U.S. Companies Become EU Tax Collectors

Published December 1, 2003

Since July 1, U.S. firms selling certain goods to customers in the European Union (EU) have been required, under a law passed by the EU last year, to act as tax collectors on behalf of EU officials.

Concerned that overtaxed consumers might otherwise escape the EU’s value-added tax (VAT), member countries adopted on May 7, 2002 a plan that imposes the VAT on software, videos, computer games, and music downloaded via the Internet from non-EU companies. The EU claims the extra-territorial tax scheme is necessary to level the playing field for its own retailers.

European companies traditionally add a VAT to the services and products they sell online. A Dutch company collects the Dutch tax on any online products it sells, regardless of where the customer lives.

By contrast, companies headquartered outside the EU impose only the taxes required by their national governments. They have not collected an EU value-added tax on sales to EU customers, because the point of sale is not in the EU.

The EU’s new VAT on Internet sales changes that dynamic, by shifting the point of taxation from where the good is sold to where it is consumed. Under the new VAT, a U.S. company selling to an EU customer is expected to collect the VAT and remit it to the EU government.

Revenue Bonanza

As the cost of international shipping continues to fall, highly taxed Europeans are increasingly turning to the Internet for tax-free purchases. In July, Amazon.com reported that its international sales are growing faster than its North American sales, thanks mostly to Europe’s “big three” Internet markets: Germany, France, and the United Kingdom. In 2002, according to Amazon.com, those countries accounted for 70 percent of the e-commerce in Europe.

A study by Emarketer, which conducts Internet and e-business research and analysis, projected that in 2004 the United States will have 168 million Internet users, 75 percent of whom will be online buyers. In Europe, the group projected, 221 million people–86 percent of whom will be shoppers–will be online.

Provided non-EU companies comply with the VAT requirement, the revenue potential could be huge. Some of the revenue would be offset by the VAT measure’s new export preference, which excludes from the VAT sales to U.S. customers by EU companies. That concession costs the EU little, however, because few foreigners buy from EU firms.

Extending the VAT to Internet purchases by EU consumers is also unlikely to do serious damage to the Internet economy; that market is certainly big enough to absorb the loss of some EU customers. And there is virtually no political cost: Non-EU companies do not vote in Europe, and the new tax revenues will allow EU member countries to score political points with new or expanded government services.

Perpetuating Tax-and-Spend Mentality

By imposing the VAT on Internet sales, EU politicians expect to be able to continue their tax-and-spend ways without suffering any consequences for their behavior. They accuse non-EU nations of “poaching” their taxpayers–as if their citizens are tax slaves, perpetually bound by the tax laws of their home government regardless of where they work, save, shop, or invest.

The EU’s approach completely reverses causality. It is not “poaching” by more-responsible governments that makes cross-border shopping attractive. Rather, European consumers are shopping elsewhere because the EU has made it too expensive to shop domestically, by requiring all member nations to harmonize their value-added taxes at a rate of at least 15 percent.

Non-European businesses have three options for responding to the new VAT.

First, they can register their business and set up headquarters in an EU country. They would then pay that country’s tax rate on sales to customers in any EU country. That is the option chosen by America Online, which will move its European headquarters to EU’s lowest-VAT country, Luxembourg. Exercising this option is complicated and costly but, according to an AOL spokeswoman, “it certainly beats the alternative.”

The second option is for non-EU companies to pay the tax rate for the country where the customer lives, ranging from 15 percent in Luxembourg to 25 percent in Sweden. Companies exercising this option must collect information about each customer and comply with the rules of several tax jurisdictions. Amazon.com opted for this approach after it realized how much the new regulation would affect its operations through which third-party new and used items are sold. By assessing the VAT on each of its commissions, Amazon will see its costs increase significantly.

Finally, non-EU companies can ignore the new regulation. In theory, the cost of noncompliance could be steep: The EU threatens to force “cheaters” to pay back taxes plus fines up to 200 percent of the back taxes, among other penalties. Yet the EU measure makes no provision for how it will enforce this rule against smaller companies with no EU presence.

Dangerous Precedent

The high cost and complexity of complying with the EU tax–not to mention the indignity of having been drafted as European tax collectors against their will–are not the only reasons U.S. companies feel threatened by the measure.

E-commerce companies are also worried the EU initiative might fuel efforts by state and local governments in the U.S. to tax domestic interstate e-commerce. “Companies will have to put in place procedures and software to implement VAT, and once they’ve done that it’s relatively easy to do the same in the U.S.,” explained James Lewis, director of the technology and public policy program at the Center for Strategic and International Studies.

To date, Internet retailers in the U.S. have been protected by the Supreme Court’s 1992 Quill decision, which determined states may not require out-of-state retailers to collect and remit sales taxes if the retailer does not have a substantial physical presence in the state. To bypass that “nexus” requirement would require an act of Congress.

Veronique de Rugy is a policy analyst at the Cato Institute in Washington, DC. Her email address is [email protected].