Are digital products taxable in United Kingdom?

Value-added tax (VAT) is a consumption tax levied on the supply of goods and services in the United Kingdom. Businesses making taxable sales are required to register for and charge VAT. The standard VAT rate is 20%.

For nonresident businesses selling digital products to customers in the UK, VAT registration is required from the first B2C sale. No registration threshold applies. B2C sales of digital products are subject to 20% VAT. The VAT must be collected and remitted to HMRC. For B2B sales, the reverse charge mechanism applies. UK business customers account for the VAT instead of the supplier charging it.

Determining if your product is taxable in United Kingdom

To determine whether VAT applies to the sale of your digital product or service, there are three main factors to consider:

1. Customer's location: You need to identify the location of your customer, as tax regulations vary by country. Common pieces of evidence for customer location determination include billing address, customer account address, and credit card country.
2. Taxability of your product: Your digital product or service needs to qualify as a digital good or service for VAT purposes. This typically means that it is delivered electronically over the Internet or an electronic network, is automated, relies on technology, and is not a physical good.
3. Customer’s tax registration status: If you sell to other businesses located in United Kingdom, you should collect and validate their tax registration numbers (tax IDs). In United Kingdom, sellers are not responsible for VAT on B2B transactions with the proper documentation, and the responsibility of accounting for tax is transferred to the buyer through a reverse charge mechanism.

Getting VAT compliant in United Kingdom

To ensure compliance with VAT regulations, here are the general steps that a nonresident company selling software or other digital products should take:

1. Collect customer addresses and tax IDs: Even if you are not registered for VAT, collecting customer tax IDs can save you expenses in the future. This step can be taken right away for customers outside the US.
2. Understand your VAT obligations: Determine where you have VAT obligations by cross-checking customer locations and the product taxability and registration thresholds in each country. Each country has its own registration threshold, which triggers the requirement to register.
3. Monitor VAT exposure and register in exposed jurisdictions: If your sales reach the registration threshold in United Kingdom, you are required to register for tax purposes.
4. Apply VAT where necessary: Identify transactions that require tax collection and apply the correct rates to those invoices. Though United Kingdom utilizes the reverse charge mechanism for B2B transactions, you should still validate VAT IDs for B2B transactions to confirm the customer’s status, but charge tax if a valid VAT ID is not provided.
5. File VAT returns, make payments, and keep records: Periodically file tax returns with the jurisdictions in which you sell, reporting the tax collected and remitted. Be prepared for foreign exchange conversions and cross-border payments in various currencies. Many countries also have a legal requirement to keep tax records for a certain period of time.

Risks of delaying compliance

Delaying tax compliance can expose your business to various risks:

• Audits: As tax legislation for digital goods is relatively new, audits for international sellers are increasing. Facing an audit for which you are not prepared can result in fees and penalties that can significantly impact your business.
• Paying out of pocket: Regardless of whether your customers pay tax, you are responsible for the tax on the sales you make. If you are audited or register late, you may have to pay the tax out of pocket, along with penalties and fees.
• Reputational risk: When expanding internationally, your compliance with tax rules may be questioned by potential business partners or customers. Failure to comply with tax regulations can harm your reputation and even lead to blocked business opportunities.

To learn more about tax rules and regulations for nonresident businesses around the world, explore Anrok’s VAT index for digital products.