By Gareth Kobrin, Director at Vatglobal
It sounds like a thriller. Ivan Bixio, colonel in the Guardia di Finanza, starts his investigation rifling through the books of independent hotels and guesthouses on the Italian Riviera. What he finds sparks an international investigation that goes to the very top of the business world.
Unfortunately for anyone hoping for a thrilling climax, the story concludes not with Ferraris engaged in a high-speed chase along the Meditarrenea sea, but a bureaucratic request for cooperation despatched to a corporate HQ in relatively sedate Amsterdam.
The headquarters in question belong to online accommodation website Booking.com. Italian authorities say that the company evaded taxes and needs to cough up. In response, Booking.com says it’s all a big misunderstanding about what their role is and who really is responsible for managing VAT.
If that seems like a rather abstract defence, it’s because it points to an important ambiguity about how VAT functions in the modern digital economy.
A question of principals
The investigation started with a thorough analysis of hotel revenues in Liguria by Italian financial investigators. The investigators maintain that Booking.com facilitated reservations for independent establishments valued at over €700 million, on which no VAT was paid. The attendant VAT liability stands at an eye watering €153 million.
But note that word ‘facilitated’; it’s one of the key points of contention.
As far as Booking.com is concerned, they did not actually sell the services (accommodation in an Italian hotel or guesthouse) but merely acted as an intermediary between two other parties (the customer and the accommodation owner). In the jargon of VAT regulation, they were acting as the agent, not the principal.
Italian investigators don’t think it’s so simple. And on the face of it, they have a point. The main point of contention is that Booking.com allegedly applied the reverse charge mechanism improperly. The reverse charge mechanism is a bit of regulatory acrobatics that enables the buyer to account for VAT on a transaction in order to simplify VAT recovery. At least on paper. In effect, the reverse charge mechanism is supposed to apply to cross-border B2B transactions on which VAT is ultimately recoverable. Ultimately, no one ends up paying any more or less VAT than they are supposed to, even though on paper, the VAT liability shifted from one party (the seller) to another (the buyer).
Now in the case of Booking.com, many of the independent accommodation businesses were not VAT registered. And, at least according to investigators, Booking.com was aware that many of those businesses were not registered for VAT. In which case, the reverse charge mechanism could not properly be applied. And indeed, it turns out that the relevant VAT was accounted for neither in Italy (where the hotels are located) nor in the Netherlands (where Booking.com is based).
Ambiguity is bad for business
The first, and most obvious, point is that regulatory ambiguity makes it hard to run a business. Companies need a concrete understanding of their VAT obligations so that they neither massively overpay VAT nor risk potentially ruinous penalties.
After all, not all companies have the luxury of fighting all the way to the ECJ. (Booking.com is owned by Booking Holdings, which generates revenue in excess of $15 billion.)
And these are not niche areas of VAT compliance. Online selling is booming (and the Covid crisis only accelerated e-commerce) and increasingly businesses either sell through, or operate, online marketplaces or digital platforms.
At least partly to provide much-needed clarity, regulators (for instance, in the EU and UK) have introduced legislation that clearly places the responsibility for charging and reporting VAT squarely on the platform, rather than the underlying seller, under prescribed conditions.
I say partly because the new rules are also obviously designed to make revenue collection easier to monitor. It’s much simpler to demand reliable up-to-date sales data from Amazon than to try and catch every nonresident drop shipping seller of knock-off sneakers that doesn’t bother to report their VAT liabilities.
Political economic questions
So the solution is simple enough … we just need good, clear rules spelling out who is liable for VAT when online transactions take place?
As always in the world of VAT, things are a little more complicated than that. Because the question of precisely where VAT liability lies also potentially determines not just who has to file what paperwork, but how the larger economy is structured.
The dynamic plays out most strikingly in recent court decisions affecting gig economy workers. The very term ‘gig economy’ is already pretty loaded. The notion is that those jobs are side hustles rather than primary income sources. Yet, for many so-called gig workers, the work they do via digital intermediary services (a fancy way of saying app) is their primary livelihood.
However, that raises an additional question. Are delivery drivers independent professionals or do they effectively work for the companies that operate the platforms?
Historically, digital platforms have held that they are merely intermediaries that facilitate a transaction between two parties: the gig worker and the customer. As such, they are not actually the supplier of the goods or services under question and thus do not have to account for the attendant VAT.
However, recent court decisions threaten to overturn that conception of the gig economy. A Dutch appellate court found that Deliveroo drivers are not independent contractors, and thus do not have to be VAT registered. Moreover, the court held the relationship between Deliveroo drivers and Deliveroo is an employment relationship, with the attendant responsibilities.
Shortly thereafter, the UK Supreme Court ruled that Uber drivers are entitled to the benefits of employees.
When VAT policy affects business strategy
The implications go beyond the practical questions of who is obliged to pay VAT or whether gig workers are entitled to leave. After all, the business model of many gig worker companies is predicated on an independent contractor model. Indeed, Uber claims that their service won’t be viable (or at least that excess costs will have to be borne by consumers) if the EU enacts legislation classifying Uber drivers as employees.
Of course, it’s not just about Uber. The Supreme Court ruling sets a precedent for the larger UK gig economy. And naturally, observers are paying close attention to developments in EU courts.
Regulators are, naturally, aware of how urgent and important these issues are. For instance, the UK is investigating the realities of the sharing economy, with a view to modernising legislation. And organisations like the OECD are working on creating common standards designed to meet the challenges of VAT in a digital world.
But it’s important to understand that VAT policy decisions don’t occur in a vacuum. VAT legislation doesn’t merely adapt to economic and technological change, it can also shape the economy in far-reaching ways.
And for that reason, staying on top of VAT policy isn’t merely something to add to the finance department’s to do list. Surprisingly often, a deeper understanding of VAT is an essential component of strategic business decision making.