In 2017, Russia was the first country among CIS1 and EAEU2 member states to introduce a VAT regime on B2C electronically supplied services (ESS), followed by Belarus in 2018, Uzbekistan in 2020 and Tajikistan in 2021. Meanwhile, in 2019, Russia expanded its B2C ESS regime to also apply to B2B transactions. As a result of such changes, technically, foreign suppliers of ESS are now required to directly register for all tax purposes in Russia, and to collect, report and pay Russian VAT (in Russian rubles) on ESS-related revenues.
Earlier this year, Ukraine and Kazakhstan introduced VAT regimes on B2C ESS, effective 1 January 2022. Russia is also about to adjust its 2019 VAT regime on B2B ESS. This article summarizes the recent key VAT developments related to taxation of e-services and digital economy in Russia, Ukraine and Kazakhstan.
Unique VAT regime on B2B ESS and expected changes
Starting from 2019 foreign suppliers of e-services to Russian companies and individual entrepreneurs must register for Russian tax purposes, as well as collect, report and remit VAT in Russian rubles themselves. There are no minimum thresholds for the tax registration, which is mandatory. Technically, if a foreign vendor has even one minor transaction with an ESS component with just one Russian customer (including the vendor's Russian affiliate), it must register tax in Russia.
Compliance with the Russian ESS regime is burdensome and implies investing in significant adaptation of enterprise resource planning systems and necessary advice on legal, tax and accounting matters, which requires considerable time and resources from taxpayers. Unlike many European jurisdictions, Russia does not have a separate VAT-taxpayer registration. Foreign entities that register in Russia to comply with the VAT regime on ESS are also deemed registered for other tax purposes3. For many foreign vendors, such registration and compliance can add a substantial extra cost and exposure. Many market players decided not to "sell" into Russia for this reason.
On 24 April 2019, the Russian Federal Tax Service issued a legally non-binding guidance letter that has essentially "allowed" parallel use of the "old" reverse-charge rules, where Russian customers may self-assess VAT on ESS in B2B transactions starting from 1 January 2019. Formally, relying on the approach expressed in the letter carries incremental risks for the business, including a fine (with a maximum of 10% of Russian turnover4) for the failure to register. Some Russian customers even refuse to acquire ESS from non-registered ESS vendors.
Overall, the new regime has brought much disruption to business and is unlikely to have contributed to a better investment climate in Russia. Many foreign business associations are now actively discussing the boundaries of the target regulation for B2B ESS with the Federal Tax Service. The regulator has tentatively agreed to carve out inter-company transactions from the regime.
The key issue on the agenda is whether the regulator will also agree to introduce a minimum threshold for tax registration. Such a threshold could be based, for example, on a meaningful minimum number of Russian "business" customers of a particular vendor. Another open item is whether a new statutory definition of "digital companies" will be introduced to keep the traditional "real sector" companies outside the scope of the existing VAT regime on B2B ESS.
It remains to be seen how far the Russian government would be prepared to go in order to soften the unpopular ESS regime while at the same time ensuring maximum VAT collection for the budget.
VAT exemption on software use licenses cancelled
Starting from 1 January 2021, the VAT exemption for software and database licenses – that was in effect from 2008 – has been substantially restricted. It now applies only to software and databases included in Russia's National Software Register (NSR). The NSR does not list software programs, (in) directly owned by more than 50% by non-Russian residents. The VAT exemption is, thus, no longer available to foreign software vendors. Also, the exemption does not extend to provision of access to advertising and online marketplace software.
This significant change has already adversely impacted the profitability of foreign IT companies in certain sectors in the Russian market. The abolishment of the VAT exemption may have the greatest impact on sales of foreign software to customers that may not recover "input" VAT, such as banks and financial institutions, individuals and companies with VAT-exempt revenues, and SMEs applying special tax regimes.
The healthcare sector has also been affected. Many foreign vendors licensing software including updates installed on medical equipment previously imported into Russia VAT-free now have to charge 20% VAT on their respective license fees. It may be possible, however, to register medical software as a medical device that may potentially enjoy a VAT-exempt status. At the same time, it remains to be seen how the regulator and the Russian courts address the conflict between the prior statutory VAT exemption on medical devices and the 2021 rule cancelling the VAT exemption on software usage licenses.
The existing VAT exemption for patent and know-how licenses remains unchanged and is still available to both Russian and foreign companies.
Foreign tech companies required to register in Russia
On 1 July 2021, Russia adopted a so-called "landing" law requiring foreign tech companies with a daily audience of over 500,000 and other categories of companies5, to establish a local office (i.e., to "land" on Russian soil), in the form of a representative office, branch or a subsidiary. Such local presence has to be the legal representative of the foreign entity in scope of the "landing" law in Russia. Separately, foreign companies that fall in scope of the "landing" law must register an online account (regulatory e-office) with Roskomnadzor, the key federal state agency with the Ministry for Digital Development.
According to some parliament members, the regulatory e-office of registered foreign tech companies could be integrated with the ESS vendor's e-office registered with the Russian tax authorities. Respective guidance is expected to be released later this year. It remains to be seen how such integration will be implemented and whether foreign tech companies will be exposed to additional tax risks.
It is also possible that the existence of a local office – especially in the form of a representative office or a branch – could facilitate the collection of turnover fines for failure to register under the VAT regime on ESS (if such registration was required). In the long run, such registration could also contribute to a greater nexus of non-resident enterprises with the Russian taxing jurisdiction, whether for the purposes of recognition of a digital permanent establishment or allocation of greater audit and taxing rights to Russia based on rules to be developed by the Parliament or Russian courts. Given the increasing trend to interpret provisions of double tax treaties in favor of the budget, this risk should be factored in even where a treaty protection is available. Tentatively, a subsidiary in the form of an LLC- with a minimal functional profile should be the safest form of presence, from a Russian tax law perspective. It limits access of the Russian tax authorities only to the activities of the respective LLC.
The impact of the "landing" law has to be carefully assessed among other factors for structuring purposes in Russia. Companies should collect data internally to accurately assess the exact regulatory and tax risks of the "landing" law for both the entity that is required to register, bearing in mind that more than one entity within a group may be in scope of these new rules and its related ESS vendor(s) already registered or to be registered with the Russian tax authorities.
On 3 June 2021, the Parliament of Ukraine adopted the so-called ESS VAT Law6 ("Law"), which introduces 20% VAT on ESS provided by non-residents to Ukrainian customers. On 2 July 2021, the Law entered into force. In turn, the ESS VAT regime will apply from 1 January 2022.
Scope and ESS definition
The ESS VAT regime covers supplies of digital services to customers under the B2C model as well as – in narrowly defined cases – under the B2B model. In this context, for B2B purposes, 20% VAT would apply to ESS supplied to "private entrepreneurs" who are not registered for VAT purposes. In accordance with Ukrainian law, private entrepreneurs are private individuals who register for tax purposes as a business.
ESS are defined as "services that are provided  via the Internet network,  in an automated manner,  by means of information technologies, and  predominantly without interference of humans." The Law provides for a non-exhaustive list of ESS, including, inter alia:
- supply of digital copies, access to images, text and information, including subscription to online newspapers and journals, e-books
- supply of digital copies and/or access to audio-visual works, video and audio on-demand, games, including the provision of services involving participation in such games, access to television programs, unless they are broadcast simultaneous to being transmitted over a television network
- provision of access to informational, commercial and entertaining electronic resources, other similar resources
- distance teaching via the internet, the supply of which requires no human intervention, including virtual classrooms
- cloud services in terms of computing resources, data warehousing resources and electronic communications systems
- supply of software and updates, including digital copies, as well as remote servicing of software and electronic equipment
- provision of advertising services via the internet, in mobile applications and via other electronic resources, the provision of advertising space including banner ads on a website/web page/web portal
The Law expressly excludes from the list of ESS:
- supply of services ordered via the internet but delivered offline (without the use of the internet)
- supply of goods and/or services, other than electronic services, which include electronic services, if the cost of electronic services is included in the total cost of such goods/services
- supply of copies of works in the field of science, literature and art on physical storage media
- supply of consulting services via e-mail
- rendering of internet access services
Determining customer status and location
The Law presumes that a service is provided to a private individual, unless a customer agreement states that such a recipient of a digital service is a business. ESS are deemed to have been supplied at the customer location. The Law provides a non-exhaustive list of customer location proxies:
- "main" proxies in case of supply through:
- a fixed land line – the customer is presumed located in the country where the fixed land line is located (location of the telecommunications provider whose services were used in the process of receiving digital services)
- mobile networks – the customer is presumed to be located in the country identified by the mobile country code of the SIM card used to receive the services
- other means – the customer can be presumed to be located where the device is situated or where the access card is sent to for use there, including the IP address of the device used by the customer
- "additional" proxies that should be applied simultaneously with the main proxy:
- the billing address of the customer
- bank details such as the location of the bank account used for payment for digital services
- other commercially relevant information
Registration, reporting and payment
Non-resident ESS vendors must register for VAT in Ukraine by 31 March of the reporting year, if the overall sales of digital services exceed UAH 1 million (c. USD 37,143) for the preceding calendar year. The registration application may be filed online and in English. No state-issued electronic signatures will be required.
The VAT returns should be filed online on a quarterly basis, within 40 calendar days following the reporting quarter, in Ukrainian or English.
VAT liability should be: (i) assessed with respect to the price of the digital services at 20%; and (ii) paid: (a) in EUR or USD, (b) within 30 calendar days following the statutory deadline for submission of the VAT return, and (c) to a bank account of the State Treasury Service of Ukraine.
The Law requires the intermediary/platform to account for VAT on supplies of digital services instead of the legal supplier. In turn, payment processing intermediaries are expressly excluded from the scope of the Law.
While the Law does not expressly address the permanent establishment matter, it may reasonably be interpreted that the VAT registration should not per se give rise to a permanent establishment of non-resident ESS vendor for Ukrainian corporate income tax purposes.
Taxpayers are not required to open a local bank account, for VAT liabilities may be discharged directly from respective foreign bank accounts. Taxpayers are also not required to issue VAT invoices and/or to appoint a local fiscal representative.
Scope and ESS definition
Kazakhstan has also introduced, with effect from 1 January 2022, a VAT regime in relation to B2C ESS transactions. The regime applies to foreign marketplaces (i.e., operators of internet platforms) and foreign corporate suppliers of ESS that do not already have a registered legal presence in Kazakhstan.
ESS are defined broadly as services provided to individuals through a communication network or internet. Even though an illustrative list of the ESS was included in the draft law on the topic, it was omitted from the final version of the law. It appears that the absence of any examples of the ESS was lobbied by the tax authorities so as to capture all types of electronic supplies.
Determining customer status and location
The ESS would only be subject to the new regime if the individual customer meets any of the following tests:
- The customer resides in Kazakhstan.
- The bank account used to purchase an ESS has been opened at a Kazakhstan bank.
- The IP address used to purchase an ESS has been registered in Kazakhstan.
- The international phone code used to purchase or pay for an ESS has been assigned to Kazakhstan.
The law does not prescribe any specific due diligence requirements by ESS suppliers. However, it may be expected that, once the new regime takes effect, the tax authorities will require ESS suppliers to independently verify some of the above tests (e.g., IP addresses, phone numbers or bank accounts).
Registration, reporting and payment
There is no registration threshold. Therefore, the new regime applies regardless of the revenue derived from any past or future sales. Each covered entity should register for local VAT purposes by sending a paper-form letter to the local tax authority indicating its legal name, fiscal or equivalent number (if any), corporate (or equivalent) number, bank details which will be used to pay the tax, and the company’s contact details (email and postal address).
Following a review of the application letter, the tax authorities will make the so-called "conditional registration" of the supplier. Such registration means that the supplier will be recorded in internal systems of the tax authorities, but no official tax or VAT number will be assigned.
The VAT registration should not, per se, give rise to a permanent establishment for local income tax purposes.
Registered ESS suppliers will need to charge and pay local VAT at a rate of 12% on their electronic supplies that meet one of the trigger tests. Foreign marketplaces will need to pay 12% VAT on the purchase price for goods ordered by local customers through the relevant platform. No input VAT credit will be available.
There is no regulation for payment intermediaries (such as mobile companies) in the Law. The new law suggests that only service providers (and not payment intermediaries) should pay VAT. It remains to be seen how the tax authorities will approach the issue once the VAT regime takes effect.
The new regime requires payment of VAT in the local currency (i.e., tenge). Since tenge is generally not freely convertible outside of Kazakhstan, it may be practically difficult for foreign ESS providers to pay the VAT without opening a local bank accounts. A general tax registration in Kazakhstan is required to open a local bank account. Such tax registration will not per se create a permanent establishment (or give rise to any other adverse tax implications).
VAT on ESS will be payable on a quarterly basis, no later than the 25th day of the second month following the relevant reporting quarter. Unlike some other CIS countries, Kazakhstan has not created a virtual e-office for VAT taxpayers. However, the new law does not require preparation and filing of VAT returns or the preparation of any other VAT documents (such as transaction registers) or issuance of VAT invoices. No fiscal representative will be required for VAT purposes in Kazakhstan.
The only exemption from the new VAT regime is provided for in cases where individual customers pay local import VAT in relation to acquired goods and provide evidence of such payment to the respective ESS provider. This exemption is largely relevant only for marketplaces and not for other ESS suppliers.
Tax audits of covered entities are technically not prohibited. However, there is no detailed regulation of such audits. It remains to be seen whether they will be conducted at all, since it may prove difficult for local tax authorities to audit foreign ESS suppliers which do not have any local legal or tax presence.
The new rules do not change anything in relation to B2B transactions. Hence, a local business which is registered as a VAT payer should continue paying reverse-charge VAT (12%) from its own funds if the place of supply is deemed to be Kazakhstan. Such VAT would be treated as ordinary input VAT which is available for credit.
Compliance with international best practices
In summary, the new VAT regime in Kazakhstan deviates from global best practices in a number of respects including the following:
- no list of ESS, whether exhaustive or illustrative
- no minimum registration threshold
- the requirement to pay VAT in the local currency (and the consequent requirements to register for local tax purposes and open accounts at local banks)
- no online portal for registration and compliance
- no specific language on the ESS regulation not affecting the tax nexus for direct or indirect taxes (although this is reasonably clear from general provisions of tax law)