of a non-UK business arising from sales of goods in the UK via that online marketplace, where that marketplace ‘knew or should have known’ that the non-UK business should be registered for VAT in the UK. The ‘knew or should have known’ test is more commonly referred to as the Kittel principle (Axel Kittel v Belgium, Belgium v Recolta Recycling (C-439/04, C-440/04)) and has been subject to significant litigation through the UK Courts and the European Court of Justice.The Joint and Several Liability provisions in respect of specified goods, introduced in 2003 as section 77A of VATA, were not employed as frequently as originally anticipated, owing in large part to the identification of the principle in Axel Kittel v Belgian State (C-439/04) and Belgian State v Recolta Recycling SPRL (C-440/04). The principle continues to evolve, intertwined with principles of abuse (Halifax). 

How these principles will evolve and how they might influence the UK’s interpretation post-Brexit is a matter of continued debate. It will be interesting to see how, and to what extent, this new and discretionary J&S provision will be applied. It is of note that the s77A and Kittel provisions apply to traders in the transaction chain. This new J&S provision applies differently, to a third party that is not a part of the transaction chain itself.

Also it will not always be obvious whether a seller should be registered for VAT. Marketplaces will need to satisfy themselves and HMRC that they have taken sufficient reasonable steps to protect themselves against challenges that they ‘knew or should have known’ that a seller should be VAT registered in the UK. Effective and clear guidance will be crucial.

Verification of VAT numbers:

Online Marketplace operators will be required to display the VAT number of their third- party sellers (generally within 10 days of being provided with it) and take reasonable steps to check that the VAT number provided is valid. Where the online marketplace becomes aware that the VAT number is not valid, it is required to remove it from display within 10 days.

The most common way of checking whether a VAT number is valid is to use the online VAT number validation service provided by the VAT Information Exchange System (VIES); operated by the European Commission. The system uses real-time data feeds from individual member states’ VAT systems so the information should be up to date at all times.

What provision will be made for UK taxpayers to validate VAT numbers after Brexit? It is not clear whether the VIES online validation check (or similar) will remain available.

Concern for future marketplaces: 

Also consider new marketplaces who may launch in the future – they will be lumbered with VAT worries from day one potentially putting them off and lessening competition. Retailers following Tesco, Halfords and GAME (who all launched their own marketplaces) might think twice about doing likewise if they are liable for any VAT their retailers don’t pay and fewer marketplaces is bad for the industry.

New means of committing Fraud:

The online marketplace operator can escape liability by removing the trader from its site, and the fraudulent  overseas trader can both escape liability, and continue selling its goods online, by reincorporating into a new entity and continuing where it left off. This well-known technique may also be employed in circumventing the amended powers in s48.

Final Remarks: 

Online marketplaces will need to enhance their due diligence to satisfy HMRC that they took all reasonable measures to ensure they did not know or ought not to have known that there could be a VAT loss. The success of the new measures to tackle online VAT fraud set out in the Budget will be as much dependent upon the actions of HMRC as it will on the cooperation of online marketplaces. The HMRC has been ordered to implement a cooperation agreement with online marketplaces by March. An Ebay spokesman said the company continues to work with HMRC to keep their business standards in line with tax laws while an Amazon spokesman said they were reviewing the committee’s recommendations.

“We offer extensive information, training and tools to assist sellers in their VAT obligations, and we work closely with HMRC on this matter,” the Amazon spokesman said. 

Collaboration between the online marketplaces and HMRC will be crucial to the success of tackling online VAT fraud, as any enforcement is intertwined between both organisations to share key evidence to support any fraudulent activity.