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Taxing digital content

It has never been easier for businesses – particularly those selling digital content such as apps, e-books and music or film downloads- to find new customers and enter new markets.

November 2013

Many businesses whose customers are located in their "home" jurisdiction will give very little, if any, thought to tax questions such as should I charge my customers VAT? or where will my profits be taxed?, but where business is transacted cross-border these questions become much more important and, potentially, more difficult to answer. Neil McKnight, a senior associate in our tax group, summarises some of the tax issues faced by businesses distributing content across borders.

Value added

EU country flagsAcross the EU, VAT is gradually becoming more harmonised but cross-border transactions – particularly those involving digital content - remain complicated. 

Non-EU businesses selling content to consumers are generally required to charge VAT in each EU member state in which their customers have their usual place of residence.   This imposes compliance difficulties, as there are 28 member states within the EU VAT area each with their own administrative rules; so, in an effort to address this, non-EU businesses are now permitted to register in one member state, submitting one VAT return for all their EU sales to customers.  Whilst this is welcome, businesses must be aware that this simplification does not alter the requirement to charge VAT at the applicable rate for each jurisdiction.

Sales of digital content to consumers by businesses located within the EU are currently treated in the same way as sales to domestic customers – they must charge VAT at the normal domestic rate (in the UK, 20%).  However, from 2015 these rules will change and EU businesses will be required to charge VAT in each member state in which they do business.  This change is, in part, intended to address the competitive advantage given to businesses established in certain jurisdictions with lower VAT rates - for example, the standard rate of VAT in Luxembourg is currently 15%, as opposed to 27% in Hungary.  Whilst this change will in some respects level the playing field between businesses in different jurisdictions, it will add to the complexity of transacting business in multiple EU jurisdictions.

For businesses selling digital content to non-EU customers, or EU business customers, the position is more straightforward and VAT is generally not chargeable by the supplier - although an EU business purchasing digital content may be required to charge itself VAT under what is known as the reverse charge.

The operation of the VAT system requires businesses to operate systems which allow them to identify accurately the location of their customers and the capacity in which their customers are purchasing digital content.  This can often prove challenging, but many tax authorities will impose penalty charges where businesses have failed to take reasonable care in complying with their obligations in this area.

Taxing profits

Tax chartsBusiness selling content cross-border will encounter the difficult area of determining where their business profits should be taxed.  In many jurisdictions the starting point is residence, and in the UK a company (regardless of incorporation) will be resident for tax purposes if it is strategically managed and controlled in the UK.  This fairly high threshold means that simply selling content in the UK will not create tax residence – and many other jurisdictions employ a similar test in this area.  This is not, however, the end of the matter because non-resident companies may also be subject to tax in any jurisdiction in which they have a fixed place of business (a permanent establishment) on the profits generated by that permanent establishment. 

Generally a permanent establishment requires some form of fixed physical presence in the jurisdiction – an obvious example being a sales office.  In the digital economy, some tax authorities stretch this definition by classifying servers and websites as permanent establishments, recognising that digital businesses often do not have traditional fixed infrastructure in the jurisdictions in which they operate.  There is currently no consensus in this area but helpfully in the UK, HM Revenue and Customs have indicated that they do not consider that the definition of permanent establishment can be stretched to include servers.  Unfortunately not all tax authorities share this view so businesses should take care to determine whether their activities will result in a taxable presence in the jurisdictions in which they operate.

BooksIdentifying a taxable presence in a jurisdiction is only the first step.  In the digital economy what is perhaps more challenging is identifying relevant profits and allocating taxing rights between the home jurisdiction and other jurisdictions.  To deal with this, many jurisdictions have entered into double taxation treaties providing a framework for this - the UK having one of the largest treaty networks in the world.  However, whilst many of the UK's treaties are broadly similar in structure there are often key differences which makes consideration of their specific terms essential.

Withholding taxes

Selling digital content cross-border may raise the question of withholding taxes, as payments made for the right to enjoy digital content may be treated as royalties (as opposed to payments for the acquisition of physical items such as CDs and books which are generally treated as payments for the sale of goods notwithstanding that it is generally the content, rather than the medium, that is valuable).  

Double taxation treaties may reduce or eliminate withholding taxes on royalty payments, but jurisdictions may impose procedural requirements before treaties can be relied upon so it is helpful that many jurisdictions do not consider payments for the sale of digital content to be royalties for tax purposes.  Of course, each jurisdiction of operation should be considered separately to identify whether this is a concern.


CodeThe digital economy is creating exciting opportunities for the distribution of content to new markets, but with these opportunities come new tax issues which many businesses may not have faced. The difficulties faced in taxing the digital economy have been recognised by European Commission, which recently announced the creation of a high–level  expert group tasked to examine the best ways to tax the digital economy in the EU, and also the OECD who, in its report on base erosion and profit shifting, has identified the strain placed on global tax systems by the digital economy. 

This complexity makes specialist tax advice all the more essential to businesses operating in this area.

If you have any questions on this article please contact us.

Neil McKnight

Neil McKnight

Neil McKnight summarises some of the tax issues faced by businesses distributing content across borders.

"The digital economy is creating exciting opportunities for the distribution of content to new markets, but with these opportunities come new tax issues which many businesses may not have faced."