New EU tax rules stand to stimulate cross-border payments for U.S. merchants

Online cross-border payment technology is opening new markets for e-commerce firms and new shopping options for consumers — but the European Union's tax system hasn’t kept pace, creating compliance headaches for U.S. digital merchants and confusing bills for customers on the Continent.

In an attempt to fix that problem, the European Commission has simplified its value-added-tax (VAT) regulations governing online sellers and cross-border payments. VAT, which is assessed in Europe and other countries, is the equivalent of a sales tax but is structured differently. U.S. sales taxes are levied at the point of sale as a percentage of the overall purchase, while VAT is based on calculations that determine the increase in value of a good or service at different stages of production or distribution.

That distinction alone creates compliance challenges for U.S. e-commerce sellers, especially for smaller merchants that are new to international payments and unaccustomed to the different point-of-sale taxation methods in EU countries, much less their various VAT rules.

"Under the old rules, an online store would have to keep a record of all of the VATs in different languages in different countries," said Mark Berger, co-CEO of Global Vatax, a New York-based VAT consultancy. "Imagine the chaos for a company in the U.S. that's not even aware of the VAT tax."

E-commerce sellers have been traditionally required to have a VAT registration in each EU member state in which they surpass earnings volume thresholds that vary among countries. The new rule establishes a common threshold of €10,000 (about $11,800) across the EU, above which the VAT is paid in the member state in which the goods are delivered. Online sellers can also access an "Import One Stop Shop" digital portal to manage VAT obligations across the EU by onboarding in a single member nation, thus enabling VAT payments in multiple countries while being registered in just one. And while there's still a potential language barrier for U.S. firms, it would be limited to just the single EU member state of registration.

This OSS portal is designed to ensure the correct VAT goes to the member state in which the purchase has been made. If it works correctly, consumers — who ultimately have the VAT passed on to them — will pay it directly to the seller at the point of sale instead of receiving an additional and often unexpected bill at delivery as in the past.

For sellers, this requires the VAT to be included in the invoice, but it also reduces the confusion of managing payment compliance in up to 27 different countries simultaneously, according to Berger. "It makes a huge difference if you are able to deal with a single EU member state in order to meet your EU VAT compliance obligations," Burger said, "especially if each member state requires you to deal with them in their home language, like Dutch, Portuguese, French, etc."

Individual countries change VAT rules frequently, though the framework that governs VAT rules in the EU hasn’t been changed since 1993, when the EU was formed.

The EC's update is focused on consumer e-commerce, which has expanded in the past few years in a manner that's attracted smaller companies selling across borders. These transactions often involve less valuable items than the large transactions that dominate traditional business-to-business supply chain payments between the U.S. and Europe.

Distributed-ledger technology such as blockchain has played a major role, as firms like Ripple use the technology that underpins cryptocurrency to support international payments. By removing the need for correspondent banks and other third parties, cross-border e-commerce has become faster and more accessible, but the VAT structure was not designed with any of these trends in mind.

The European Commission's statement on the VAT updates said the pandemic has accelerated an existing boom in online retail, underlining the need for reform to ensure the VAT gets paid to the country of the consumer in a sale that does not necessarily involve a physical store, or a merchant with a base in the EU. The existing EU VAT rules are "ill-suited" to the needs of businesses, consumers and administrators in an internet-driven shopping environment, the EC says.

While the new rules represent a "big change" in the way EU online businesses deal with their VAT needs, they will bring "untold benefits" in simplifying commerce and in improving the consumer experience, according to the commission.

"A lot of small businesses may not have the compliance officers to manage VAT," said Bob Dowd, CEO of North America for MoneyCorp, a London-based cross-border payment and foreign exchange company.

While the EC update is designed to boost compliance by making VAT registration easier, the rules include a tax increase. The old rules exempted goods valued at less than about $27 from VAT if sold by non-EU firms. This exemption has been lifted due to sellers mislabeling consignments of goods, according to the EC. This allows non-EU sellers to undercut EU firms, a loophole that costs the EU about $8.5 billion in tax revenue each year, according to the EC.

"Enabling a single registration for online sellers within and without the EU will make VAT compliance easier," said Eric Grover, a principal at Intrepid Ventures. Companies that serve firms selling online in the EU will operate under the new compliance regime, so their operations should become easier, he said.

But there's also a drawback as less confusion requires less consultation or management for third parties or payment processors. Payment processors often use VAT as a way to expand relationships with merchants by offering compliance services to U.S. merchants that are unaware of the differences in sales taxes between the U.S. and other countries, and providing payment rails to digitize the multiple currency conversions required to pay VATs.

"Simpler compliance will somewhat reduce the value these firms add — helping merchants cope with the tax-compliance complexity,” Grover said. “Easier is better, but easier also means the marketplace will provide a bit less."