Digital products are easy to distribute and never out of stock. Once they are created, they can be sold to customers all over the world without worrying about transport and customs formalities. Many entrepreneurs have built entire businesses around digital products and freelancers consider them a great way to generate passive income.
However, there is one thing that makes digital trade quite complicated and it is the fact that sales of digital products often result in sales tax compliance obligations outside the seller’s home state. For remote sellers of digital products, keeping up in today’s sales tax world is increasingly difficult. Nearly all U.S. states have enacted economic nexus laws that require non-resident sellers to charge local sales taxes on remote sales of taxable digital goods and services once certain monetary or transactional thresholds are exceeded. This means that if you sell only within the U.S., you may end up having to register, collect and remit sales taxes in 45 states that include more than 11,000 taxing jurisdictions. And if you sell to other countries, the situation becomes even more complicated. Almost 100 countries have some kind of economic nexus laws imposing registration and tax collection obligations on foreign sellers. This article will explain and compare the economic nexus laws in Canada and the European Union.
Canada
Selling digital products to Canadian customers can pose many challenges due to the complexity of the Canadian tax system, which consists of a combination of federal and provincial taxes. The goods and services tax, or GST, applies nationally, and six provinces (New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, and Prince Edward Island) harmonized their provincial sales taxes with the GST to implement the harmonized sales tax, or HST, which operates in the same way as the GST. Separate provincial sales taxes are collected in British Columbia, Manitoba, Quebec and Saskatchewan. Four provinces (Alberta, Northwest Territories, Nunavut, and Yukon) do not apply any provincial sales tax.
The federal government and all provinces that levy a separate provincial sales tax have enacted their own economic nexus laws. The scope of these laws varies significantly. Most jurisdictions apply an economic nexus threshold (C$30,000 in Quebec and for the federal GST/HST, and C$10,000 in British Columbia). However, there is no economic nexus threshold in Saskatchewan and Manitoba, meaning that the respective provincial sales taxes need to be collected as from the first transaction.
The federal GST/HST and Quebec sales tax have the broadest scope and apply to all digital goods and services. Manitoba’s retail sales tax is on the other side of the spectrum as it excludes many digital services that are taxable in other provinces. For example, Manitoba does not levy RST on cloud computing services that do not require downloading any software.
If a company provides web-based training to Canadian customers, it must charge GST/HST and QST but not the provincial sales taxes of Manitoba, Saskatchewan and British Columbia. Audiobooks are taxable everywhere except Manitoba and Saskatchewan. As both the taxability of products and the tax rates vary by province, U.S. companies selling into Canada need to determine where their Canadian customers are located. The Canada Revenue Agency provided detailed guidance on how to determine the location of the customer for the purposes of GST/HST, taking into account various indicators.
U.S. sellers are not required to charge Canadian taxes on sales of digital products to Canadian customers who are registered under their respective tax regimes, and provide their registration number or an exemption certificate. All provinces except British Columbia have implemented marketplace facilitator rules that relieve marketplace sellers of the requirement to register and to collect tax where the marketplace facilitator is obliged to do so. In British Columbia, a marketplace facilitator law will take effect in July 2022.
European Union
In the European Union, value-added tax is levied only at the country level. There are no provincial or other local taxes that foreign sellers of digital products would be required to collect. U.S. businesses selling digital products to EU customers need to charge the VAT of the customer country unless the customer provides them with its VAT identification number, indicating a business status. As EU business customers are required to calculate and remit tax on digital products that they receive from abroad, the VAT collection obligation for foreign sellers exists only with respect to business-to-consumer sales.
The tax rates vary by country and range from 17% in Luxembourg to 27% in Hungary. Although nearly all EU countries apply one or more reduced rates, most digital products are subject to the standard rate. Common exceptions include electronic books and other electronic publications whose physical counterparts are reduced rated.
The EU does not apply any economic nexus thresholds, meaning that U.S. businesses need to register and collect VAT as soon as they start selling to EU customers. The registration procedure is relatively easy: A simplified registration regime called One Stop Shop allows foreign sellers to register in one EU country where they will subsequently file quarterly returns and remit all taxes collected from all EU customers. There is no obligation to register for VAT if sales of digital products are facilitated by an online marketplace.
Summary
U.S. companies selling digital products to Canada and the EU will face foreign tax collection obligations unless they sell via online marketplaces or sell only to registered businesses.
The EU VAT is easier to comply with than the Canadian sales taxes as it applies to all sales of digital products. In contrast, in Canada, the product taxability may vary by province. To determine the applicable tax rate, it is necessary to determine in which country (EU) or province (Canada) the customer is located.
U.S. businesses selling digital goods and services to Canadian customers may end up having five different tax registrations if they exceed the relevant federal and provincial economic nexus thresholds. This may not seem like a lot compared to 45 tax registrations within the US, but it is definitely more complex than selling into the EU, where one tax registration is sufficient to sell digital services to consumers in 27 EU member states.
