Leo: Welcome to Business Over Borders. I'm your host, Leo Tucker. This program is brought to you by the Reach Network. Today, I'm joined by Grigory Shchichko, our head of indirect tax here at Reach. Grigory, welcome to the program.
Grigory: Hi, Leo. Thank you for having me here today.
Leo: So one thing I was thinking about today is it seems to be that tax compliance, global tax compliance, is important more so today than it seems to have been ever. What is the reason for such attention to tax compliance for global merchants? Why now?
Grigory: Back in 20 back in 2015, only 33 countries, imposed tax on cross border sale of digital services. Right? And, actually, the whole story began in 2015. But, as of today, 90 countries require foreign merchants to collect tax if they sell cross border. I'm talking about digital services at the moment.
Right? So can you imagine that? So they they increase is, like, threefold. And these 90 countries, if we can see that the US is a single country, but we probably should not because, in the US, the sales tax is divided on on the state level. So instead of just, counting it as one country, we should count it as 47, states with different with different tax regime.
So, basically, the the this this this is huge. The the the level of complexity for international merchants is, is nothing that has been seen before.
Leo: So what prompted the big change in 2015? I mean, we started with 33, and we're at, you know, nearly triple that at 90. What happened in 2015?
Grigory: 2015 was, like I said, the beginning of this digital service tax era, as I call it. The European Union initiated this trend. They they enabled the new legislation, where, basically, foreign vendors required to calculate, collect, and remit tax on sales to individual consumers within the EU countries. And, by the way, the UK was part of the EU back then. So, basically, the European Union pioneer with this.
And after 2015, other countries followed the trend. And if we look at the the graph, then, the the spike was obviously during the pandemic. So in like, as you can imagine, starting from 2019, a lot of people who were, like, you know, in their homes, they they started consuming a lot more things like goods and services on the Internet. So the governments all around the world realize that, actually, it's something that they cannot ignore. That's actually the the the greatest opportunity for them to collect additional income.
Leo: Right. So you've got this big boom of people ordering their their groceries, their, you know, their Snuggies and their Netflix services, online. So everybody said, hey. We've got this big boom of, traffic and orders coming, and let's, let's make sure we're collecting our piece of that. Is that that kinda what was going on?
Grigory: Basically, yeah, it was about, missing revenue for for governments, all around the world.
Leo: So what does that mean? So that's that's kinda kinda how it goes with digital services. That makes sense. Like, we're all we're ordering things. But, I mean, I guess, to take it back to my Snuggy reference, I imagine the rules for digital services are probably a little bit different than the rules for physical goods.
You know, if I'm ordering my, you know, my Netflix, my Amazon services like that, that's one thing. But what about physical goods? Like, I'm I'm ordering my Snuggies. I'm ordering my my coffee mugs, my my comfy house shoes. How are those treated differently, digital services versus physical goods, and what does that mean specifically for merchants who deal in 1 or the other?
Grigory: 1st of all, I'd say that surprisingly I mean, like, ordering physical goods on the Internet, has been here for for many years. Right? I I would say that even digital services are more recent thing compared to physical goods. What Amazon started with, it was it was it was books. Right?
Right. Yeah. The progress of taxing digital services is much, like, is much more than that for for for physical goods. So and with digital services, it's relatively simple for for merchants to, to manage, taxes. Basically, it's all about destination principles.
So digital services, they are taxed in the country where they are consumed. So no matter where the company, selling this, like, whatever, subscription or, streaming services is located, it's all about where the end user, the consumer, is based. Right? And this is where digital services are taxed. And for digital services, for most of the countries, the registration threshold for international merchants is new.
So it means that you need to be registered from from the first sale, basically. Right? With physical goods, it's much more complicated. At the moment, 40 countries, 40, require foreign merchants to collect, taxes at the point of sale than we talk about cross border cross border sale of of our physical goods compared to 90 for digital services. Right?
So there is, like, this gap. So, countries are still catching up with this. The second difference significant difference is that, when it comes to digital services, most of them are taxed at the standard rate. So you don't need to guess what the right rate of tax, to collect from from your from your consumer.
Leo: So they get taxed at a single rate across across the board?
Grigory: Usually, it is. Usually, it's it's true. But for physical goods, it it can be it can be everything. Right? So, I mean, in terms of the tax rates.
The third key difference is that most of the countries which impose taxes on cross border sale of physical goods, they have so called low value good threshold. So, usually, international merchants are required to collect taxes only from goods up to the certain amount. I'll give you an example. Just it's probably easier to explain it by example. Yeah.
Example, if you sell something to Australia, then the, low value good threshold is 1,000 Australian dollars. So it means that the the value of the of the consignment of the parcel that you you sell to to your buyer in Australia is below this, $1,000 threshold, then you, as a merchant, must calculate and collect Australian GST at the point of sale. Right? But if the parcel is above this threshold, then you don't need to collect it. It will be collected at the border along with customs duties, but it's customs duties is separate.
Leo: Okay. So so that's gonna you know, I've gotten a package before, got an email that said something to the effect of, you know, your package is here, but it incurred some duties and taxes along the way. And in this case, that would have been something that was above that threshold of $1,000. You know, I buy my really fancy Snuggie, gold studded, bedazzled Snuggie. It's over $1,000.
It's very nice, very exclusive. That's gonna incur some sort of at the border charge, Whereas if I had bought the bronze level Snuggie, that would have been charged at the time of purchase. Am I understanding this correctly?
Grigory: So there's low value goods and high value goods. So for high value goods, yes, this the the obligation is on the buyer to settle these, taxes and customs duties at the border. But for low value goods, the obligation stays with the international merchant to collect those taxes and then, obviously, remit them to the to the government. Right? But those so Okay.
With digital services, moving back to digital services, that's much easier. So you don't need to distinguish between, like, low valued digital services or high value digital services. It's just digital services. You collect taxes and that's it.
Leo: Let's say the merchants in the United States, and they're selling this item in Australia, and let's say they're also selling it in New Zealand. So there's 2 countries there, and then, you know, if they sell it another country, what is the process for them to actually, a, calculate, b, you know, hold that money, and then remit it to the local government? Is that that sounds like a fairly complicated process of, you know, getting that to the right entities.
Grigory: That's very true. That's that's that's that's very true. And, to give your head, another spin, there is also there might be a registration threshold for international merchants selling physical goods, to consumers around the world. Like, for example, if we continue in our example for Australia, the registration threshold is, 75,000 Australian dollars. If your if your revenue, if your turnover for that 12 months is less than that, you are not required to collect tax.
So if you had just few occasional sales to someone from Australia. Right? With Singapore, for example, it's 100,000 Singaporean, Singapore dollars. Right? So those thresholds it's not all it's it's not just about this, low value.
Good threshold that you need to keep in mind. It tells you about this registration threshold. After that, you need to be registered. But, yeah, I mean, the registration process is, again, another roadblocker for for, merchants to expand their, ecommerce merchants to expand their sales globally because you need to obtain all these tax registrations. And depending on the country, it might be pretty easy, especially if it's, say, an English speaking country.
But if it's not, then, you need to, provide, like, a set of documents. You need to obtain this registration. Right? And then, you need to file, as you rightly mentioned, you need to file tax returns depending on the country. Again, it can be monthly, quarterly.
It can be my bimonthly.
Leo: So as a merchant who's selling products, digital or physical, cross border to a multiple countries, what are the options for getting this right? I imagine you could hire somebody to work in house. You know, you hire a tax man. We you know, my business, I hire a Grigory, and you do all this for me. You know, you calculate the taxes, make sure we're getting it right, make sure we're registered in the appropriate jurisdictions, make sure we're settling that money in the correct way and the correct times.
Is that the only option? How does a merchant provide this service and do it correctly?
Grigory: I'll give you an analogy. So in probably early nineties, like, I mean, in the previous century, then, the Internet has just started. Most of the companies, they hired programmers. So most of the companies have some IT, quarter in house who developed some custom built software. That was the only option.
Right? And it was feasible back then. But after some time, I mean, it's probably hard to imagine nowadays that company whose core business is something else would hire, like, a team of programmers who would call something like, I don't know, Office 365, but, you know, custom built. It's it's it's not feasible. Right?
Leo: So Right. In house.
Grigory: In in house. I mean, you can still do that probably, but efforts and time that you need for that. I believe that, if we consider taxes for taxes on cross border supply of digital services and physical goods, it's a similar situation now. So like I said, when it all, started back in 2015, it was pretty much doable to to handle it internally inside the company. Right?
Even though I calculated, I made my own estimates, and I believe that and and they were conservative that, and I have this, like, calculation somewhere that, a company if if the company decides to keep it in house, nevertheless, it would cost the the the company at least $500,000 to handle that per year.
Leo: I'm sorry. Did you say $500,000?
Grigory: Yes. Half half a million.
Leo: That's incredible. That's incredible.
Grigory: It it is because you need to hire one person won't be able to handle that. And and, again, just imagine the just consider the risks. If if if everything is handled by just one person, what happens if they fall under the bus? Right? So right?
So you need to have you need to have a team. And, it's about tax legislation. So it's not carved in stone. Right? So, rates are changing.
For example, during the pandemic time, a lot of countries temporarily reduce their VAT rates to ease the pressure on the economies. And as International merchant, you must have considered this. Right? Because you cannot, again, charge the same the same tax as before.
Right? And new countries are catching up with these trends. So you need to monitor the legislation. You need to calculate this tax. You need to collect tax and obtain all all those registrations that might take from my experience,
If you start right from the beginning, it might take up to 18 months in the best case scenario to cover all the countries. So, like, one and a half year, right, to to to get all these registrations. And, there's another thing that a lot of people don't think about that from time to time, tax authorities like to conduct tax audits. It doesn't mean that someone did something wrong. Sometimes so they they they might be triggered by some noncompliance, but some countries, they actually they they practice, you know, like, these just, you know, sample checks, as I call them.
And, again, you need to handle them, and, usually, they are very much time constrained. So, usually, you need to respond to an inquiry from a tax authority within, like, certain pretty limited amount of time.
Leo: Okay. So that's, that's option 1. That's option 1. You need a half a million dollars, a year and a half, somebody to make sure you're staying compliant and maintaining the appropriate rates and remittance laws, and handle any audits that come up. Okay.
Scenario 1. It's not looking good. What else we got?
Grigory: I would say to use a solution which is available on on the market, which is known as a merchant of record.
Leo: Okay.
Grigory: The merchant of record concept, has become popular, along with the with the growth in this sales over the Internet. So, the merchant of record is, like, an intermediary between the original merchant selling these, fancy Snuggie, as you call it, and Mhmm. The the buyer. So at the moment when the sale happens, the sale is handled by the merchant of record. Not only, the merchant of record provides access to multiple payment methods.
So it's another it's another benefit. Right? But, also, a merchant of record, usually handles taxes. Right?
Leo: Because they're the ones actually doing the sale and the payment gateway, you know, connection there. Okay. So they're handling the taxes too. Alright.
Grigory: Yep. And another benefit and, in my opinion, pretty important benefit, for for a merchant who uses, the merchant of record services is that the obligation and responsibility for taxes stays within merchant of record. There is almost no chance that this liability can be shifted to the original merchant. So it means that if something goes wrong or, I don't know, like, the the rate was miscalculated or the tax authorities decides to conduct, tax audit, it will be, again, like, so the the merchant is, like, you know, safeguarded by the merchant of record.
Leo: Yeah. Absolutely. So the merchant, her record takes on that that liability of the the tax compliance and the filing, collection and ultimate, remittance of those to the local governments. So that makes sense. So they can come in and say, hey,
We'd love access to your your payment gateways, your multiple payment methods. In addition, you'll take care of the taxes. I imagine that's quite a value add to to especially any small medium business that's just you know, we're just trying to get off the ground and sell our Snuggies globally.
Grigory: I believe that for every business, the possibility to focus on their core business, is actually is a very good thing.
Leo: Things sort of seem to start changing in 2015, and here we are in 2024 past, you know, post pandemic. What trends do you see going forward? Like, how is the landscape of international tax compliance going to affect businesses, large and small, digital and physical? What what's coming down the pipe?
Grigory: 1st of all, big news, guys. It's not gonna become any easier. Right? Sorry. Sorry.
Sorry about that, Leo. But, basically, if we consider all the countries worldwide, if I'm not mistaken, about 170 countries, 170, has some kind of consumption tax, whether it's VAT, GST, sales tax. And out of that 170, only 90 implemented tax on digital services and much less, implemented tax on physical. Right? So it means that
Leo: Just over half, roughly. Yeah?
Grigory: Yeah. Yeah. And with with physical goods, it's even less than half. Right? Much less than half.
And what countries realized why it's important for them to to do so? There are 2 2 key reasons as I as I see them. The first reason is leveling the playing field. Say we've got 2 ecommerce stores. Let's it be Brazil.
It's probably a good country for for for example. You got a local store in Brazil saying selling some Snuggies, and this store, because it's domestic, it usually needs to be registered for for for VAT or equivalent of tax in this country and collect tax on these Snuggies from Right. Local, local buyers. Right? But I can set up
The same store somewhere abroad with the with the same Snuggies and sell it cross border to consumers in Brazil, and I don't need to collect tax. So because it's it's actually actual example because Brazil at the moment, one of the few, large countries, which the which, hasn't imposed tax on cross border sale. Neither digital services or
Leo: So is it advantageous then at the moment to set up, you know, an entity outside and sell into Brazil than it is to actually sell from Brazil to Brazil. Wow. Okay.
Grigory: And and given that on average on average, the VAT rate is something like about 15%. It's very average. Right? It's it it it it differ from 5 to 27. 27 is the the the highest rate in the world.
But on average, say, it's 15%. So you can, give, your, buyer a discount easily of 10% if we, like, elaborate on the on this example. Right? And you would still get you would still get more. Like, you will still be better off 5% compared to to to the to the local store. Right? That's what I call leveling the playing the playing field. If I haven't put you asleep yet, so I'll give you I'll give you another trend. It's more related to digital services than to physical goods.
It's what is called digital service tax. So, we've just discussed, VAT or equivalent taxes like GC or what they called consumption taxes because, effectively, they are taxed on on on on on consumption.
Leo: Consumables. Yeah.
Grigory: Countries that has been doing this journey for quite some time. But what about corporate income tax? Those merchants, they they paid in their country, right, in their country where they established. So the new trend, which is currently unfolding, is this the second level of taxes, which is called digital service tax. So there was actually this this practice was paused for a couple of years because countries believed back then that they would be able to come up with a universal solution to that.
But, apparently, it was supposed to start, from 2023. Now the deadline was moved to 2026, and there's no certainty that that that, like, all the countries because, you know, they need to be like, they need to reach an agreement, basically, right, how to, how to tax universally these, global companies.
Leo: Yeah. I get dozens and dozens of countries to agree to the same terms. Yeah. It sounds reasonable and easy to do.
Grigory: they need to they, I mean, like, they need to to handle it by themselves. So more and more countries, have recently started imposing additional like, the second the second layer of of taxes. But, so far, it's only applicable to, very large companies. So, usually, the threshold is about, €750,000,000 or $1,000,000,000 in global sales per year. So it's relatively large companies that, fall under under this.
Like, sorry, breach this threshold, not fall under, but above this threshold for digital service. That's right.
Leo: That's interesting. And it seems like it's only getting more and more complicated, which is why something like a merchant of record, someone who'll handle the the compliance, the filing, and just knowing how to calculate the taxes in the first place is only gonna become more important and more valuable. Grigory thank you very much for your time. I've enjoyed chatting with you. This is certainly the most enjoyable talk about tax I'm likely to ever have.
So thank you for walking me through this.
Grigory: My pleasure. Thank you for having me here tonight.
Leo: And that's all we've got for Business Over Borders. Until next time. See you. Brought to you by the reach network. Visit withreach.com/network for more.

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