Not all too many smartphone users are likely to have stopped to think about what happens with the money they pay for the mobile apps they buy from various online platforms (from the existing Android market places, Apple's AppStore, or Blackberry's App World) and how this money reaches the developers of the respective apps.The number of those who have pondered the tax and legal implications for this new type of trade is certain to be even smaller.

Without a doubt, we are dealing with a niche market that has grown exponentially over the last seven years.The complexity of the business models employed and the creativity of the main players (developers, aggregators, mobile operators and the like) often leave regulatory bodies catching their proverbial breaths and unable to design the appropriate regulatory framework.

Like any uncharted territory, this market is full of pitfalls but also opportunities for those participants with the right mix of skill, agility and, more importantly, knowledge.

It seems that the business models most commonly used for the app market are based on two theoretical models: the "collection agent" and the "buyer/reseller". We say "theoretical" because in real life, no business model neatly fits the actual pattern of one theoretical model or the other.

The "collection agent" theoretical model refers to a situation in which the developer of the app and the smartphone user are in direct contact. In other words, the contractual relationship is established and the economic transaction occurs between the app creator and the final consumer. Of course, in a virtual marketplace, the merchants can come from the most unexpected places, as can their customers. This geographical dispersion created an opportunity for specialized third parties to emerge and to facilitate the relationship between the parties and, implicitly, to encourage consumption. These third parties are usually payment aggregators and/or mobile operators. In a "collection agent" model, payment aggregators and mobile operators intervene in the supply chain and direct the flow of money from consumers to developers, through what is generically referred to as collection services.

At first glance this model might appear simple. However, in practice a transaction chain may have a significant number of participants from a variety of jurisdictions. It is axiomatic that, on one hand, a complex structure such as this cannot exist without inherent legal risks (mainly those concerning the legal nature of the contractual relationship and the applicable law) and tax risks (mainly those concerning value added tax and the withholding tax) and, on the other, that these risks will increase proportionally with the number of transactions/participants in the chain.

As regards the second model, the "buyer/reseller", the transactions are structured quite differently in the sense that the license for the apps is transferred from one party in the supply chain to the next until it reaches the final consumer. In other words, the developer will transfer the license to an aggregator, to a virtual trading platform, or to a mobile operator who will then "sell" the app to the final consumer.

An important difference between these theoretical models is that in the "collection agent" model the "sale" occurs between the developer of the app and the consumer (a so-called Business-to–Consumer transaction) while in the "buyer/reseller" approach there are several "sales" that occur between businesses (so-called Business–to-Business transactions) until the final stage in the transaction chain where the "sale" is a Business–to–Consumer transaction.

You may ask yourself why this analysis of the theoretical models is relevant. To try and put your mind at ease, we have summarized a few of the reasons:

  1. Each online platform uses its own distribution model, which will never be a perfect replica of either the "collection agent" of the "buyer/reseller" theoretical models, but instead will be a more or less viable hybrid of the two. To understand the real model and the responsibilities of each party, depending on their position in the transaction chain, one has to possess a good understanding of the theoretical models.
  2. The actual business model (especially if it is a hybrid one) should be properly reflected in documents (e.g. contracts between parties) to ensure the necessary transparency vis-a-vis third parties. Without the proper documentation, a potential risk is that the model is challenged and reclassified from a tax perspective, for example.
  3. Each theoretical model is subject to different tax rules, both in terms of VAT and withholding taxes. Knowing the tax implications of theoretical models makes it easier, on one hand, to understand the tax implications applicable to real models and, on the other, to apply the correct tax treatment accordingly.
  4. The legislative process in this field is very dynamic (even if it remains insufficient in some cases). Under these circumstances, a good understanding of the existing regulatory framework will allow businesses to more efficiently assimilate the expected legislative changes and to be quicker in adapting to these changes. A good example is the amendment of the European VAT Directive which will result in a completely new VAT regulatory framework for the app market as of 1 January 2015.

Conclusions

App trading is a complex business because:

  • the relevant marketplace cannot be located geographically and, as a consequence, it is hard to create a common regulatory framework for it, especially if the parties involved are from outside EU;
  • the market holds a great number of participants from many jurisdictions, which makes the transaction chain extremely complex and difficult to manage;
  • the legal and tax treatment applicable to individual transactions may be flawed by certain inconsistencies between jurisdictions, which may lead to non-taxation, double taxation, disputes between the parties, etc…

With so many unknown variables, it is likely that the authorities will not have the experience necessary to understand this new kind of trade.Consequently, they are likely to adopt an extremely conservative approach that may generate tax and operational costs for the parties involved.

Despite all this, the app market will continue to grow at a fast pace and the prospect of a quick buck will make traders accept, in a first instance, the tax and legal risks that are inherent to this particular type of trade. Still, we expect that not long from now, these risks will turn into financial losses. It is only then that we will truly understand the advantage of those companies which possess the right mix of skill, agility and, more importantly, knowledge.