01 June 2015

Startups’ growing need for VAT reform

The European Parliament spoke in unison regarding the new rules on VAT, and their effect on small business and startups, echoing the concerns of many industry leaders. The January changes have made the European VAT scheme burdensome for startups and we are in dire need of a threshold for smaller businesses, under which VAT will not be charged.

The recent message from the plenary was clear and uniform — the current VAT regime is creating an unmanageable administrative burden, particularly in the case of tech and digital startups. Building to the Unconvention in July, EYIF examines how growth is being suppressed by the current VAT framework and how it must change quickly to meet the needs of tech and digital startups looking to grow and scale.

What are the Current Rules?

In January 2015, an important change was made to the way VAT is charged. The new Directive introduced modified “place of supply” rules which now mean that digital business, or SaaS business (‘Software as a Service’) to be technical, is now charged VAT based on the location of their customer. This is in contrast to previous rules through which rates would be charged in relation to the location of the business itself. For internet-based companies operating online in multiple Member States, this has caused a huge headache. Two examples illustrate the change:

Pre-January 2015: Startup A is registered in Belgium and has customers in Belgium, the Netherlands and Germany. Under the old rules startup A would pay VAT exclusively in Belgium and according to Belgian law regardless of the location of their customer base.

Post-January 2015: Startup B is registered in Belgium and has customers in Belgium, the Netherlands and Germany. As of January 2015 startup B has to register with the tax authorities in all three Member States and comply with the different rules in each jurisdiction.

How are the new rules detrimental to startups looking to grow?

For startups seeking European expansion and growth, current VAT rules create one enormous, and in many cases impassable, obstacle. Startups must be registered in every Member State in which they are trading. If that wasn’t inconvenient enough, each Member State administers its own tailored version of the EU VAT regime – a consequence of a policy of minimum harmonisation. The Commission itself, in the ‘Digital Single Market Strategy’ has estimated the cost of compliance to be “at least EUR 5.000 annually for each targeted Member State”.

Somewhat paradoxically, the modification to the rules, agreed upon in 2006, were actually implemented expressly for the benefit of startups. In a recent plenary session Vice-President Ansip recalled that in the build-up to the adoption of the new VAT Directive there were complaints of digital giants, establishing themselves in tax-favourable Luxembourg to avoid higher VAT rates in other Member States – so-called jurisdiction shopping.

For startups this created an environment in which the conditions of competition were weighted heavily against those who could not afford to relocate. It was the intention of the Commission to introduce a more competitive market but the current VAT regime is widely regarded to have failed in this respect.

Commenting on the effect on UK startups in the run-up to the implementation, Carol Tricks of Temple Bright reported in The Guardian that “businesses who supply digital services in Europe face an unappealing choice between losing sales from Europe and therefore remaining VAT exempt in the UK, or having to pay an extra 20% on all earnings in the UK”. Anecdotal evidence, particularly from the raft of MEPs from across the political spectrum, indicates that this has played out as predicted.

The Digital Single Market Strategy for VAT

The ‘Digital Single Market Strategy’ delivered on May 6th has recognised the complications which have arisen out of the current rules on VAT in the context of digital entrepreneurs. Without being too specific, the long-awaited strategy outlined that the Commission would be “introducing a common EU-wide simplification measure”. In the plenary, Vice-President Ansip announced that he will commission a report for completion in 2016 and then address the problem building on this basis. It seems for the current crop of startups looking for growth, these rule changes may come too late.

VAT for startups: What is needed?

Ultimately we have two problems that we must avoid. On the one hand, Europe needs to maintain its stance on jurisdiction shopping. On the other hand, it is not feasible to request startups to maintain compliance with different VAT rules in up to 28 Member States.

The answer, echoed by more or less every party speaking out on this issue including EYIF, is a common threshold. This could for example mirror the supply of goods threshold, as pointed out by  Dominik Tobschall writing for Tech.eu. A harmonised threshold of between EUR 80,000 and EUR 100,000, below which a startup would not have to pay VAT on sales in a given Member State, would be a measure which would both encourage startup growth and avoid jurisdiction shopping. It has been tried and successfully tested on a national level in a number of European countries.

However, for the startups that are ready to scale and grow, this change is needed now if the European ecosystem is to remain competitive. It is for this reason that the policy of introducing simplified VAT rules is included in the upcoming EYIF StartUp Act. As part of our ‘Better Start’ proposal we are encouraging that VAT, among other burdensome regulations, is designed with the development of the European startup ecosystem in mind. This question, as well as the StartUp Act, will be presented at the upcoming Young Innovators Unconvention that will take place on 1st July. Pre-register to engage in the discussion with us, your voice will be needed to get these changes!