Managing indirect taxes in the digital age. Mobile money and e-payments

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1 Mobile money and e-payments

2 Mobile money and e-payments The development of the technology to allow electronic payments affects not only the way that goods and services are rendered but also how these supplies are paid for by customers. Today, payments can be made any time, using any device, by customers located anywhere. Mobile money consists of making payments or managing cash via mobile devices. Each has specific VAT /GST consequences and can include: mobile money at the point of sale (e.g., mobile wallets, and smart phones used at the cash register); mobile payment platforms (e.g., solutions to send money from consumers to merchants or from person to person via mobile devices); direct carrier billing (e.g., paying digital merchants by adding items to the user s phone bill) and closed loop mobile payment (e.g., mobile store-specific credit cards). European Union While these developments represent significant progress for customers, they can present significant challenges for merchants that have to deal with several different providers of payment solutions, each of them supplying a different range of services subject to different VAT/GST rules. VAT/GST challenges also exist for service providers. Although this type of service is generally considered to be exempt from VAT, the scope of any such exemption has often provoked questions that have also been brought to the CJEU, creating uncertainty for affected businesses. Notwithstanding the criteria provided in the past by the CJEU, recently the Court has been asked to respond to questions intwo new cases (C-607/14 and C-130/15) aimed at clarifying the scope of the EU VAT exemption for card handling services. Australia On 6 May 2016 the Treasurer released a discussion paper flagging potential changes to the GST law to enable digital currencies to be treated in the same manner as conventional currencies. Currently, digital currencies are subject to GST in Australia because the ATO considers them to be intangible property for GST purposes. As such, the supply of digital currency is subject to GST, whether or not the supply is in exchange for money or other goods and services. As a result, consumers using digital currency to pay for other goods and services pay GST twice once on the acquisition of the digital currency and, subsequently, on their use. The discussion paper states that if digital currency is treated as money, a payment in digital currency will not be a supply for GST purposes, other than when digital currency is exchanged for other money, in which case it will be an input-taxed supply. Key indirect tax issues VAT rules in this area are complex with little consistency between countries. Inevitably, the VAT/GST rules lag behind commercial developments in the field. Unexpected VAT/GST liabilities may result in margin erosion or less competitive pricing and failure to comply with any VAT/GST compliance obligations may lead to penalties and reputational damage. Mobile money comes at the merger of two different sectors (financial services and telecommunications) each having its own specific indirect tax and commercial issues. Depending on where the different stakeholders stand in the supply chain, the VAT/GST consequences may vary and have significant impacts. Each party must consider the capacity in which they are acting and assess their VAT/GST liability in light of any new income streams. Contractual and commercial relationships need to be agreed carefully and clearly defined. 2

3 How EY can help We can help businesses understand and plan for the VAT implications of digital financial services. This includes adopting new ways of doing business online and aligning financial products and business models. By identifying VAT technical issues and incorporating the most favorable treatment, we can help businesses mitigate risks, reduce VAT costs and improve cash flow. Targets include traditional financial service companies (e.g., banks) and new entrants to the sector (e.g., telecommunications and fintech companies). We can help address VAT issues relating to: The treatment of electronic payments Helping online payments and retail payments Mobile wallets, mobile financial services, crypto currencies, block-chains and multi-purpose vouchers Reducing VAT recovery restrictions on costs Supplies made to and by intermediaries 3

4 Interview Interview with the Global VAT Director at a banking and financial services corporation In your view, what are the biggest challenges of the advances in digital technology from a VAT/GST perspective for a global bank? VAT costs are a real challenge for a financial institution like ours. With the advances in digital technology, we see convergence between different industry sectors. Technology companies are moving into the financial services space and are, in general, not applying the VAT exemption. This puts them at a competitive advantage against traditional financial institutions. Because our services do typically fall within the VAT exemptions, the flipside is that we cannot recover VAT on associated costs while they can. This is not helped by VAT legislation in the EU, which is about 40 years old and doesn t cater to the financial services of today. Here we don t have a level playing field. Further, VAT can be a barrier in the process of moving from local to global. Traditionally, 15 different retail banking jurisdictions may mean 15 different debit cards. While there would be synergies in centralizing and standardization, VAT may prove a real challenge on the resulting intercompany charges, especially in countries where we have subsidiaries. And with the Skandia case (Court of Justice of the European Union, C7-13), VAT costs may also arise on our intraentity transactions often substantial amounts due to transfer pricing requirements. Another concern I have is around B2C e-commerce services. Clearly this is trending at our bank as well, where new fintech-type services are being provided. While it has not been anticipated that these services fall within the Mini One Stop Shop for electronically supplied services, I do have to regularly monitor that the bank doesn t fall within this regime. The final issue is governance. Typically, local tax functions report to local finance. As a result, issues may arise with regard to speed and decision-making, which is typically required when dealing with global issues like digital. What do you see as the biggest advantages or opportunities afforded by advances in digital technology? More opportunities using data and IT forreal-time monitoring of VAT compliance position. This means we can better evidence that we are in control of our VAT position. Have you planned your digital tax/indirect tax strategy? We don t yet have a digital tax strategy. I see digital tax as a means to an end, not a strategic goal in itself. However, we do want to execute our indirect tax strategy with data and IT tools. In looking 5 to 10 years ahead what changes do you anticipate as a result of digitization from an indirect tax perspective? In 5 to 10 years, I would imagine we would have predictive data analysis available to us. So, for example, if the European Central Bank changes the interest rates, we would be able to immediately see the likely pro rata impact across our jurisdictions. Right now, we have designed and implemented inconsistency queries in our ERP system as part of our VAT control function. In the future, robotics may mean evolving to a self-learning machine that designs new and even better data queries, better evidencing that we are in control of our tax position. Robotics may result in a form of shared services center for our global tax function. Today, we already have automated reading and processing of purchase invoices. However, we still have some fallout where accounts payable teams have to manually key in the invoices, leading to more potential for errors. In the future, a shared services center could scan purchase invoices 100% and connect with our various systems to take care of a number of compliance functions, resulting in calculating our pro rata and prepopulating our VAT returns. People would be involved with the governance, validation and monitoring aspects of the compliance function. Have your company s activities changed as a result of digitalization? If so, in what way and how does this have an impact on the indirect tax position of the company? If not, do you expect changes in the near future? The bank tries to be a front-runner among the established banks in terms of fintech the tone comes straight from our management board in the search for best practices. We have bought a number of stakes in fintech companies and have developed a new app. One example is an e-wallet allowing you and your friends to split a bill at a restaurant without having to key in International Bank Account Numbers. There is a question to what extent the established banking sector can compete with new entrants in the financial market that are currently in a less regulated environment and can perhaps bring new products to market quickly. VAT is also a factor. In the Netherlands, for example, fintech companies providing online merchant card acquiring services are seen 4

5 Interview as providing taxable services. This is good news for them as it means they don t face VAT costs, while the online merchants can generally also recover any VAT charged. Because our bank typically combines the acquiring service with crediting the bank account of the merchant, its services are treated as VAT exempt. This causes irrecoverable VAT in the supply chain where typically the bank may work together with external technology providers on the service offering to the merchant. This is a real level-playing-field issue. Has your role changed as a result of digitalization? If so, in what ways? If not, do you expect changes in the near future? The role of the tax person has changed from pure advisory to process owner/ business partner. This may in part be due to digitalization that has given more transparency in the VAT compliance process. On the other hand, the role has changed because of a number of other factors, such as the spotlight on tax as a result of, for example, Base Erosion and Profit Shifting. What do you see as the top three priorities for managing indirect taxes in the digital age? Automating standard processes, achieving VAT efficiencies and controls, and providing input on the debate on tax. For example, as part of standardization, we would look at the way in which VAT accounting is done locally and our tax control framework is governed. Data and IT tools will be very important aspects as part of this. In terms of providing input, we think it is fair for the banks to have a level playing field in tax compared to other providers of financial services. In China, we recently saw that banking services will be subject to VAT, achieving neutrality for us. In the EU, we would like to see VAT on fees, and, for margin business, ideally VAT on B2B transactions and a zero rate for interest charged to consumers! Do you see any trends in how tax administrations are collecting and using data? What is the impact on your company? Not yet on the indirect tax side. We do see the tax administrations recruiting more IT auditors for VAT. They are already asking for batched data. For now they are merely looking no doubt this will evolve. The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made. 5

6 Case study E-payments: the EU VAT treatment is far from clear The old saying claims that cash is king. And even in the digital age, cash is still by far the main means of making payments. However, this situation is rapidly changing. Cashless and virtual payments are increasing in popularity because of factors such as the development of technology and the spread of electronic devices and high-speed internet connections. Globally, the value of cashless payment instruments is expected to almost double by The most common payment instruments used as alternatives to cash are credit and debit cards, but other means are quickly spreading. Electronic and mobile payments (e-payments and m-payments) 2 already account for 35 billion and 29 billion operations, 3 respectively, with more growth than traditional means of payment. These instruments are expected to become even more popular, fueled by the spread of smartphones and other mobile devices, as well as the increased availability of innovative payment solutions developed by banks and other players, including telecommunications companies, manufacturers of mobile devices and media companies. In this framework, payment methods such as virtual currencies are already playing a significant role. Even if they remain limited in terms of total value of intermediate transactions, they are assuming more and more relevance in the market, increasing the pressure on financial institutions to reduce costs and propose innovative services. The VAT dimension While the spread of alternative payment options provides many benefits to customers, it raises many questions for businesses operating in the payment industry. That includes understanding what value-added tax (VAT) treatment to apply to the different transactions, as well as the related consequences of input VAT recoverability. This situation is rendered more complex because each means of payment, from the traditional to the digital, has its own features and specific facts, possibly resulting in very different VAT treatments. EU VAT treatment of payment services Transactions connected to payment services are commonly exempt from VAT in the EU, whereas the mere transfer or exchange of money is outside the scope of the tax. But the scope of the financial services exemption provided by the EU VAT legislation is not always clear. This has led tax courts in individual Member States to refer cases about the VAT treatment of payment transactions to the Court of Justice of the European Union (CJEU). Let s consider two examples: In its judgment in the case of Everything Everywhere Ltd (C-276/09), the CJEU decided that payment-processing charges are not consideration for a supply that is distinct and independent from the principal supply of telecommunication services and, therefore, they are subject to VAT. 1 The European House Ambrosetti, based on World Payments Report 2015 data. Cashless payments are estimated to have risen to USD389.7 billion in 2014, up from USD314 billion in Payments made with cell phones and other mobile devices. 3 The European House Ambrosetti, based on World Payments Report 2015 data. Cashless payments Debit cards Debit cards are similar to cash because they allow money to be withdrawn to pay the merchant directly from the holder s bank account. Therefore, the payer needs to have a positive bank account balance to make the payment. Credit cards Credit cards are also linked to the holder s bank account, but the amount due to the merchant is not withdrawn immediately. Instead, it is anticipated by the bank (or by another institution) that manages the card, while the cardholder has a credit line with the card issuer and pays interest on outstanding payments. Digital currencies Digital currencies are commonly defined as currencies other than those issued and backed by central or national banks, through which it is possible to buy real goods and services. Virtual currencies, on the other hand, have traditionally allowed parties to buy or exchange only virtual goods (for example, in connection with an online game). But that is changing: businesses are starting to accept bitcoin and similar digital currencies to conclude other types of transactions. E-payments E-payment systems allow customers to pay for goods and services electronically without using cash, checks or other traditional means. M-payments are electronic payments made using mobile devices. 6

7 Case study Similarly, in the AXA UK PLC (C 175/09) case, the CJEU concluded that a supply consisting of collecting, processing and then paying to merchants the sums due to them under patients insurance plans is a debt collection service and is subject to VAT. Unfortunately, the CJEU judgments have not resolved all the doubts and uncertainties about the correct VAT treatment of payment transactions. Two phenomena have exacerbated these difficulties: the emergence of new payment systems and the trend for inancial institutions to outsource certain activities and services to third parties. New payment systems Each payment system has its own unique features that influence whether and how VAT applies. One example of the EU VAT issues created in this area involves the dispute over the VAT treatment of digital currencies, for which each Member State has taken its own view and approach. 4 The CJEU has now clarified that bitcoin has no purpose other than to be a means of payment (Hedqvist, C-264/14) and, consequently, transactions consisting of exchanging digital currencies for traditional currencies should be exempt from VAT. Outsourcing Using third parties to perform certain back office activities is not a new phenomenon in the financial services sector. 5 But the trend is growing, fueled by the continued focus of banks and other financial institutions on their key processes and cost control. Constant changes in the EU regulatory environment have contributed. The introduction of the Single Euro Payments Area (SEPA), which seeks to eliminate the differences between national and crossborder payments within the EU, has forced banks to invest heavily in IT platforms to achieve cheaper, more efficient and safer cross-border payment procedures. In addressing SEPA, some financial institutions have preferred not to build the necessary infrastructure in-house, outsourcing it instead. Consequently, they receive services (such as payment processing, clearing and settlement) from specialized third parties. These types of outsourced services are covered by a VAT exemption if they form a distinct whole and they are specific to, and essential for, an exempt transaction. 6 However, the mere fact that a constituent element is essential for completing an exempt transaction does not necessarily lead to the conclusion that the related service is exempt. If a VAT exemption does not apply, the services are taxable (generally at rates of 17% to 27% in the EU) and the recipient may be in a position to recover the tax charged. VAT recovery Because payment transactions are usually seen as exempt from VAT, businesses operating in the payment industry have traditionally not recovered VAT in full as the performance of exempt transactions does not grant the right to recover the input VAT on associated costs. Although the application of the VAT exemption may be perceived as a benefit for the recipients of those services, it raises issues for the suppliers because the related input VAT is a cost. For example, if an outsourced service does not qualify for VAT exemption, the VAT charge is likely to be at least a partial cost for the bank or financial services company that incurs the cost. This associated cost will either reduce the bank s profit margin on its payment services or result in a higher onward charge to its customers. Cross-border VAT Different countries apply different criteria for determining the VAT treatment of cashless payments. In today s global economy, the question of whether VAT applies to particular payment services can become even more complex because they are increasingly rendered between counterparties established in different jurisdictions. Suppliers may need to decide whether their transactions fall under the definition of e-services applied in different countries and, if so, whether that confers additional VAT liabilities or opportunities. Business recipients must determine whether VAT should be self-assessed on the services received. In some jurisdictions, an option for VAT for those types of services may also apply. 7 4 In some jurisdictions, bitcoin has been initially considered a voucher. In others, it is viewed as a currency or a negotiable instrument. 5 This is confirmed by the fact that a case concerning the VAT treatment applicable to outsourced payment services was brought to the judgment of the European Court of Justice (ECJ) in 1995 (Sparekasserness Datacenter v. Skatteministeriet, C-2/95). 6 The ECJ acknowledged those principles with the judgment of 5 June 1997, Case C-2/95. 7 Based on our information, such an option is currently provided by Belgium, Estonia, France, Germany and Lithuania. 8 Bookit Limited case (C-607/14) and National Exhibition Centre Limited (C-130/15). 7

8 Case study VAT changes what should you do? The correct VAT treatment of payment transactions has never been an easy topic because the legislation does not provide enough clarity about the exact scope of the exemption for this type of services. The situation is made even more complex by the emergence of new means of payment with specific features and by the economic trend toward outsourcing some of those services to third parties. This is a fast-moving and changing area of VAT law. Businesses in the financial services sector should be aware of how different countries around the world are adopting and adapting indirect tax legislation to reflect the digital economy. In the EU, the rules are developing apace, and the CJEU is expected to provide judgments in the next few months in at least two cases specifically concerning the VAT treatment applicable to payment transactions. 8 Businesses that provide payment services should: Identify the correct VAT treatment of new payment services (in each jurisdiction) Identify whether a VAT exemption may apply to outsourced services Identify any opportunities for increasing the recoverability of input VAT incurred on costs Track the impact of legislative changes and legal developments in this area Contacts Yannick Zeippen yannick.zeippen@lu.ey.com 8

9 Case study Spotlight on Fintech The integration of the technology sector, which is one of the most successful sectors of our time, with the financial sector, which has struggled since the economic crisis almost a decade ago, has led to one of the most innovative businesses of our generation: Fintech. These innovative financial technology (fintech) businesses are changing the way that financial services are supplied to consumers from robo-advisors helping them invest their savings to smart gadgets fitted into cars that are helping to reduce drivers insurance premiums. The use of technology by financial services organizations to enhance the provision of their services is not a recent development. The change is the use of technology, not to enhance financial organizations services, but to actually provide them. A short history The traditional financial services industry was introduced to technology in the 1950s when Bank of America commissioned the first large commercial computer. Since then, the banking industry has seen the introduction of automated teller machines (ATMs), electronic funds transfers and banking applications for smartphones, with the latter half of the 20th century seeing an increase in technology use throughout the sector. Value added tax (VAT) 1 as we know it in Europe was originally introduced in France in Other jurisdictions across the globe followed suit (with more than 160 countries now in the VAT net ). Logically, the VAT legislation in most countries was drafted and enacted using the goods and services supplied at the time when the tax was introduced. However, technology and business models have evolved greatly in that time to the extent that it is now difficult in many cases to apply the largely unchanged VAT legislation of the 20th Century to the activities of today s digital economy. VAT liability is an important commercial consideration Fintech is disrupting the traditional financial services sector in two ways: first by the introduction of fintech companies as competitors (e.g. the robo-advisor ) and second through the use of fintechs by financial services organizations to enhance their existing supplies (e.g. the gadgets ). The qualification of the services supplied by fintechs is vital in determining the VAT liability to be attributed to those services. This distinction is far from academic. Where fintechs are competing with traditional financial service providers (for example, for processing payments), the ability to recover VAT on costs can be the differentiator in determining commercial success. The horse or the cart? You need a strategy The complication when considering the VAT position of a fintech and the services it provides centers on the determination of the services as a supply of the technology cart or the financial services horse. Traditionally, the supply of financial services results in a VAT burden in the hands of the financial services provider because its services fall within an exemption from VAT with no, or limited, right to deduct the VAT on associated costs. If the fintech is supplying its services to a bank or to a private individual, ideally its services will also fall within the scope of an exemption, thereby reducing the VAT burden on its customer. The downside of exemption is that the fintech itself is not able to recover the VAT on its costs. Given that the fintech is likely to have incurred significant technology costs, the related VAT is also likely to be significant (more than 20% of the value on average in the EU). Alternatively, fintechs that render their services to fully taxable businesses (e.g., shops and restaurants) are likely to choose a strategy where their services are fully taxable. This will allow them to recover their input VAT on costs and purchases whilst the service establishments (shops, restaurants) recover the input VAT that the fintech charges them. Obviously, the tax authorities may well take an opposite view in both situations that we described as that view brings them more non-deductible input VAT. In the EU the debate on exempt financial and insurance services versus taxable operational services (telecom, payment processing) has led to a number of decisions from the Court of Justice. 2 These cases have shown how small the differences are between exempt and taxable supplies. The facts of those cases are different from today s fintech operations. But the conceptual framework to determine whether an exemption applies or not is still valid. On the other hand as indicated, if the fintech supplies its services to businesses such as online retailers (which are likely to be able to recover any VAT they incur), it could seek to charge VAT on its services, resulting in the ability to recover its own VAT. That can be a win/win for the fintech and the customer. 1 References to VAT also encompass similar forms of indirect taxes, such as goods and services tax (GST), consumption tax and sales tax. 2 C-2/95 (Sparekassernes Datacenter SDC), C-349/96 (Card Protection Plan CPP), C-235/00 (CSC Financial Services CSC), C-453/05 (Volker Ludwig), C-472/03 (Arthur Andersen) and C-350/10 (Nordea Bank). 9

10 Case study VAT issues are not always easily resolved for traditional players. If a financial services organization chooses to enhance its technologically-based services, the VAT it incurs will, in most cases, be a cost. Digitalizing its business, or working in partnership with a fintech, can result in a reduction in headcount andtherefore a cash saving. However, this should be weighed against the additional irrecoverable VAT cost as salaries are not subject to VAT costs. Uncertainty over the VAT treatment creates commercial issues both for fintechs and traditional financial services businesses: If VAT is chargeable, should the supplier reduce its margins or potentially suffer a competitive disadvantage (where VAT is a cost to its clients)? If the supply is exempt, should the supplier factor in any irrecoverable VAT on its costs into its pricing decisions thereby maximizing its margins or should it not include the irrecoverable VAT in its prices to obtain a competitive advantage. In either case, the supplier faces a commercial conundrum. Electronic services Before technology was widely accessible to all, financial services were traditionally supplied either in person or they were largely paper-based. With the evolution of technology, the widespread use of the internet and the increase in cross-border trade, the creation of electronicallysupplied services in the sector was unavoidable. This development results in yet a further dilemma: can financial services qualify as electronically-supplied services for VAT purposes? Is a fintech, or a traditional financial services organization partnering with a fintech for the supply of its services, at an administrative disadvantage because it makes its supplies online rather than in person? Depending on the nature of the customer the qualification of financial services as electronically-supplied services can lead to additional VAT compliance obligations and to more fundamental commercial issues, particularly where the VAT treatment of certain services can vary between different jurisdictions. This is a key issue in the EU and in other jurisdictions around the world that tax cross-border digital services Taking stock It is fundamental to the success of any business model within the financial services industry that the VAT impact is considered. Considerations include the costs to be incurred, the qualification of the services and the nature and domicile of the intended customers. With the speed of change surrounding the financial services sector and fintech, it is important that innovators analyze whether it is advantageous that the technology cart is before the financial services horse. Contacts Shima Heydari shima.heydari@nl.ey.com Andrew Bailey abailey1@uk.ey.com 10

11 Contacts Global Director of Indirect Tax Gijsbert Bulk Europe, Middle East, India and Africa (EMEIA) Kevin MacAuley Americas Jeffrey N. Saviano New York Boston Robert S. Smith Global Trade William M. Methenitis Neil Byrne neil.byrne@ie.ey.com Asia Pacific Adrian Ball adrian.r.ball@sg.ey.com Excerpt from Managing indirect taxes in the digital age. Read the full report and access interactive content at ey.com/indirectdigital.

12 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY s Indirect Tax services Indirect taxes, ranging from value-added tax (VAT) and customs duties to environmental levies, affect the supply chain and the financial system. They pose unique challenges to multinational tax functions since they must be managed accurately and in real time. These often invisible taxes can have significant impacts on cash flow, absolute costs and risk exposures. Thanks to our network of dedicated Indirect Tax professionals, who share knowledge and ideas, we can provide seamless, consistent service throughout the world and help you deal effectively with cross-border issues. These include advising on the VAT treatment of new and complex transactions and supplies, and helping resolve classification or other disputes and issues with the authorities. We provide assistance in identifying risk areas and sustainable planning opportunities for indirect taxes throughout the tax life cycle. We can provide you with effective processes to help improve your day-to-day reporting for indirect tax, reducing attribution errors and costs, and making certain indirect taxes are handled correctly. We can support full or partial VAT compliance outsourcing, help identify the right partial exemption method and review accounting systems. Our customs and international trade teams can help you manage customs declarations, audit and review product classifications, and evaluate import and export documentation. Our globally integrated teams can give you the perspective and support you need to manage indirect taxes effectively EYGM Limited. All Rights Reserved. EYG no GBL ED none This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made. ey.com