VAT Exposure for Canadian Exporters of Digital Services

The GST/HST rules specify that foreign suppliers of digital services that have no physical presence in Canada are not considered to be carrying on business here, and therefore do not have to register for and charge GST/HST. Much has been written about the competitive disadvantage that the rules create for Canadian suppliers of the same services, and the issue has become even more widely known with the Quebec announcement that it intends to amend QST rules to collect tax in such circumstances (with no specific effective date: see Tax Havens: Tax Fairness Action Plan, November 16, 2017, chapter 2). Lost in the tax fairness debate is the fact that Canadian suppliers of digital services are now required by many countries to pay VAT on sales of digital services to customers in those countries.

Countries that have updated their VAT/GST legislation in the last five years in relation to supplies of digital services include the European Union (all 28 member states), Russia, Japan, South Korea, and South Africa. The pace of change can easily be seen on this website. (Under "Tax Type," click on "VAT, GST and other sales taxes" and choose "Digital.") The majority of changes affect suppliers of business-to-consumer (B2C) services, although there are a few changes in respect of business-to-business (B2B) services. There are a range of different types of electronically supplied services that are affected by the new rules. Examples include electronic books, online gaming, online streaming, web-hosting services, and software.

Historically, the place of supply for B2C services has been the place where the supplier was established. The recent trend, in line with the OECD's 2017 International VAT/GST Guidelines (paragraph 3.112), is for the place of supply to shift to the location of the customer. This change can result in suppliers of electronically supplied services having to register for and charge VAT/GST when they have customers located in the relevant country; many countries have no safe harbour VAT registration threshold for non-resident entities.

In my experience, suppliers with no physical presence in those countries often are unaware of these relatively new registration requirements. Late registration can result in penalties and interest. Although registration requirements are often simplified in the no-physical-presence situation, VAT/GST returns must still be filed. The bigger impact, of course, is economic—customers pay more when VAT/GST is added to the previously untaxed amount. For example, VAT rates in the European Union on electronic services currently vary from 17 percent in Luxembourg to 27 percent in Hungary—far in excess of Canadian GST/HST rates.

Ally Murphy
Ernst & Young LLP, Toronto

Canadian Tax Focus
Volume 8, Number 1, February 2018
©2018, Canadian Tax Foundation