Europe’s new tax rules are bad for games

As of January 1, 2015 the European Union has instituted changes to the existing rules regarding value added taxes (VAT) on electronic services. The changes are designed to address tax evasion from large corporations, but the new rules have a number of implications that could burden small business and make it even harder to compete with the multinationals.

SuperData VAT Graph

Ye olde VAT system

Under the old system, companies could charge a single VAT rate across the EU. That rate was determined by the VAT of whichever country the company was physically based. However, large corporations like Amazon and Apple created complicated tax and legal structures to declare revenue in Luxembourg, whose VAT is the lowest in the EU. According to the European Council, this practice has created a “VAT gap” which it estimated at €177 billion ($210 billion US) in 2012.

The change

Now, companies providing digital services are required to pay VAT on wherever each customer is located. This means companies will be responsible for calculating VAT across 28 different EU member states ranging from 17% to 25%. Companies will also be responsible for identifying their customer’s location through two pieces of information, e.g., IP address, billing address, SIM card country code, etc. Additionally, they must update their terms and conditions to inform users they are now required to disclose their location.

In an effort to alleviate the added administrative load, the EU has launched the Mini One Stop Shop. The web portal will allow companies to register VAT in one country, which will distribute the earnings to other EU member states. Companies, however, will still be responsible for calculating what they owe to whom. This has enraged many small business owners who are demanding a threshold be set to exempt small nascent companies.

How does VAT affect mobile game companies?

The most obvious effect of the new rules is that users in places with high VAT like Denmark and Sweden will pay more for digital goods when buying directly from companies. However, how exactly costs will shift in online markets like Apple’s App Store are still unclear. For example, platforms could charge the lowest VAT across the EU and absorb the extra cost or raise prices for everyone. Alternatively, they could individually adjust prices in each country or even pass some the cost to developers.

But perhaps most alarming is the effect this has on especially small-sized transactions. Mobile game publishers have reported seeing a negative effect on overall sales and an increase in customer complaints following Apple’s minimum price increases. This creates two problems for game companies: first, they are now in a defensive position and forced to educate the consumer. With free-to-play already under fire, it presents a very real problem to publishers who have to explain why the cost of their goods and services has gone up. Second, it creates another barrier between the largest, most successful game companies on mobile, and those at the bottom. On the long term, this reduces the success rate of smaller, and generally more innovative, companies and pushes mobile game publishers toward a more defensive, risk-averse strategy.

Outside the EU

One piece of good news for small companies is that they will no longer be required to levy VAT to customers outside the EU. On the other hand, US-based companies delivering digital products to the EU are technically required to charge VAT accordingly. However, this mostly applies to large companies with a physical presence in Europe as those without one are rarely if ever prosecuted.