In a changing world, where discussions often revolve around the impact of new technology, it is easy to overlook the basics. VAT is a basic, yet very important part of every business. Do you know why?
Most of us have probably heard the quote “Culture eats strategy for breakfast”. Today, maybe it is more likely to come across quotes like “Software eats expertise”, and “Maybe we need less real stupidity and more artificial intelligence”.
Over the last couple of years, FinTech companies have entered the finance sector and are frequently starting to be seen either as a way to empower and develop banking, or as an alternative to the traditional banks. Whichever way you look at it, the digital revolution is here, and words like digitalization, big data, automation and AI, are part of our everyday vocabulary. So far, nothing new, but another word that might be important to add to this fairly new vocabulary is Value Added Tax, usually referred to as VAT.
So VAT’s the big deal?
FinTech might be relatively new, whereas VAT is not, and the general VAT rules apply for the FinTech companies, as for other companies providing services within finance and/or technology. So far so good. However, once you start trying to qualify the business activities of a FinTech company for VAT purposes, you can quickly run into trouble.
Payment service or an app?
Many FinTech companies offer technology for different payment solutions, or payment services. There are numerous apps for cashless payments using a smart phone or smart watch, e-payment platforms and online platforms for secure international payments and currency exchanges available on the market already. Fundamentally, no VAT should be charged on payment services, but when it comes to payments facilitated through applications, the question is whether the service is still a payment service, or something else, such as a mere technical solution, which should be subject to VAT. Another question is whether any other services are provided to the customer, and if so, if these trigger a VAT obligation? For electronic services provided to private individuals living in different countries, does this mean that the FinTech provider suddenly has VAT obligations in all those countries?
Crowdfunding and peer-to-peer lending – VAT what?
The innovative form of loan financing called crowdfunding and “peer-to-peer lending” is another complex area from a VAT perspective. Among other things it is necessary to determine if there is an element of “intermediation” (= usually no VAT), or if the activities have the character of “finders fees” (= subject to VAT). Some activities, such as crowdfunding could even fall completely outside the scope of VAT as the crucial “supply against remuneration” element could be missing.
Blockchain and cryptocurrencies – it’s all just virtual money, right?
Not really! Transactions in the realm of blockchain and cryptocurrencies contain a plethora of VAT topics, where some activities (mining) can be out of scope, other fees (the purchase of cryptocurrencies) can be VAT exempt, and other elements (certain utility tokens or fees for authorization) are generally subject to VAT.
Intermediation – beyond networking
FinTechs have introduced a range of new possibilities to collaborate with financial operators, where intermediation of clients to banks, insurance companies etc., happens via apps and online portals, and where almost no in-person interaction is required, meaning that borders become almost irrelevant. From a VAT perspective, this begs the question whether what the intermediary is doing is a VATable transaction, which would normally be the case for intermediation of clients, or some kind of VAT exempt financial service? Equally importantly, the providers of these solutions should consider if the fact that the services are rendered via apps or online portals could lead to potential VAT obligations in other countries.
Other scenarios where VAT should be part of the analysis, are barter transactions, factoring/debt collection services, services related to investment funds… the list goes on.
Old legislation meets new technology
One of the main reasons why it is so challenging to get to the bottom of how all these “new” types of business activities should be treated from a VAT perspective is simply that VAT legislation is quite old! VAT has been around for quite a while in the European space, and the foundation to today’s VAT legislation in the EU as well as in Switzerland was written before the internet was even born. Historically, VAT legislation took aim at traditional business activities – good old-fashioned manufacturing, and a bit of lending and insurance in the financial services space. These in some sense ancient rules for how to assess traditional transactions now have to be applied to new technologies that were unknown and unimaginable when the law was written. Not only is the legislation hopelessly behind the times, but the fact that a lot of tax authorities have had limited exposure to FinTechs, doesn’t exactly help.
There is an inherent conflict between the old and the new, and this is unlikely to go away, so it is all the more important to proactively address the topic of VAT. A first crucial step is to do the homework and analyze the business activities from a VAT perspective. This is sometimes known as a VAT “health check”. Apart from identifying risks and opportunities, internal documentation of this type of health check is a huge advantage in the case of an audit being initiated by the tax authorities. Another way of being proactive and getting clarity on the VAT position, is to consider reaching out to the tax authorities preemptively – in some countries it is quite common to apply for a formal or informal VAT ruling, which is generally binding for the tax authorities.
VAT in, VAT out, how hard can it be?
Something VAT advisors hear quite often are comments like that tend to go along the lines of: ”Is VAT really an issue? You pay VAT and you get it back, isn’t it just cash flow?” Or just a succinct: ”We don’t pay VAT”.
So, why should you make VAT a priority? First of all, this is basic but nevertheless important – VAT is a transaction-based tax, meaning that there is a potential VAT question that can arise in every single business transaction. Simply put, VAT has the potential of triggering the domino effect really fast – you get something wrong once and you get it wrong every single time after that, and the risk just keeps building up. The statute of limitation in Switzerland is 5 years, which is similar to many other European countries. Underpaid output VAT or overdeclared input VAT, together with interest, can lead to quite the bill in the end. Apart from the financial risk, one should not lose sight of the importance of being compliant, both in the client relationships, as well as towards the authorities.
VAT in numbers
To illustrate the importance of VAT, we want to wrap this up with an example putting numbers on a few of the VAT topics discussed.
Revenues and output VAT
Let’s say that a company that has developed a nifty new payment solution generates revenues of 100k CHF in year 1 of having launched its product. The company assumes this to be taxable for VAT purposes, and reports Swiss VAT at 7.7%, i.e. 7.7k CHF on the income.
Investments and input VAT
The company has obviously had to make quite a few investments in developing this product and has claimed back all the input VAT charged by different subcontractors. Let us assume that the total amount of VAT claimed back is 77k CHF (on an investment cost of 1mio CHF).
Audit and reassessment
Two years down the line, the tax authorities decide to perform a VAT audit. The key finding during the audit is that the payment solution is actually a VAT exempt payment service, thus no VAT should have been charged, and the company has had no right to deduct any input VAT.
The requalification of the service in this example has a significant impact – not only the VAT reported on sales of solution has to be corrected, but also the input VAT paid on any investment costs.
The 7.7k VAT charged to clients can be claimed back, but this generally requires a correction of the invoices issued to clients with 7.7 % VAT, e.g. through credit notes.
The other side of the coin is that the input VAT of 77k CHF is suddenly entirely non-recoverable and has to be paid back to the tax authorities.
In the end, assuming that the output VAT is claimed back by the tax authorities, but instantly credited to clients, this part of the equation is a zero-sum game. Due to the denied input VAT deduction, the company however has to pay back 77k CHF of overclaimed input VAT to the tax authorities + interest (currently 4% in Switzerland). In addition to the monetary cost, audits and corrections take up time and efforts, which could be spent more productively on other things.
So, VAT or no VAT, do you know what to answer?