Social distancing guidance implemented as a result of Covid-19 have disrupted the education sector in an unprecedented way as traditional on-campus classes and conferences have been canceled, requiring universities to shift their education programs to the virtual space. While online learning and teaching have become a norm at least temporarily during the Covid-19 crisis, the long-term impact of distance learning and teaching on the future of higher education remains to be seen.
As universities embrace higher demand for online teaching and expand their online offerings to reach a larger and global audience, these institutions should carefully review whether tax considerations, such as value added taxes (VAT) for example, may negatively impact the viability of the programs offered because of exposure to tax and the creation of additional regulatory risks and obligations. While U.S. universities often are structured through an entity with tax code Section 501(c)(3) tax exempt status, resulting in certain of their revenues being exempt for income tax purposes at the federal and state level in the U.S., the same does not automatically apply outside the U.S.
When an institution’s online footprint encompasses jurisdictions outside the U.S., evaluations need to be made from both an income tax and an indirect tax perspective. From an income tax perspective, it is necessary to review the risk of creating a permanent establishment and the risk that withholding tax is applicable to the program fee collected directly from the students or from in-country partners. These risks can be heightened when the server hosting the course is in the same country as the students. This article will focus on the VAT aspects of online program offerings, especially those courses offered for a fee. Online programs offered without charge are outside the scope of this discussion. In this article, U.S. universities and other higher education organizations are all referred to as “universities.”
Before going to the detailed analysis, an introduction of the landscape change in indirect tax may be helpful.
A Brief Introduction to VAT
VAT, also known as goods and services tax (GST), is the most common consumption tax utilized globally today. Approximately 170 jurisdictions impose a VAT, including all the members of the Organization of Economic Cooperation and Development (OECD), except the U.S. A VAT is analogous to sales and use taxes imposed by U.S. state and local governments, in that it operates as a consumption tax where businesses act as tax collecting agents on behalf of the government.
However, a VAT has several characteristics that distinguish it from a sales and use tax. Sales and use taxes, as imposed by the U.S. states, apply to sales of tangible personal property and selected services. Although more and more U.S. states have included digital goods which may include online courses in the definition of tangible personal property, VATs cast a broader net in that they apply to all sales of tangible personal property, services, and intangibles. As a consequence, in countries with a VAT, education and related services should be considered taxable unless a specific exemption applies.
Moreover, sales and use taxes are in principle only charged at the last stage of the supply chain when the consumption occurs. As a result, businesses may often be considered a “consumer” bearing the tax burden if they cannot benefit from a specific exemption on certain of their purchases that serve as inputs to the business operation. In a VAT regime, VAT is charged at each leg of the supply chain, with a credit provided for tax paid on purchases made for business purposes. When a good or service is purchased by the final consumer, however, no credit is available as the item is for personal consumption, and the consumer bears the ultimate burden of the tax. Businesses therefore only bear the burden of the tax in exceptional circumstances, i.e., if no credit is available for certain purchases they may have made.
Where VAT Fits in the Taxation of the Digital Economy
In 2013, the OECD launched its Base Erosion and Profit Shifting (BEPS) project with the aim of restoring trust and ensuring fair competition among all actors, while maintaining the ability to eliminate double taxation. Primarily focused on direct tax issues, Action 1 addressed the tax challenges arising from the digital economy and included an important section on the challenges of collecting VAT on digital products and services. Embracing the OECD VAT/GST International Guidelines, BEPS Action 1 proposed to shift the sourcing of services, including digital services provided to a final consumer (B2C), to the location where the customer is established. In other words, the seller of digital services must collect tax based on the location of the customer, resulting in a VAT registration and collection obligation for the nonresident digital services provider. However, in a business-to-business (B2B) transaction, the customer should, in principle, be liable to self-assess the VAT through its VAT return (so-called reverse charge mechanism), thus relieving the nonresident provider from any VAT obligation.
Since Action 1’s release, over 70 countries have adopted the OECD’s recommendations and passed domestic tax laws to provide clarity on the VAT treatment of digital services, most often requiring nonresidents to register for VAT purposes on B2C sales. As a consequence, U.S. universities that provide distance learning to individuals abroad may have foreign VAT liabilities if their services qualify as digital services. However, if the online education course is provided to a business, for instance in the form of a vocational training, the university’s foreign VAT risk is rather low as only a few jurisdictions (e.g., Malaysia, Russia, and South Africa) require nonresident digital services providers to register for VAT for B2B sales of digital services. The focus on the following discussion is thus on the B2C provision of online education services.
Delivery Methods Driving VAT Obligations
The OECD further recommends that for sales of digital services through an intermediary such as an online platform or marketplace, countries should place the liability for collecting VAT and complying with all other VAT obligations on the intermediary. Therefore, if the university’s online training is structured such that courses are offered through a third party platform, and the learners’ fees are collected by the platform, any VAT obligation with respect to the online service should in principle fall on the platform and not the university. However, the VAT liability does not automatically shift to a third party if the courses are offered on the university’s platform and the university uses an in-country partner whose role is limited to marketing and collection of any fees for the course. In these circumstances, depending on the contractual terms and the jurisdictions in question, the university may be viewed as having direct B2C sales and still be liable for VAT registration.
While most countries that have implemented special sourcing rules for digital services have also implemented these intermediary rules, there may be differences in the approaches adopted. A few jurisdictions, such as Japan, have not implemented intermediary rules. In these jurisdictions, the online education provider and the intermediary will need to determine which entity under the rules is responsible for VAT collection. Further attention should be paid if the intermediary rules in a particular jurisdiction are limited to certain situations. These could, for instance, include that the intermediary must be established in the local jurisdiction or that the online education provider is not already registered or required to be registered for VAT purposes.
The intermediary rules generally operate in one of two ways. First, some countries deem the intermediary to perform a buy-sell operation, regardless of the contractual relationship between the parties. Under this scenario, the intermediary should self-assess VAT under the reverse charge mechanism (if the intermediary is established in a VAT jurisdiction requiring such self-assessment) and then apply the correct VAT treatment to the B2C provision of digital service. Under the second method, the intermediary is only liable to collect the VAT without being considered having performed a buy-sell transaction.
Other questions to consider if online classes are offered through a partner’s platform include whether the partner is a taxable entity or tax exempt for VAT purposes, how the revenue share is structured between the parties, and whether the fee received by the university is structured as a royalty, a license, or a fee for services. A careful drafting of the agreement will determine the character of the service and fee, thus potentially resulting in different VAT (and withholding tax) implications. In those cases, working with an in-country adviser to structure the agreement in the most tax efficient manner possible is important.
Distance Learning and Digital Services
When the potential VAT obligations cannot be shifted to a third party, either because the services are provided directly to learners or the intermediary rules are not applicable, the university should determine whether its services fall under the sourcing rules for B2C provision of digital services. Some jurisdictions have fully incorporated the OECD VAT/GST guidelines considering that all B2C services being sourced to where the customer is located. This is, for instance, the case in Australia and New Zealand. Therefore, regardless of the characterization of the service, it will be sourced to these jurisdictions if provided by a nonresident to a final consumer established there.
However, the majority of the 70+ jurisdictions, which have implemented the OECD guidelines on digital services, have adopted a limited approach focusing exclusively on digital services. Most of these jurisdictions include a broad definition of digital services. For example, the EU VAT Implementing Regulation defines digital services as services delivered over the Internet or an electronic network and the nature of which renders their provision essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology. As such, asynchronous online education (see below example) fitting this general definition should therefore qualify as digital services for VAT purposes.
To provide more clarity, jurisdictions provide either exhaustive or non-exhaustive examples of what services should be considered a digital service. With respect to online education, it appears that the delivery method may be key when determining the VAT treatment. Online courses can take the form of webinar style where a pre-recorded course is downloaded or streamed with minimum or no interaction (asynchronous) or take the form of virtual teaching where instructors are teaching live sessions to students online (synchronous). They can also be offered as a combination of both live and pre-recorded and online self-paced learning. In certain jurisdictions, the degree of interaction between the instructor and students or among participants may change the qualification of the service from a digital service to an in-person education service, which is subject to different sourcing rules.
In the EU Implementing VAT regulation, distance learning is specifically listed as a service qualifying as digital service. However, teaching services, for which the course content is delivered live by a teacher over the Internet or an electronic network, do not qualify as digital services in the EU and are thus not sourced to where the customer is located. Rather, they are sourced to where the education activity takes place, which is to be determined based on the facts and circumstances of the service provided. Similarly, the Inland Revenue Authority of Singapore also included distance teaching via pre-recorded medium in the list of digital services, providers of which are required to register under the Overseas Vendor Registration regime.
Unfortunately, not all jurisdictions offer a clear distinction between live online education and pre-recorded/self-paced education. In South Africa for example, under digital services rules that became effective April 2019, the definition of digital services does not clearly include a reference to automated services that have a limited human intervention so that online education, whether pre-recorded or live, may fall within the definition of digital services.
Moreover, even in jurisdictions that provide a distinction between pre-recorded (in scope) and live (out of scope) online education services, there are no clear guidelines on how to apply the distinction when the education program includes both elements. A good example is a university providing an online course which includes live streamed courses that can be reviewed on demand by participants. In addition, the course includes several self-paced modules and quizzes that the student is required to pass before taking the final exam. Another example would be an online course offering that includes facilitators or coaches having live sessions to provide students guidance in between the pre-recorded classes. When there are both pre-recorded and live elements, whether the entire fee or only part thereof, is subject to VAT needs to be analyzed based on the specific facts and circumstances. A similar analysis should be performed when the online education course is a bundle that includes different elements subject to different rates (e.g., an online course subject to the standard rate and an e-book subject to a reduced rate).
Education Exemption Offered by Foreign Jurisdictions
Once the university has determined that its services qualify as digital services and are thus sourced to a VAT jurisdiction, it does not have an automatic VAT compliance obligation. Indeed, most VAT jurisdictions have implemented a VAT exemption relating to education services. However, as many of the U.S. universities have likely experienced, foreign jurisdictions often do not offer the same broad tax exemptions as prescribed in the Internal Revenue Code or state laws. The education exemption offered in many jurisdictions is often narrowly defined to cover K-12 type education or a degree granting education program. As a consequence, a university should carefully review the course content, the delivery method, and the target audience to determine whether its online course could be exempt.
For example, for GST purposes, India defines exempt education institutions as one of the following: (1) pre-school education and education up to higher secondary school or equivalent; (2) education as a part of a curriculum for obtaining a qualification recognized by any law for the time being in force; or (3) education as a part of an approved vocational education course. U.S. universities that offer online classes either directly to learners or through a partner are outside of the defined services unless the education course is pre-approved by the Indian government.
Certain jurisdictions do offer a broader exemption for education services, including vocational training. This is the case in the U.K. where vocational training is VAT-exempt if it is provided by an eligible body, which includes nonprofit organizations. However, in jurisdictions with a broader education exemption, the application of the VAT exemption may be limited to education providers that are duly approved by a public authority such as the country’s department of education while in other jurisdictions the education must be provided by an eligible body to be VAT exempt. Determinations of who is an eligible body may either be based on the status of the entity or be subject to obtaining an eligible program or eligible body status before fees can be exempt from VAT.
Finally, some jurisdictions apply a very limited definition of VAT education services, especially when it comes to online education. This is the case in the Kingdom of Saudi Arabia (KSA) where private education services are subject to VAT at standard rate of 5 percent (15 percent effective July 1, 2020).
Registration Threshold and Practical Challenges
Once the online education provider determines that it has a VAT liability in certain jurisdictions, it should further review whether its sales volume exceeds the registration threshold of those jurisdictions. Many countries have established thresholds when it comes to the registration of nonresident digital services providers. These registration thresholds may vary from nil, thus triggering a VAT compliance obligation from the first sale, to a relatively elevated annual gross receipts amount. For instance, in Russia the registration threshold is nil, while in Australia the registration threshold is AUD 75,000 (AUD 150,000 for not-for-profit entities and endorsed charities).
A careful review of the online revenue using multi-year data for risk assessment purposes is important to allow the online education provider to identify the jurisdictions where the most risk exposures in the most efficient manner. Registration under the European Union’s Mini One-Stop Shop (MOSS) may be the first step toward VAT compliance for online education providers with a European market reach as it offers a harmonized compliance model covering 28 (soon 27) jurisdictions. However, outside the EU, the approach is less harmonized and can does be more challenging to comply with.
Compliance with these foreign VAT obligations may also include practical challenges such as determining the location of the online learners when they take the course. The billing address may vary from where the student takes the class, and a student’s permanent address may be different than either of those. The IP address of the learner may be the best indicator of the location at which a course was taken, but it may prove to be difficult to obtain for privacy reasons and limited technology capability. Several countries have set forth specific criteria for establishing the location of the learner that will need to be met. Gathering information on the learners’ physical location at the time of enrollment may prove to be a happy medium. Having adequate systems with information on both the revenue earned and the learner data without too much manual reconciliation is also critical. Other practical issues include complying with the country’s invoicing requirements (which can be complex as in India), managing the filing obligations, keeping sufficiently detailed records, and setting up processes and procedures to minimize the global VAT risk.
We close this discussion by emphasizing the need to review VAT obligations and its impact on program profitability in online program offerings of U.S. higher educational institutions. Adding an online digital footprint in jurisdictions in which the university already has a tax presence (e.g., through a foreign campus) may add additional risks and increase the spotlight on the university in that particular jurisdiction.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Charlene Hu is Associate Director of Global Business Services at Stanford University.
Philippe Stephanny is a Senior Manager, WNT-SALT at KPMG LLP.