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III. Shortcomings of the Present European VAT System with Respect to Electronic Supplies

This part of the paper intends to examine the operation of the Sixth Directive within the digital world. The rule-by-rule analysis of the Directive in chapter 3 will show that the European VAT system is unable to handle electronic transactions with certainty. The last chapter will inquire into the impact of this dysfunction on the operation of the internal market. For the better understanding of the shortcomings of the present VAT system, first the basic characteristics of electronic transactions should be described.

1. Classification of E-Commerce Transactions

This chapter provides a brief summary of the changes in the trading environment owing to the emergence of e-commerce. To identify the specific fields of online trade where the conventional VAT model proves to be dysfunctional a distinction should be made between the different types of e-commerce transactions. Based on the extent to which the Internet is utilized in the course of a transaction, the essay will talk about indirect and direct electronic commerce.¹⁰⁵ This classification will help us to see that the problematic issues of VAT are concentrated to a very narrow section of e-commerce.

Electronic transactions take place in a virtual marketplace. This virtual marketplace is formed by utilizing the Internet for commercial purposes.¹⁰⁶ The Internet and other types of electronic networks altogether constitute the metaphoric concept of "Information Highway."¹⁰⁷ This chain of interconnected computers, by using common protocols for communication, ensures the unlimited flow of information regardless of the real physical location of the computers.¹⁰⁸ The most user-friendly version of the Internet is the World Wide Web, which facilitates the network with the use of texts, images and sounds through multimedia systems.¹⁰⁹

The individual transactions take place through websites.¹¹⁰ Companies wishing to offer goods and services over the Internet create a website displaying information on the company and its products.¹¹¹ The website, after having been placed on the Internet through a computer, becomes accessible to all customers with a computer connected to the network. After inspecting the information and the offers placed on the website the customer may order goods and services from the company.¹¹²

Depending on whether the whole transaction or only some phases thereof take place through the Internet, e-commerce activities are categorized as indirect and direct.

According to the Green Paper indirect e-commerce means the `electronic ordering of tangible goods.'<sup>113</sup> The definition indicates that transactions belonging to this group make use of the Internet for the purposes of providing information, ordering products and perhaps payment. The phase of delivery happens through traditional channels.<sup>114</sup> A common example for indirect e-commerce transactions is the ordering of computer hardware through the website of a specific company, such as `canon.com' or through general distribution websites like `amazon.com.' Indirect e-commerce may include the supply of services as well, such as purchasing air tickets via the Internet. In both cases the conclusion of the contract and perhaps the payment take place online, but the company sends the product by traditional courier service or performs in other conventional ways.¹¹⁵

Direct electronic commerce, on the other hand, utilizes the virtual market place to full extent, not only as a means of transferring information.¹¹⁶ In such cases every phase of the commercial activity happens online, including delivery. The most prevalent type of such activity is the downloading of software from the Internet.¹¹⁷ Downloading of music from the network is also becoming quite popular,¹¹⁸ suffice to mention the notorious website of Napster.

Based on its relation to traditional forms of trade a further categorization of direct e-commerce transactions may be introduced. In some instances of direct e-commerce traditional goods and services are digitized and transferred through the Internet. This happens when downloading software or music from the network, which were previously provided in the form of tangible CD-ROMs. In these cases, online commerce competes with traditional forms of trade.¹¹⁹ In other cases the goods and services supplied through the network are inherently digital, therefore online provision is the only way of supplying them. Such is the case with web-design or colocation¹²⁰ services, which do not compete with any traditional business activities.

The advantages brought about by e-commerce,¹²¹ both direct and indirect, have already induced a rapid growth of supply and demand of goods and services through the Internet. Statistics and estimates promise a further exponential increase in the next few years.¹²² It has also been recognized, though, that for e-commerce to thrive, certain critical characteristics must be in place.¹²³ These include a secure financial environment. The following chapters of this essay will be concerned with identifying and solving the dysfunction of the VAT system with respect to digital trade impeding the creation of a secure financial environment.

2. General Problems of the Operation of the VAT System

Upon reviewing the types of online commercial activity it is not difficult to conclude that it is direct e-commerce that causes major headaches to taxing authorities. While utilizing the opportunities offered by the Internet, the indirect form of online trade retains traditional forms of distribution, and therefore does not put a pressure on conventional tax concepts built on the physical reality of trade.¹²⁴ This cannot be said of direct e-commerce. Within the virtual world ordering and supplying of goods mean nothing else than a series of digital signs traveling through the global network without geographical and personal identity.¹²⁵ This phenomenon represents such a fundamental change in the circumstances of commercial activity what the concepts and presumptions of the traditional VAT systems are not prepared to handle.

The emergence of direct electronic commerce surprises the traditional VAT system on three main `fronts.'

The first problem follows from the sudden growth in the number of international business-to-consumer transactions.¹²⁶ Within the traditional trade environment the consumer was supposed to be in the `neighborhood' of the supplying business, or at least had to change his location if he wished to purchase from supplier located further away.¹²⁷ Therefore, traditional VAT systems are designed with the assumption in mind that business-to-consumer transactions predominantly take place within national boundaries. The emergence of mail-order systems¹²⁸ changed this scenario somewhat, but it still had not resulted in such a boost of international business-to-consumer transactions as e-commerce. Since the proliferation of Internet as a common communication tool, entering into a contract with a foreign supplier has become possible for consumers even without leaving their cozy armchair.¹²⁹ Present systems of VAT, based on the previously mentioned assumption are unable to catch foreign transactions to consumers in many cases.

As a second problem, direct e-commerce questions the traditional classification of supplies as goods or services. Within the sphere of e-commerce, where electronic transactions compete with traditional forms of supply, the goods, originally supplied through conventional channels become digitized.¹³⁰ Upon digitization the products lose physical appearance, therefore the regime governing the taxation of goods cannot be applied anymore.¹³¹ The question therefore is how to tax these supplies or whether to tax them at all. The same doubts arise with respect to new types of digital supplies.¹³² In addition, new types of transactions are difficult to fit into the existing lists of goods and services to which different rules are applicable under the present systems of VAT.¹³³

Thirdly, tax administrations are overwhelmed by the evasive nature of online commerce. Under all existing VAT systems suppliers need to tell the tax status and the location of their customers if they wish to discharge their administrative and payment obligations properly.¹³⁴ Accordingly, enforcement in lack of voluntary compliance is based on the authority's knowledge of the identity and geographical data of the supplier.¹³⁵ Acquiring of these data was not problematic within the traditional trade environment where trade partners met in person and articles of commerce traveled through physical checks. It goes without saying that the picture is different in case of digital trade. Based on the anonymous series of digital signs representing the transactions it is almost impossible to identify and locate the supplier and the customer.¹³⁶

After the exposition of problematic issues in a general manner, the subsequent chapter will provide for a specific analysis thereof within the context of the European VAT.

3. Specific Problems of the European VAT System Owing to E-Commerce

Upon the foregoing it has become evident that the traditional conceptual framework of value added tax has not proven to be entirely functional within the digital environment. This chapter aims at highlighting these functional problems with regard to the European VAT system in detail. Given the intrinsically cross-border nature of electronic commerce analysis will primarily focus on the theoretical and practical weaknesses of the Sixth Directive in handling inter-jurisdictional transactions.

A. Theoretical Problems of the Place-of-Supply Rules of the Sixth Directive

The place-of-supply rules answer the primary question of a VAT system in connection with cross-border trade, namely which country has the jurisdiction to tax.¹³⁷ These rules, by ensuring the proper allocation of tax revenues and tax burden play a crucial role in securing level competition¹³⁸ throughout the internal market. However, when it comes to e-commerce the playing field cannot be limited to the territory of Member States. The international nature of electronic trade requires thinking in terms of ensuring fair competition and even allocation of revenues on a global scale.¹³⁹ The question is whether the VAT system designed to handle European trade can live up to these expectations.

(a) Classification of Digital Transactions - Goods or Services?

For the proper determination of the applicable place-of-supply rules the Sixth Directive requires the knowledge of several factors from the supplier. The first of these is the classification of the supply as one of goods or services.¹⁴⁰ How should the digital supplies be categorized? To find the satisfactory answer to this question, all possible alternatives under the Sixth Directive should be examined.

The first issue to be decided by the Community is whether the Sixth Directive should tax digital services at all. This question equals to asking whether these supplies are capable at all of fulfilling the criteria of the traditional definition of either goods or services. A negative answer would place these supplies outside the scope of the European VAT. Understandably, when viewing the difference between the traditional and the new way of providing supplies one cannot help to be slightly doubtful as to the taxability of digital provisions.¹⁴¹ But, in the light of the Sixth Directive's goal to levy VAT as broadly as possible,¹⁴² the answer should be in the positive. That is, apart from the usage of a new medium, digital supplies have all the characteristics of a taxable transaction.¹⁴³ They are effected for consideration, supplied by businesses registered for VAT purposes to businesses with the same status and to final consumers. And these supplies represent an added value that forms an increasing portion of the GDP.¹⁴⁴

Subsequent to establishing the desirability of taxing digital transmissions the next question is whether the VAT system should tax them under the regime of goods or services?¹⁴⁵ As stated earlier, the definition of the supply of goods requires the tangibility of the object of supply.¹⁴⁶ Despite this requirement the next section of the same article lists `electric current' as tangible property. If this section were interpreted in a strict, grammatical sense, digital supplies, as a series of electric current, would be considered as supplies of goods.

But, setting aside the strict textual interpretation, the purpose of broad taxation should be reinforced again. In pursuance of this goal, the Sixth Directive sets forth two different regimes governing the supply of goods and of services based on the lack or presence of tangible character.¹⁴⁷ The reason why trade in electronic current is regulated under the rules on goods is not because of its `tangibility.' The explanation lies in the fact that such activity, as provision of public utility, is usually closely controlled by the authorities, therefore its trade route is transparent enough to apply the place-of-supply rules for goods.¹⁴⁸ This cannot be said about electronic deliveries. Their vague nature would render taxation impossible under the regime designed for taxing the supply of goods.

In light of the foregoing VAT systems wishing to tax digital transmissions in general, and the European VAT system in particular, should classify these supplies as supplies of services. International consensus behind this interpretation has already come to existence within the OECD framework.¹⁴⁹ This consensus however has not yet been reinforced within the European Community through legislative or judicial action. Namely, the Sixth Directive has not been amended with regard to this question, and the European Court of Justice has not yet given a preliminary ruling that would oblige national authorities to interpret the Sixth Directive in line with the above conclusion. Such lack of consistency in this question obviously threatens with double or non-taxation. Efforts taken by the Commission to clear this inconsistency will be discussed in part IV in detail.

(b) Detailed Analysis of the Place-of-Supply Rules of the Sixth Directive Governing the Supply of Services

After establishing that taxation of digital deliveries is only realistic if governed by the rules on services, this section aims at scrutinizing the provisions determining the place of supply of services in abstract. These provisions, as mentioned previously, implement the destination principle with respect to business-to-business transactions and are governed by the origin principle when taxing supplies to final consumers.¹⁵⁰ The analysis following the brief survey of the black-letter law and the theory behind it will show that the dysfunction of these rules constitutes the core of the problems following from the application of the Sixth Directive to digital trade.

Place-of-supply rules of services are provided for by Article 9 of the Sixth Directive. This Article pursues the double aim of concentrating VAT revenue to the country of consumption, while preserving administrative feasibility.¹⁵¹ This twofold objective has resulted in a rather extensive and complicated framework of place-of-supply rules.

Section (1) of Article 9 sets forth the general rule. This rule assigns taxing jurisdiction to the country where the supplier has established its business. As a complementary rule, taxation may occur in the Member State where the supplier has its fixed establishment¹⁵² if the use of the previous location would lead to an irrational result or a conflict with another State.¹⁵³ The choice of the place of business as the general rule is justified by the reasons of straightforwardness and avoiding interpretative difficulties arising in case of applying concepts such as the `place of utilization.'¹⁵⁴

The general rule, based on the origin principle is designed to catch business-to-consumer transactions or national supplies to business customers. It is based on the already mentioned belief that due to technical limitations supply of services to consumers normally takes place within one country, therefore the supplier, the customer and the consumption are all located within the same jurisdiction.¹⁵⁵ Taxation of supplies that might cross the border before reaching the consumer happens through the lex specialis described below.

Under the section at hand, the responsibility to account for and pay the tax lies with the business supplier.¹⁵⁶ This rule is in line with the administrative realities of business-to-consumer transactions, since business suppliers are the ones in possession of necessary data and equipment for the discharge of this obligation.¹⁵⁷

Section (2) of Article 9 lays down special rules with respect to certain services. For the purposes of this paper subsections (c) and (e) of section (2) bear most significance.

Subsection (c) deems the location where the service is physically carried out as the place of supply. This rule covers services, which predominantly comprise the utilization of personal qualities, such as cultural, artistic, educational or entertainment activities.¹⁵⁸ This nature of the services makes the central business establishment of the supplier relatively mobile.¹⁵⁹ Therefore, apart from the intention to realize taxation in the country of consumption as best as possible, this subsection also aims at preventing the suppliers from establishing their businesses in the countries with the lowest tax-rates, which they would probably do, were the general rule applicable.¹⁶⁰

Both business-to-business and business-to-consumer supplies of the listed services are meant to come under this subsection regardless whether the two parties reside within the borders of the same country. According to this subsection the business supplier should discharge its VAT responsibilities in compliance with the tax rate and other requirements of the national VAT regime in the country where it carries out its supplies.¹⁶¹

Subsection (e) of section (2) contains regulations with regard to intangible services, such as consultancy, advertising or data processing. Following from their nature, these services are primarily supplied to taxable entities, therefore they are presumed by the Sixth Directive to be more susceptible to cross-border delivery.¹⁶² Consequently, in case the central businesses of the supplier and the recipient are not established within one Member State, the section stipulates as the place of supply the location of the recipient's business in line with the destination principle. This rule is coexistent with the application of the `reverse charge' method under which the liability to account for and pay the tax is imposed on the business recipient.¹⁶³ The supplier in turn does not have to charge VAT, i.e. the supply is zero-rated in the country of origin.¹⁶⁴

Upon reading this rule together with subsection (b) of section (1) Article 21 it becomes clear that the reverse charge also applies to cases where a taxable person established outside of the Community renders services to a European taxable person.¹⁶⁵

The subsection also applies to instances where the customer - regardless of its tax status - is established outside of the European Community. This solution naturally follows from the underlying theory of taxing in the country of consumption.

When the recipient of the services listed in subsection (e) section (2) is a final consumer residing in the Community the supply is taxable according to Article 1. The general rule also applies to cases where the supplier and business recipient both have their central businesses within the borders of one Member State.¹⁶⁶

In order to avoid the possibility of double or non-taxation of these services following from the possible manipulation of the place of business or residence,¹⁶⁷ the Sixth Directive contains a provision complementing the preceding place-of-supply rules. According to section (3) of Article 9 national VAT systems may deem the place of `effective use or enjoyment' of these services as the place of supply, when this place is different from the location of the supplier or the consumer, and when these different rules lead to different results as to the applicability of the Sixth Directive.

After reviewing the relevant sections of the Sixth Directive the following chart gives an overview of the application of these rules to intra-Community and international digital transactions.

TABLE I

The above chart shows serious anomalies in the functioning of the place-of-supply rules of the Sixth Directive with regard to electronic transmissions. The number of digital transactions handled properly under the present regime is clearly outnumbered by the problematic cases.

Most of the problems seem to follow from the application of section (1) to business-to-consumer transactions more often than it would be justified by the requirement of taxing at the place of consumption.¹⁷³ Section (1) was designed to deal with national supplies, based on the already mentioned assumption on the model of transactions to consumers. Despite the fact that this underlying assumption has been set aside by the explosion in the number of private Internet users, section (1) remains applicable in a lot of cases in lack of a better rule.

A better rule would be one of the special place-of-supply rules. But the lex specialis is applicable only in case of services specifically listed therein and under special conditions stipulated thereby. This interpretation has been acknowledged by the ECJ in the Dudda-case: "In every situation the question which arises is whether it is covered by one of the instances in Article 9 (2); if not, it falls within the scope of Article 9 (1)."¹⁷⁴ It follows that new types of services¹⁷⁵ or traditional services supplied in a novel constellation fall under the general rule.¹⁷⁶

The over-application of the general rule leads to two undesirable consequences. The first of these consequences appears within the Community. Namely, taxing at origin leads to the misallocation of VAT revenues among the Member States under a given pattern of consumption (see lines 7 and 9).¹⁷⁷ Moreover, it has the potential of distorting consumption patterns and intra-Community competition by offering the opportunity to consumers to make their purchases from Member States with the lowest VAT rates.¹⁷⁸ It is obvious that, for example, for a Swedish consumer who has the choice to order supplies from Luxembourg with a VAT of 15 percent the decision to do so will be of no minute keeping the fact in mind that the Swedish rate is 25 percent.¹⁷⁹

The other undesirable consequence of the overwhelming application of the general place-of-supply rule occurs on the global playing field. This problem is apparent from comparing the tax consequences detailed in lines 14, 17 and lines 21, 24 of the above chart. These lines show on the one hand that in cases of inbound international supply of services not listed by the special rules the place of supply is deemed to be outside of the Community. Therefore, supplies of these services to European businesses or consumers are not taxable under the Sixth Directive.¹⁸⁰ If the country of the supplier does not have a VAT regime, like in the United States, the service remains untaxed.¹⁸¹ On the other hand, outbound international supply of the same services is taxable in both cases.¹⁸²

Consequently, under the general rule situations may occur where European businesses charge VAT on their supplies to European and third-country customers, while third-country suppliers provide services without tax both within the Community and internationally. This situation is disadvantageous to European businesses on both the European and the international playing field.¹⁸³ Moreover, it potentially distorts the pattern of transactions for two reasons. Firstly, this situation induces European businesses to supply their services through websites set up in third countries to retain their competitiveness.¹⁸⁴ Secondly, due to the difference in prices final consumption will shift to VAT-free international supplies.¹⁸⁵

As seen from the chart, even the application of the lex specialis might cause some problems with regard to digital deliveries. Namely, the place of supply of services listed under subsection (c) of section (2) might be different from the place of receipt or consumption when supplied digitally.¹⁸⁶ This possibility follows from the special features of digital delivery. For example, in cases of receiving music or motion pictures online in one of the Member States, performance thereof might have occurred previously outside of the EC or in another Member State.¹⁸⁷ When the place of performance does not coincide with the place of receipt or consumption there is chance of non-taxation or misallocation of VAT revenues.

After reviewing the theoretical flaws of the place-of-supply rules of the Sixth Directive governing the supply of electronic deliveries, the following section will be concerned with the difficulties of the practical implementation of these rules within the digital trade environment.

B. Problems with the Practical Application of the Place-of-Supply Rules

Theoretical soundness of the place-of-supply rules in itself is not enough for the proper functioning of the VAT system. Taxation is possible only if these rules are capable of practical implementation. ¹⁸⁸ Therefore, after reviewing the VAT implications of cross-border electronic trade in abstract, this chapter turns to more practical issues. It aims at showing that even in the rare cases when the place-of-supply rules in theory assign the proper taxing jurisdiction for digital trade, fulfillment of the VAT obligations might stumble upon the practical difficulties of compliance and enforcement arisen due to e-commerce. The following is a step-by-step analysis of these problematic issues arising in the course of applying the rules of the Sixth Directive in practice.

(a) Goods or Services? What type of service?

Without an intention of entering into a detailed discussion on the difficulties arising in the course of classifying electronic deliveries, suffice to note here that the new and ever-developing technology, by blurring the line between traditional categories of services and offering a wide-scale opportunity for the supply of composite products,¹⁸⁹ poses serious practical problems in this field. Therefore, even in case of theoretical clarity of the Sixth Directive with respect to classifying different supplies, these practical difficulties might frustrate the proper functioning of the VAT system.¹⁹⁰

(b) Identifying the Consumer: Finding out Its Location and Tax Status

Apart from understanding the nature of supply orientation within the cobweb of place-of-supply rules requires the knowledge of several other data. As seen above, choice between the general and special rules might depend on the location and tax status of the customer.¹⁹¹

Determination of the tax status of the recipient when necessary is facilitated by the VIES.¹⁹² In the process of verifying the registration number the supplier and the tax authorities make use of traditional media for the exchange of information. However, in the sphere of e-commerce, the transaction between the supplier and the customer is taking place online. Clearly, the inability of the VIES system to provide online, real time verification prevents the suppliers from fully exploiting the comfort and speed offered by electronic trade and therefore potentially hampers the pursuance of such activity.¹⁹³

Simultaneously with confirming the tax status of the customer his location should also be verified. With regard to business purchasers, if the verification process through the VIES system was successful, the location of the business can be inferred from the registration number.¹⁹⁴ In case of final consumers there is no such supplementary system. Within traditional circumstances the consumer either paid on the spot or was required to let the supplier know of his address for purposes of delivery and payment. When ordering online, consumers use electronic mail for communicating with the seller, but e-mail addresses tell little about the real, physical residence of its user. ¹⁹⁵

The most evident means of finding out their location is to ask the customers to self-declare this information.¹⁹⁶ But, unless underlining this practice with reliable verification buyers might feel tempted by the anonymity of online trade to disclose false facts.¹⁹⁷ Despite the diverse efforts to solve this problem, there is still no reliable and feasible means of identifying and locating consumers in lack of voluntary compliance.¹⁹⁸ For the time being suppliers might verify disclosed data by using the credit card information requested from the purchaser previous to the conclusion of the contract.¹⁹⁹ They might also rely on the currency of payment in determining the taxing jurisdiction.²⁰⁰ Evidently, neither of these examples is a dyed-in-the-wool solution.²⁰¹

(c) Determining the Place of Effective Use and Enjoyment

In case of services listed under section (2) subsection (e) of Article 9 establishing the fact that the location of the customer is inside or outside of the Community is not always satisfactory. The VAT systems of Member States that implemented the derogation provided by section (3) of Article 9 require the determination of the place of effective use or enjoyment of these services. If such place is different from the location of the customer it should be considered as the place of supply to realize taxation at consumption.²⁰²

In the light of the difficulties with establishing the location of the customer, the conclusion that determining the place of effective use or enjoyment is almost impossible within the digital environment may be drawn without a long analysis.²⁰³ The evasive nature of e-commerce necessitates new tools for detecting the flow of digital services through the Internet.²⁰⁴ In the lack of reliable technological means, the supplier remains dependent upon the information revealed by the customer voluntarily.

The above factors have a negative impact on the fulfillment of obligations under the Sixth Directive. As the other side of the coin, these practical deficiencies also undermine the effective enforcement of VAT rules in lack of voluntary compliance.²⁰⁵ The pieces of information needed by the supplier for compliance are also essential for the tax authorities for enforcement.²⁰⁶ To recognize and fight infringement of VAT rules, they need to identify the transaction and gather data on the supplier and the customer. It is obvious that without re-tailoring the rules of the Sixth Directive according to the needs of e-commerce and finding the necessary technological means for their implementation, value added taxation of electronic trade remains vague and incidental.²⁰⁷ The steps taken by the Community to find viable solutions will be detailed in part IV.

(d) Administrative Problems

Last, but not least some problems with regard to the performance of administrative requirements under the Sixth Directive should be mentioned briefly. Disharmony between the new way of conducting business and the traditional rules stipulating fulfillment of administrative obligations results in an increased compliance burden.²⁰⁸ The complication of rules in turn serves as a disincentive for compliance.²⁰⁹ The following are the areas where the Sixth Directive is clearly behind the requirements of electronic trade.

(i) invoicing

The invoice is the heart of the VAT system.²¹⁰ It records information necessary for the proper taxation of a transaction and it is a prerequisite for claiming VAT deduction.²¹¹ In order for businesses to be able to realize the advantages following from paperless transactions the facilitation of electronic invoicing is crucial.²¹² Such an idea, however, is absent from the Sixth Directive. Although Article 22²¹³allows Member States to accept this type of invoice, this is clearly an inadequate basis for uniformly implementing electronic invoicing in the Community. Member State legislation already in place in this matter is often solely focused on domestic electronic invoicing.²¹⁴ In addition, such rules are generally accompanied by cumbersome administrative requirements.²¹⁵

(ii) other

Taxable persons are required to comply with other types of administrative requirements, already listed in chapter 3 of part II. The arguments for introducing the opportunity to discharge these obligations by electronic means are the same as the arguments for electronic invoicing. The time and expense of the paperwork required under the present system obviously impairs the positive implications of electronic delivery.²¹⁶

After identifying the theoretical flaws and problems of implementation of the VAT rules laid down by the Sixth Directive, the following chapter intends to explore the negative consequences following from this dysfunction.

4. Consequences of the Dysfunction of the Sixth Directive

As explained in part II of this essay, the Member States have chosen to adopt VAT as the main form of consumption tax due to its neutrality to consumption patterns. Through its neutral functioning the VAT system is expected to contribute to the building of the internal market and a level field of competition within the Community.²¹⁷

The previous chapter revealed the anomalies in the application of the present VAT regime to electronic transactions. This chapter aims at examining the consequences of the VAT system's dysfunction and establishing whether these consequences impinge on the achievement of the internal market objective. Specifically, the chapter attempts to examine whether and to what extent these anomalies might result in the decrease of the European Community's own resources and to assess the harmful impact of the dysfunction on the competitiveness of European businesses.

A. Revenue Loss

As a first step in estimating the probability and extent of erosion that might occur in the Community's budget following from the dysfunction of existing legislation, the structure of the Community's own resources and the nature of the VAT resource should be examined.

Article 269 of the Rome Treaty states that "the [Community] budget shall be financed wholly from own resources."²¹⁸ In pursuance of this objective the Council passed a Decision on the replacement of the Member States' financial contributions with a system of own resources in 1970.²¹⁹ Since then the Community's budget has been comprised of three different types of resource, including the value added tax resource.

The VAT portion of the own resources is calculated upon a harmonized basis of assessment,²²⁰ which includes all taxable and zero-rated transactions according to the Sixth Directive. The rate by which this base is to be multiplied has been fluctuating through the years in correlation to the changing needs of the Community budget. The insufficiency of resources finally led to the introduction of a fourth type of own resource calculated upon the gross national product of the Member States.²²¹

Unlike customs duties and agricultural levies the VAT resource cannot be considered a genuinely autonomous source of revenue.²²² By constituting a separate item in the budgets of the Member States, the VAT resource is fluctuating in accordance with the varying amount of their revenues.²²³ In pursuance of establishing a truly European budget the percentage of VAT revenue has been continuously decreased to the present rate of 1% since the introduction of the GNP resource.²²⁴ The last relevant Council Decision envisaged the reduction of the VAT resource rate to 0.75% by 2002 and to 0.5% by 2004.²²⁵ The complete abandonment of this source is predictable in the long term.²²⁶

It is apparent upon the foregoing that a possible decrease of VAT revenues following from the anomalous operation of the VAT system would potentially effect the budget of the Community. With this conclusion in mind the following part of this section tries to assess whether the loss of Member State revenues resulting from non-taxation of certain electronic transactions and misallocation of the VAT revenues are substantial enough to have a harmful impact on the 1% of the VAT base accruing to the Community. Examination of the possible impact of the above phenomena on the Community budget is based on the following presumptions:

(i) It will be presumed that a decrease of national tax revenues owing to the irregularities in the operation of the VAT system may occur only if electronic trade results in the reduction of the number of properly taxed conventional transactions.²²⁷ Since new digital services have never been taxed under the conventional VAT legislation, their present non-taxable status does not result in revenue loss in the strict sense. The focus therefore should be restricted to electronic supplies, which compete with traditional forms of transactions.²²⁸

(ii) The possible effects of the misallocation of VAT revenues within the European Community will be disregarded for the purposes of the following impact analysis. In consequence of the fact that the amount of VAT lost by one Member State accrues to the budget of another, misallocation does not result in a decrease of Community revenues. The effect of the difference between the VAT rates of Member States is negligible.²²⁹

(iii) Focus of the analysis will be restricted to business-to-consumer transactions. The rationale behind this restriction is that under the operation of the classical VAT system business-to-business transactions do not result in net revenue for the government due to the right to reclaim the tax.²³⁰

Following from the preceding premises there are two types of digital supplies which should be put under closer scrutiny:

(A) Services listed in subsection (e) section (2) of article 9 of the Sixth Directive, when supplied electronically by third-country businesses to final consumers residing in the Community; and

(B) Services listed in the first indent of subsection (c) section (2) of article 9 of the Sixth Directive when supplied electronically by third country businesses to final consumers residing in the Community.

ad (A) The place of supply of these services, not coming under any of the special rules, is determined according to section (1) of Article 9.²³¹ The general rule stipulates the location of the supplier's business as the place-of-supply. At first sight therefore the transaction is not taxable since the place of the supply is outside of the Community.²³²

Theoretically, though, there are two ways of taxing these services under the present European VAT system, as already mentioned in the preceding chapter. One of the options is the application of the "effective use and enjoyment" derogation provided by section (3) of Article 9. The other option is obliging the foreign supplier to appoint a fiscal representative acting on his behalf in the consumer's Member State.²³³

In practice neither of the solutions can guarantee the taxation of these services. First of all, the Sixth Directive leaves the adoption of both of these rules at the discretion of the Member States, therefore there is no uniform Community practice in this field. Secondly, as seen above, in lack of appropriate technical means, determining the place of effective use and enjoyment or the location of the consumer is not possible with certainty.²³⁴

The effect of non-taxation should be examined with respect to the volume of these services and the extent to which they are apt to substitute traditional transactions.

An exponential growth in the number of these services and their replacement of traditional forms of supply is expected under the present consumption pattern due to the conveniences following from electronic delivery.²³⁵ In addition, the fact that these services remain untaxed when supplied by third-country enterprises has the potential of shifting consumption to these supplies from the taxed supplies of European businesses.²³⁶ This practice in turn gives an incentive to Community businesses to provide such services electronically through servers established in third countries to avoid VAT.²³⁷ These tendencies potentially lead to the total shift of consumption from the domestic to the untaxed foreign supplies and a consequent reduction in VAT revenue.²³⁸

ad (B) the place where these services are deemed to be supplied is the place of their performance. As mentioned previously, the place of performance of these entertainment services might be different from that of consumption when supplied by electronic means.²³⁹ Therefore, when, for example, music is supplied digitally from a third country, the performance can easily be determined as taking place in the territory of that country. Consequently, the transaction might be non-taxable under the Sixth Directive.

The "effective use and enjoyment" derogation is not applicable to services listed under section (c) of Article 9. The previous comments on applying the requirement to appoint a fiscal representative are equally valid with respect to cultural services.

Increase in the number of online supplies of entertainment services is expected, especially with respect to the digital supply of music and books.²⁴⁰ Substitution of traditional forms of supply, like CDs, cassettes and videotapes, by digital delivery will definitely occur in certain fields of entertainment services under the present pattern of consumption. In other fields, due to the social and cultural role of traditional performance of certain entertainment services, like theater, substitution will probably not occur in the foreseeable future.

The potentially untaxable state of these services may shift consumption from taxed domestic supplies to untaxed foreign provisions in case of entertainment services as well. The incentive of European suppliers to supply these services through servers established in third countries will probably also occur, resulting in the decrease of taxed domestic transactions and Community revenues.

The above analysis does not reveal immediate threats to the Community budget.²⁴¹ According to statistics electronic commerce accounts for a small portion of overall European trade at the present, especially at the retail level.²⁴² Nevertheless, action should definitely be taken to prevent the potential decrease in the Community resources that might follow from the multiplication of digital transactions.²⁴³

Community action is justified even in the light of the fact that the percentage of the VAT revenue in the Community's budget is decreasing and might even disappear in the long term. VAT represents one fifth of the tax revenues of the 15 Member States,²⁴⁴ erosion of the tax base therefore is considered to be a sensitive issue. Since the area of VAT belongs to the competencies of the Community, any action should be taken in the form of Community legislation. ²⁴⁵

B. Distortion of Competition

The European Community was established with the goal of improving the competitiveness of European economy on the world market by creating a common free marketplace where a level playing field is secured for all actors.²⁴⁶ This goal has last been reinforced at the Lisbon European Council²⁴⁷ where the Commission introduced the program called "2000 Internal Market Strategy Review."²⁴⁸ Through the implementation of this Strategy the Community hopes to become "the most competitive and dynamic knowledge-based economy in the world."²⁴⁹

To preserve competitiveness on the global playing field exploitation of the advantages brought about by electronic commerce is inevitable.²⁵⁰ The new way of doing business offers such efficiency on both micro- and macro-economical level that the competitive gap between economies utilizing e-commerce to a full extent and those reluctant to do so will soon be insurmountable.²⁵¹

Europe is lagging behind the USA with regard to both use of the Internet and the importance of e-commerce.²⁵² One of the obstacles to the flourishing of electronic commerce recognized in the documents of the Community is the inconsistency of the existing European regulatory framework.²⁵³ These inconsistencies include the irregularities of the operation of the European VAT system.²⁵⁴ The application of the place-of-supply rules of the Sixth Directive with respect to the digital deliveries impedes e-commerce by distorting competition within the internal market and putting European businesses to a disadvantageous position on the global playing field.²⁵⁵

For the purposes of analyzing the distortive effects of the Sixth Directive's dysfunction in handling online transactions, the effects of misallocation of VAT revenue and burden should also be considered.²⁵⁶ Except for one case, the focus will also be on the business-to-consumer transactions. The following types of transactions will be examined:

(A) Intra-Community electronic transactions falling under section (1) of Article 9;

(B) International versus intra-Community electronic transactions to final consumers falling under section (1) of Article 9;

(C) International versus intra-Community electronic transactions falling under subsection (c) section (2) of Article 9.

ad (A) these supplies are of new types of services not listed under the special rules.²⁵⁷ In case of business-to-business supplies of these services, the receiver of the supply should go through a cumbersome and expensive refund procedure in order to get back as an input credit the VAT paid by him on the purchase.²⁵⁸ If he chooses not to spend his time and money by reclaiming tax, the `locked in' VAT will lead to tax accumulation.²⁵⁹ Both of the results lead to an increase in consumer prices and serve as a disincentive to engage in cross-border commercial activity or to comply with the VAT regulations.²⁶⁰ This scenario clearly conflicts the objective of creating a borderless European marketplace.

In case of business-to-consumer supplies of these services the VAT is calculated according to the rates effective in the country of origin. It follows that businesses established in Member States with high VAT rates will add a higher amount of tax to the consumer prices and vica versa. Therefore, taxing these transactions at origin obviously distorts competition within the internal market by potentially shifting consumption to supplies including the lowest VAT.²⁶¹

The results following from the inability of the Sixth Directive to properly handle these supplies conflict the goal of promoting a harmonious and balanced development of economic activities within the Community set out by the Treaty of Rome. These practices, unless corrected in the short term, will harm the competitiveness of the European Community on the global market.

ad (B) services discussed in this section include the services detailed under subsection (A) of the previous section and new types of digital deliveries not fitting into the list of services under the lex specialis.²⁶² As to the services discussed in the previous section, the fact that the overwhelming majority thereof stays untaxed when supplied from outside of the Community has already been established.²⁶³ The same holds true with respect to the new types of services as well. The only difference between the two settings is that in case of new services the derogation of section (3) of Article 9 is not applicable.²⁶⁴ The odds of correcting the mistakes of the general rule are therefore even lower.

The same services, though, are taxed when supplied by a European business to a consumer either in or outside of the Community, since under the general rule taxation should occur at the location of the supplier's business.²⁶⁵ The only exception occurs, if the respective Member State has adopted the derogation under section (3) of Article 9 and the supplier can prove that effective use and enjoyment of the service happened outside of the Community. The chance of success, as seen previously, is very low.²⁶⁶ This derogation, as stated above, is not applicable for new types of supplies. Considering that standard VAT rates range from 15% to 25%²⁶⁷ the above practice results in a serious disadvantage of European businesses in the price competition.²⁶⁸

ad (C) It has been found in section (B) of the previous chapter that these services might remain untaxed when supplied by a third-country business to final consumers in the Community. At the same time supplies provided by a European enterprise are taxed under the relevant section of the Sixth Directive. This pattern of taxation also results in a disadvantage in the competitive position of European businesses.²⁶⁹

To sum up the comments of this chapter it should be concluded that the negative effects following from the dysfunction of the European VAT system apparently impact the balance of competition in the global `electronic' market more seriously than they influence the amount of Community revenue. It seems therefore that Community action is primarily justified by reasons of creating equal competition within the internal market and on the global playing field. However, because of the truly global nature of the electronic marketplace, it is evident that acting on Community level alone is not enough to preserve the competitiveness of the Community. Concerted action of all participants of e-commerce, especially of the OECD countries is needed to create a global level playing field.²⁷⁰

105 See, e. g, Electronic Commerce - An Introduction, supra note 11, at 4; Albarda, Electronic Commerce, supra note 5, at 24-25; Green Paper, supra note 4, at 3; Working Paper - 1998, supra note 5, at 5; Luc Hinnekens, The Challenges of Applying VAT and Income Tax Territoriality Concepts and Rules to International Electronic Commerce in 26 Intertax 52 (1998) [hereinafter: "Hinnekens, Challenges"]; OECD, Report on the Turku Conference, supra note 6, at 8-9.

106 Nils Eriksen & Kelvin Hulsebos, Electronic Commerce and VAT - An Odyssey Towards 2001 in VAT Monitor July/August 2000, 137 [hereinafter: "Eriksen & Hulsebos, Electronic Commerce and VAT"]; Hinnekens, Challenges, see supra note 105, at 52; see also supra note 5.

107 Working Paper - 1998, see supra note 5, at 4, Albarda, Electronic Commerce, see supra note 5, at 17-20

108 See id.

109 See id; Armstrong, Internet and E-Commerce, supra note 11.

110 Kortenaar and Spanjersberg, Taxation and E-Commerce, see supra note 5, at 180-187; Albarda, Electronic Commerce, see supra note 5, at 15-16.

111 Kortenaar and Spanjersberg, see id.

112 See id.

113 Green Paper, see supra note 4, at 3.

114 See id; Electronic Commerce - An Introduction, see supra note 11, at 4-5.

115 See id.

116 Green Paper, see supra note 4, at 3; Electronic Commerce - An Introduction, see supra note 11, at 4-5, Albarda, Electronic Commerce, see supra note 5, at 13-14.

117 Digital Economy 2000, U.S. Department of Commerce, June 2000, http://www.esa.doc.gov/de2k.htm; EU: E-Commerce Set to Soar Among SMEs, E-Commerce in Europe, iPlanet [hereinafter: "iPlanet"] http://www.uk.iplanet.com/center/ecnews/markettrends/onlinesaleswe.html; Software-sales will rise from 7 percent of online sales in 1999 to 40 percent in 2004 according to Forrester Research, Spectacular Growth for Digital Delivery, February 7, 2000 reported by Nua Internet Surveys, http://www.nua.ie [hereinafter, "Forrester, Spectacular Growth."]

118 The most dramatic growth in direct, digital download sales will probably be in the music sector, where such sales could rise from 0.1 percent of online sales in 1999 to 25 percent in 2004, see Forrester, Spectacular Growth, supra note 117.

119 Electronic Commerce - An Introduction, see supra note 11, at 4-5; Green Paper, see supra note 4, at 3; Kortenaar and Spanjersberg, Taxation and E-Commerce, see supra note 5, at 180-187.

120 `Colocation' means "networking, i.e. providing network connections, such as Internet leased lines to several servers housed together in a server room." See http://www.instantweb.com/D/dictionary/index.html.

121 See supra note 11.

122 See supra note 117.

123 Green Paper, see supra note 4, at 19-20; VAT on E-Commerce - Why the Rule Need To Be Changed, 13 The Key (Taxation and Customs Union DG of the Commission, October, 2000) [hereinafter: "the Key"] http://europa.eu.int/comm/taxation_customs/publications/thekey/key-13-00.pdf; Armstrong, Internet and E-Commerce, see supra note 11.

124 OECD, Report on the Turku Conference, see supra note 6, at 9-20; Schenk & Oldman, Value Added Tax, see supra note 41, at 489-490; Howard Lambert, VAT and Electronic Commerce: European Union Insights Into the Challenges Ahead, 17 Tax Notes Int'l 1645 (Nov. 23, 1998); Hinnekens, Challenges, see supra note 105, at 54.

125 See Schenk & Oldman, Value Added Tax, supra note 41, at 490; Hardesty, Introduction, supra note 6, at 2.

126 OECD, Report on the Turku Conference, see supra note 6, at 17; Explanatory Memorandum to the Proposal for a Council Directive amending the Sixth Directive as regards the value added tax arrangements applicable to certain services supplied by electronic mean [COM (2000) 349 final] June 7, 2000, 6-7 [hereinafter: "the Explanatory Memorandum"]; Kortenaar and Spanjersberg, Taxation and E-Commerce, see supra note 5, at 180-187

127 Kortenaar and Spanjersberg, Taxation and E-Commerce, see id.

128 Does Cyber-Commerce Necessitate a Revision of International Tax Concepts? Coopers & Lybrand Belgium (International Bureau of Fiscal Documentation ed. 1998) [hereinafter: "Coopers, Revision"] at 2.

129 Hardesty, Introduction, supra note 6, at 2

130 OECD, Report on the Turku Conference, see supra note 6, at 19; Hinnekens, Challenges, see supra note 105, at 55.

131 See, e.g., Hinnekens, Challenges, supra note 105, at 55; Han Kogels, Brussels Bites the Bullet in VAT Monitor July/August 2000, 135 [hereinafter: "Kogels, Brussels Bites the Bullet"]; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 139; Ernst & Young, supra note 6; Hardesty, Introduction, supra note 6, at 3.

132 Explanatory Memorandum, see supra note 126, at 6; Mark Houtzager & Jeroen Tinholt, E-Commerce and VAT in Caught in the Web 99-102 (Deventer ed., 1998) [hereinafter: "Houtzager & Tinholt, E-commerce and VAT."]

133 OECD, Report on the Turku Conference, see supra note 6, at 20; Hinnekens, Challenges, see supra note 105, at 57; Eriksen & Hulsebos, Electronic Commerce and VAT, see supra note 106, at 137; Houtzager & Tinholt, E-commerce and VAT, see supra note 132 at 90-92.

134 OECD, Report on the Turku Conference, see supra note 6, at 9-12; Explanatory Memorandum, see supra note 126, at 7-8; Kogels, Brussels Bites the Bullet, see supra note 131, at 135; Eriksen & Hulsebos, Electronic Commerce and VAT, see supra note 106, at 139.

135 OECD, Report on the Turku Conference, see supra note 6, at 9-12; Explanatory Memorandum, see supra note 126, at 9-11.

136 See supra notes 134-135; see also the Report by the Technology TAG of the OECD, (December, 2000) [hereinafter: "Technology TAG Report"] on the technological questions of tax collection, http://www.oecd.org/daf/fa/e_com/public_release.htm.

137 See supra notes 55, 56.

138 The terms `level competition' and `level competitive playing field' are derived from Weiler, Introduction, see supra note 3.

139 See OECD Report on the Turku Conference, supra note 6, at 4; The Explanatory Memorandum, supra note 126, at 3; Ernst & Young, supra note 6.

140 See supra notes 78-80.

141 Indeed, this question gives the core of the antagonism between the American and European views, see supra note 12. Apart from the conflicting beliefs as to applying the VAT to electronic transactions or not, there is a third view propagating the taxability of digital deliveries, though not under the VAT regime but through the application of new types of taxes, such as the `bit tax.' For a detailed review of this opinion see Hinnekens, Challenges, supra note 105, at 69-70.

142 This has been the goal of the European VAT system since the issuance of the First Council Directive, see the Preamble of this Directive, supra note 66. This intention has also been reinforced by Article 2 of the Sixth Directive, see supra note 71.

143 See OECD, Report on the Turku Conference, supra note 6, at 4; Electronic Commerce: Taxation Framework Conditions, A Report by the Committee on Fiscal Affairs of the OECD, 3 (1998) [hereinafter: "Taxation Framework Conditions"]; Green Paper, supra note 4, at 19; Explanatory Memorandum, supra note 126, at 3.

144 According to the Report made in the UK last year, e-commerce is predicted to rise to between 4% and 7% of the GDP in the UK, Germany, Italy and France by 2003. See Where Does the UK Stand Now? UK Online (2000), http://www.e-envoy.gov.uk/2000/progress/anrep1/030.htm.

145 This is one of the most controversial questions of electronic commerce, since classification of digital deliveries for the purposes of VAT has an implication on the customs consequence of these services. Namely, within the Framework of WTO different agreements with different restrictions and customs consequences apply to the international trade of goods and services. Therefore, understandably, the net importers and the net exporters of electronic supplies have different opinions on the classification. See Tariffs, Taxes and Electronic Commerce, OECD Statistics Directorate, November 17, 2000
[STD/NA/ITS(2000)25], http://www.oecd.org/std/ITS_Nov2000_Meeting/docs/ITS2000_25e.pdf.

146 See supra note 78; OECD, Report on the Turku Conference, supra note 6, at 19.

147 See supra section (d) chapter 3 of part II of this essay.

148 E-mail from Geoff Trueman, Taxation and Customs Union Directorate General, TAXUD C3 (April 27, 2001) [on file with author]

149 See Taxation Framework Conditions, supra note 143. As will be seen in the following, by this document the OECD countries voted for classifying digital deliveries as services for the purposes of taxation.

150 See supra section (d) chapter 3 of part II of this essay.

151 See Terra, The Place of Supply in European VAT, supra note 53, at 57.

152 The concept of fixed establishment for the purposes of VAT is different from the notion of permanent establishment in the field of income or corporate taxation. The ECJ defined this concept as the `permanent presence of both human and technical resources necessary for the provision of services' see the Berkholz-case, supra note 56.

153 See the Berkholz-case, supra note 56; Terra, The Place of Supply in European VAT, supra note 53, at 57.

154 See the Explanatory Memorandum to the Proposal for the Sixth Directive cited in Terra, The Place of Supply in European VAT, supra note 53, at 54. The ambition for clarity can also be implied from the Preamble of the Sixth Directive, supra note 71, and from the Berkholz-case, which states that "Article 9 is designed to secure the rational delimitation of the respective areas covered by national value-added tax rules..." supra note 56.

155 See supra chapter 2 of part III of this essay.

156 See subsection (a) section (1) of 28g of the Sixth Directive, supra note 71.

157 See Terra, The Place of Supply in European VAT, supra note 53, at 56.

158 See id. at 74.

159 See id.

160 See id.

161 See id. at 75.

162 See id. at 155-156.

163 See supra section (b) chapter 3 of part III of this essay, specifically note 77.

164 See supra chapter 2 of part II of this essay.

165 See Terra, The Place of Supply in European VAT, supra note 53, at 157.

166 See id. at 155.

167 See id. at 220-222.

168 National supplies are reviewed merely for the sake of drawing a whole picture. That is, these supplies do not bear significance with respect to the application of the place-of-supply rules since these are not cross-border transactions. See Terra, The Place of Supply in European VAT, supra note 53, at 1.

169 See Eighth Council Directive on the harmonization of the laws of the Member States relating to turnover taxes - Arrangements for the refund of value added tax to taxable persons not established in the territory of the country [79/0172/EEC] Dec. 6, 1979 OJ L331 27.12.1986 p.11 [hereinafter: "the Eighth Directive"]; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 137.

170 See supra note 51.

171 See Harmonization of Turnover Taxes, Working Paper of Directorate General XXI, June 8, 1999 [hereinafter: "Working Paper - 1999"] at 14.

172 In principle under subsection (a) section (1) of 28g of the Sixth Directive Member States may require the appointment of a fiscal representative in case of taxable supplies effected by a taxable person not established within the Community. E.g. under section 259 C of the French tax code, VAT is due in France when intangible services are rendered by a seller established outside of the European Community to a French customer who is not subject to VAT. In practice, however, we will see that this rule is unenforceable in case of electronic services. See European Union/European Economic Area in 10 European Legal Developments Bulletin, Baker & McKenzie, January 1998.

173 See Working Paper - 1998, supra note 5, at 11; Working Paper - 1999, supra note 171, at 13; OECD, Report on the Turku Conference, supra note 6, at 17; Schenk & Oldman, Value Added Tax, supra note 41, at 489-492.

174 Recital 21 of the Dudda-case, see supra note 56.

175 New types of services include, for example, web hosting, we design, online arbitration services, colocation services. See Working Paper - 1999, supra note 171, at 14; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 138.

176 Working Paper - 1999, supra note 171, at 14; OECD, Report on the Turku Conference, supra note 6, at 17.

177 Application of the origin principle with regard to cross-border supplies has been denounced as distorting competition within the Community by the Commission in the Explanatory Memorandum to the Proposal for the Sixth Directive cited in Terra, Place of Supply in the EC, see supra note 53, at 55.

178 See id.

179 Coopers, Revision, supra note 128, at 5.

180 See, e.g., Working Paper - 1998, supra note 5, at 7; Explanatory Memorandum, supra note 126, at 6; Ernst & Young, supra note 6; Schenk & Oldman, Value Added Tax, supra note 41, at 489; David Hardesty, EU Proposes New Taxes on Non-EU Sellers in E-Commerce Tax News, 2-3, June 18, 2000 [hereinafter: "Hardesty, Europe Proposes"] http://www.ecommercetax.com.

181 Even in case the country of origin has a VAT regime, there is a chance that the place-of-supply rules are not corresponding to those of the European VAT system, therefore taxation might not occur.

182 See supra note 180.

183 See Working Paper - 1998, supra note 5, at 7; Explanatory Memorandum, supra note 126, at 6; David Hardesty, EU Continues Efforts to Tax Digital Products in E-Commerce Tax News, Oct. 22, 2000 [hereinafter: "Hardesty, EU Continues Efforts"], http://www.ecommercetax.com;

184 See, e.g., OECD, Report on the Turku Conference, supra note 6, at 18; Hinnekens, Challenges, supra note 105, at 57;

185 See id.

186 See supra note 171.

187 See id.

188 See Tait, Value Added Tax, supra note 42, at 270-272; Working Paper - 1998, supra note 5, at 13; OECD, Report on the Turku Conference, supra note 6, at 9-11; Taxation Framework Conditions, supra note 143, at 6; Explanatory Memorandum, supra note 126, at 3.

189 OECD, Report on the Turku Conference, supra note 6, at 20; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 138.

190 See id.

191 See subsection (b) section A of this chapter of the essay.

192 See supra note 77.

193 See Explanatory Memorandum, supra note 126, at 7; Taxation Framework Conditions, supra note 143, at 5; Peter Jenkins, The Application of VAT to E-Commerce in the EU in 22 Tax Notes Int'l, 427, Jan. 22, 2001[hereinafter: "Jenkins, Application."]

194 See subsection (d) section (1) of Article 22 of the Sixth Directive.

195 Working Paper - 1998, supra note 5, at 7, 14; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 139; Kortenaar & Spanjersberg, Taxation and E-Commerce, supra note 5, at180-187; Jenkins, Application, supra note 193 at 4.

196 See Consumption TAG Report, supra note 76, at 13.

197 i. e. by disclosing false information as to their location, consumers can save significant VAT costs thanks to the differences in the VAT rates of the Member States and third countries. See supra note 195; Coopers, Revision, supra note 128, at 2-3; Kogels, Brussels Bites the Bullet, supra note 131 at 135.

198 See Technology TAG Report, supra note 136. The conclusion of the Report is that work should be continued in the field of defining reliable technology for jurisdictional identification.

199 See Explanatory Memorandum, supra note 126, at 8.

200 See id.

201 According to the report of the Technology TAG of the OECD credit cards are likely to remain the dominant form of payment in the majority of countries for consumer transactions over the Internet. However credit cards are not reliable sources of data on consumer jurisdiction. While the concept of matching a credit card number to the country of residence was originally thought to have promise, further investigation demonstrated that there was no numerical BIN correlation to geography. See Technology TAG Report, supra note 136.

202 See supra subsection (b) of section A of this chapter of the essay.

203 See supra note 197; Jenkins, VAT and E-Commerce, supra note 5, at 4.

204 See Technology TAG Report, supra note 136.

205 See Tait, Value Added Tax, supra note 42, at 315-317; Working Paper - 1998, supra note 5, at 13; OECD, Report on the Turku Conference, supra note 6, at 9-11; Taxation Framework Conditions, supra note 143, at 6; Explanatory Memorandum, supra note 126, at 3; Kortenaar & Spanjersberg, Taxation and E-Commerce, supra note 5, at 180-187; Jenkins, Application, supra note 193.

206 See id.

207 See id.

208 See Working Paper - 1998, supra note 5, at 17-18; Explanatory Memorandum, supra note 126, at 3.

209 See id; Tait, Value Added Tax, supra note 42, at 42-43.

210 See Tait, Value Added Tax, supra note 42, at 279; Final Report on Invoicing, PriceWaterhouseCoopers on behalf of the European Commission, August 23, 1999 [hereinafter: "Invoicing"] at 4.

211 See 28h of the Sixth Directive, supra note 71.

212 See Explanatory Memorandum, supra note 126, at 4; Taxation Framework Conditions, supra note 143, at 5; OECD, Report on the Turku Conference, supra note 6, at 12; David Hardesty, EU Proposes Electronic VAT Invoices in E-Commerce Tax News 1, 4, Nov. 19. 2000 [hereinafter: "Hardesty: "Electronic Invoices"] http://www.ecommercetax.com; Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 138.

213 See subsection (c) section (3) of Article 22 of the Sixth Directive, supra note 71.

214 See Eriksen & Hulsebos, Electronic Commerce and VAT, supra note 106, at 138.

215 For a brief review of relating Member State legislation see id. See also Hardesty, Electronic Invoices, supra note 212 at 2.

216 See Working Paper - 1998, supra note 5, at 22-23.

217 See supra notes, 37, 46-47.

218 See supra note 3.

219 See supra note 8.

220 See Council Regulation No 1553/89 on the definitive uniform arrangements for the collection of own resources accruing from value added tax, May 29, 1989, OJ L155 07/06/1989 p. 9.

221 See Council Decision on the system of the Communities' own resources [88/376/EEC, Euratom] June 24, 1988, OJ L185 15/07/1988 p. 24.

222 See Opinion of the European Parliament on the Proposal for Council Decision on the system of the European Communitites' own resources, Recital 11, Nov. 17, 1999 [hereinafter: "Opinion of the Parliament"] OJ C189 07/07/2000 p. 79.

223 See id; Special Report concerning the protection of the financial interests of the European Union in the field of VAT on intra-Community trade, 1, [No. 9/98] OJ C356 20/11/1998 p. 1.

224 See Council Decision on the system of the Communities' own resources [94/728/EC, Euratom] Oct. 31, 1994, OJ L185 12/11/1994 p. 9.

225 See Council Decision on the system of the Communities' own resources [2000/597/EC, Euratom] Sept. 29, 2000, OJ L253 07/10/2000 p. 42.

226 See Opinion of the Parliament, supra note 221, at Recital 11.

227 See Explanatory Memoradum, supra note 126, at 6; Kortenaar & Spanjersberg, Taxation and E-Commerce, supra note 5, at 180-187.

228 See supra chapter 1 of this part of the paper.

229 The difference between the minimum and maximum standard rate is 10%, with Germany and Luxembourg applying 15%, and Denmark as well as Sweden applying 25%, see Coopers & Lybrand, Revision, supra note 128 at 4.

230 See supra chapter 2 of part II of this paper.

231 See supra subsection (b) section A, chapter 3 of this part of the essay.

232 See lines 16 and 17 of table I. in the previous chapter.

233 See supra note 172.

234 See supra subsections (b) and (c) of section B of the previous chapter of this paper.

235 See supra notes 117 and 118; Electronic Commerce - An Introduction, supra note 11, at 4-7; Armstrong, Internet and E-Commerce, supra note 109.

236 The distortive effects of the difference between the VAT rates both within the Community and on the global playing field have been recognized by the Commission in the Explanatory Memorandum to the Proposal for the Sixth Directive cited in Terra, Place of Supply in the EC, see supra note 53, at 55.

237 See supra subsection (b) section A of the previous chapter of this essay.

238 See Explanatory Memorandum, supra note 126, at 3; Working Paper - 1998, supra note 5, at 7; Working Paper - 1999, supra note 171, at 3-5.

239 See supra line 8 of table I of the previous chapter.

240 See supra notes 117 and 118.

241 See Explanatory Memorandum, supra note 126, at 3; Opinion of the Committee on Legal Affairs and the Internal Market of the European Parliament on the Proposal for a Council Directive amending the Sixth Directive as regards the value added tax arrangements applicable to certain services supplied by electronic means [COM(2000)349 - C5-0467/2000 - 2000/0148 (CNS)] Nov. 20, 2000 [hereinafter: "Opinion."] http://wwwdb.europarl.eu.int/dors/oeil/en/default_htm.

242 See supra note 234; Opinion of the Economic and Social Committee on the effects of e-commerce on the single market, 1-3 [CES 38/2001] Jan. 10, 2001 [hereinafter: "Opinion of the Economic and Social Committee."]

243 E-commerce will have grown from $17 billion at the end of 1999 to approximately $360 billion in 2003 including business-to-consumer transactions raising from the present 1% of the total final consumer transactions to 15% during the period of 2002-2005, see Communication from the Commission - Strategies for jobs in the Information Society, [COM(2000)48] Febr. 4, 2000.

244 See Hardesty, EU Continues Efforts, supra note 183, at 2; Jenkins, Application, supra note 193, at 2.

245 This conclusion follows from the principle of pre-emption developed through the case-law of the ECJ. This principle deprives Member States of the authority to legislate in fields where the Community has passed exhaustive legislation. See Kende, European Law and Politics, supra note 17, at 349-351.

246 See chapter 1 of part II of this paper.

247 The Lisbon European Council, held at March 23-24, 2000, belonged to the series of conferences constituting the Intergovernmental Conference organized last year. See supra note 39.

248 See Update on the Single Market, http://europa.eu.int/comm/internal_market/en/update/stategy/stratreview.htm.

249 See id.

250 See id; Opinion of the Economic and Social Committee, supra note 242, at 1-3.

251 See supra notes 11 and 250.

252 See Opinion of the Economic and Social Committee, supra note 241, at 1-2; Rita Tehan, Internet and E-Commerce Statistics in The Congressional Research Service Issue Brief, July 10, 2000, http://www.crie.org/nle/st-36.html [hereinafter: "Tehan, Statistics."]

253 See Green Paper, supra note 4, at 12-20; 2000 Internal Market Strategy Review supra note 248.

254 See id.

255 See supra subsection (b) of section A of the previous chapter of this paper.

256 See supra note 177. To show the significance of the competitive distortion that might result from the interplay between the origin principle and the differences in national VAT rates the Taxation Comment of the Institution of Directors, explores the numerical dimensions of this question, see Richard, Baron, Taxation Comment of the Institution of Directors, 1, June 2000 [hereinafter: "Taxation Comment"] http://www.iod.co.uk/vatdigitised.pdf

257 See supra note 175.

258 See line 7 of table I in the previous chapter of this essay.

259 See supra chapter 2 of part II of this paper.

260 See Schenk & Oldman, Value Added Tax, supra note 41, at 3-6.

261 See the Commission's opinion supra note 177.

262 See supra note 175.

263 See subsection (A) section (a) of this chapter.

264 See subsection (b) section A of chapter III of this essay.

265 See id.

266 See subsection (c) of section B of chapter III of this essay.

267 See supra note 227.

268 See supra note 183.

269 See id.

270 See supra notes 15 and 16.

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