Since 1 July 2003, the regulations for determining the place of taxation of electronically supplied services have been governed by the so-called e-commerce VAT Directive (2002/38/EC).

These regulations stipulate that, in the case of services supplied electronically by non-EU businesses to EU private individuals or EU non-business organizations (i.e. in the case of B2C electronic transactions), non-EU established suppliers are required to register for EU VAT and charge VAT accruing to the country where the consumer is established. EU established suppliers on the other hand have to account for VAT of the country where they are based, when they supply B2C e-commerce services within the EU.

Further to the adoption of the Directive 2008/8/EC regarding the place of supply of services, the application of these rules has been extended up to 31 December 2014. As from 1 January 2015, EU established suppliers will be subject to similar rules as for non-EU established suppliers. From this date the place of taxation of all supplies of e-commerce services to final consumers should be where this latter is established.

More recently, there have been numerous calls for a harmonization of the VAT rates applicable to similar goods and services, independently from their support, i.e. physical or electronic (e.g. paper books and e-books). At present, many European Union Member States apply reduced VAT rates on traditional, paper-based books, newspapers and similar publications and the standard rate on the sale of electronic books and newspapers considering the supply of electronic-based reading materials as a different form of supply.

Highlights of the e-commerce VAT Directive

Since 1 July 2003, non-EU established businesses supplying B2C electronic services are obliged to:

• Register electronically for VAT purposes with one of the VAT authorities of their choice
• Account for VAT at the rate applicable in the Member State where the consumer is resident
• Keep detailed records of transactions to enable the VAT authorities in the country where the e-services are supplied to ascertain whether VAT has been levied correctly

It should also be noted that, when a non-EU established business incurs EU VAT in connection with supplies of goods or services used for the performance of its economic activity, this input VAT can be recovered only by filing specific refund claims in each EU Member State where VAT was incurred. Furthermore, this input VAT refund system involves heavy administrative burdens, and it should be noted that several months are often required to process refunds after the filing of claims.

Competition-related downsides for non-EU established businesses

The current regulations summarized above have the following downsides for non-EU-established businesses (e.g. US companies), as compared with businesses established in the EU.

Non-EU-established businesses have to account for VAT at the rate applicable in the Member State where the customer is resident, whereas, when supplying the same type of electronic services to individual customers or non business organizations, businesses established within the EU only have to account for the VAT rate of their place of establishment. As a result, businesses that decide to establish themselves in an EU Member State with a low VAT rate have an advantage over their competitors in most cases.

A further disadvantage of the requirement that non-EU established businesses have to account for VAT at the rate due in the Member State where the consumer is resident is the need to deal with the VAT rates applicable in the 27 countries. Non-EU-established businesses have to be aware of the place of residence of each of their customers, compared with EU established businesses which avoid the difficulties of determining the location of the EU customer.

Non-EU-established businesses have to maintain proper records of transactions. This involves complying with requirements imposed by the VAT authorities of each country where supplies are provided. Businesses established within the EU only have to maintain proper books according to the requirements of the VAT authorities of their Member State of establishment.

The recovery of input VAT incurred may also be more advantageous for businesses established within the EU, as the input VAT incurred in the Member State of establishment can, in principle, be offset against the output VAT accounted for on the taxable supplies provided.

Choosing Luxembourg as a place of establishment within the EU

Considering the many downsides resulting from the implementation of these regulations since 1 July 2003, many non-EU-established businesses wishing to maintain competitive offers for private customers have established within the EU. Taking into account the extension of these rules up to 31 December 2014, an EU establishment can be part of a longer term business plan.

According to European case law, a company is regarded as established in an EU country providing the establishment is of a certain minimum size and both the human and technical resources necessary for the supply of the services are permanently present. The Luxembourg VAT administration, following European case law, requires a minimum of substance in Luxembourg.

However, when considering establishment in Luxembourg, not only the Luxembourg interpretation has to be taken into account. Based on the EU Implementing Regulation of 15 March 2011 (n°282/2011), and owing to Luxembourg’s especially attractive situation, the other EU Member States may also question whether there are sufficient resources in Luxembourg. For that reason, we advise incorporating a Luxembourg company (or the establishment of a substantive branch).

In addition to the general advantages of establishment in the EU to operate a B2C e-business, establishment in Luxembourg brings significant additional benefits.

Notably, Luxembourg has the lowest VAT rate allowed by the EU VAT Directive (i.e. 15%). Consequently, businesses established in Luxembourg can account for VAT on their B2C electronically supplied services at the lowest possible rate of 15% whereas, in some cases, certain competitors would have to charge up to 25% VAT.

In addition, further to the above-mentioned decision of the Luxembourg Ministry of Finance, the application of the reduced VAT rate of 3% to e-books in Luxembourg will confer further competitive advantages to businesses active in e-publishing and supplying e-books.

Based on the Luxembourg VAT Law the super-reduced rate of 3% applies only to supplies of goods and services in the categories set out in Annex B, point 5 (Art. 40, 1, 2°), which covers books (including brochures, folds and similar printed materials, albums, children drawing and colouring books, handwritten or printed music partitions, maps and hydrographical statements or other), newspapers and magazines, with the exception of materials devoted fully or primarily to publicity as well as pornographic books, newspapers and publications. Until now, e-books were subject to the standard VAT rate of 15%. The reduced VAT rate of 3% for e-books will be applicable with effect on 1 January 2012.

The reason behind this adjustment between paper books and e-books is that the application of VAT rates should not differ, given that the function of the product is identical (i.e. in their nature and use for the customer), regardless of its format (i.e. electronic or paper).

As pointed out by the EU Commission in its Communication issued on 6 December1, there are a number of factors justifying a review of the current VAT rates structure, for which one of the guiding principles should be the harmonization of the VAT rates applicable to similar goods and services. “The progress in technology should be taken into account in this respect, so that the challenge of convergence between the on-line and the physical environment is addressed”.

The above-mentioned decision of the Luxembourg Ministry of Finance strengthens the strategic positioning of Luxembourg for e-commerce activities and confirms the favourable legal and tax environment available in Luxembourg.

In addition, the Luxembourg government has the intention to transform the country into an international high-technology hub and to develop adequate technical and communication infrastructures, including an advanced telecommunications network.

Luxembourg is located in the heart of Europe and traditionally enjoys a stable political and economical environment that contributes to its prosperity.
Against this background and despite the further changes planned from 1 January 2015, there is still a considerable incentive for companies to follow the lead of certain US multi-nationals who have already opted to establish their European operating centres in Luxembourg.