Online Marketplaces as a New Entity for Tax Administration

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E-Commerce Challenges for the Tax Administration

The emergence of the Internet has profoundly changed the principles of trade and customer interactions, including a wide-scale introduction of non-cash payments for goods and services.

The subsequent development of e-commerce has given rise to local and global online marketplaces for selling goods and providing various digital services: property rentals, ridesharing, deliveries, training, and much more. These online platforms have no geographical boundaries, work globally, and use international systems for accepting payment via bank cards.

The new business structure and novel methods of conducting financial transactions have created challenges for the tax administration of all e-commerce participants. The important task is to collect the due taxes without destroying a business model that is highly popular with consumers.

Tax authorities must constantly monitor the online ecosystems and marketplace users, as well as the internal and external factors that influence their behavior and development. Online ecosystems are flexible and dynamic, and marketplaces often are non-tax residents, working from abroad. A single careless requirement or excessive pressure may suddenly lead taxpayers to move into the gray zone, and then it will be very difficult to get reliable data on their income.

Classification of Online Marketplaces

An online marketplace is a type of e-commerce website where several independent vendors sell their products and services. We classify online marketplaces by the following criteria.

Local or International Reach

Local marketplaces are the country’s tax residents who work with local buyers and suppliers in the domestic market. International marketplaces may or may not be tax residents of a country, and supply chains may be contained within a country or involve both imports and exports across its borders.

Types of Offerings

Marketplace trade offers include goods, digital products, and services. They differ in customs clearance requirements for import or export. Digital products and services do not require customs clearance as opposed to physical goods. Apple App Store and Google Play apps, cab aggregator services, Airbnb or Booking.com services are sold in the country past customs.

Roles in Supply Chain and Payments

Marketplaces’ business models differ by the roles they play in the economic relations with suppliers/service providers and end consumers.

A marketplace may act as an advertising platform that collects sales orders for merchants. In this model, buyers pay the seller directly, and the marketplace receives a commission. Alternatively, marketplaces may act as sales agents. All orders and payments go through the marketplace. Merchants receive payment from the marketplace after considering discounts, service costs, and other agreed agent charges.

A marketplace can act as a dealer. It purchases goods from suppliers. Goods are delivered to the marketplace’s warehouse, and it becomes a seller for consumers. Marketplaces may also act as virtual storefronts to suppliers for working with customers using the marketplace’s information and logistics infrastructure. A marketplace may provide additional services to merchants, for example, by handling order fulfillment in full or in part^[1].

Service marketplaces use the same approach. For example, a taxi aggregator may act as a passenger service provider, an information service provider, or an agent for individual drivers and taxi companies that deliver passenger transportation services.

The civil codes of most countries support agent-based business models, which must be considered for the tax administration of marketplaces.

Tax Administration of Digital Ecosystems

Tax authorities hardly ever analyze the market’s existing business models, history, and developmental trends. Instead, they make the simplest decisions regarding taxation. Of course, they have some influence on the market and collect some taxes. However, the result rarely meets expectations.

Tax authorities must work with online marketplaces carefully and accurately. It is important to not ruin a successful business model, to not disrupt competition in the market, and to maximize the taxes collected for the national budget.

To accomplish this, they need to solve the following key tasks:

Analyze the marketplace market, classify them, and assess their order volumes and cash flows.
Determine the prospects and feasibility of using the agency business model for marketplaces.

Many marketplaces expand the use of the agency model and increase the number of sellers on their sites looking for greater flexibility and faster business growth. Besides, it is the marketplaces, not the government, that drive economic development and stimulate the registration of new entrepreneurs.
Define clear tax administration rules for agency relationships.

This is not simple, because just transferring income from the agent to the principal does not solve the problem. It is necessary to account for costs of commissions, warehousing, delivery, returns, bonuses to suppliers, and penalties. Without these details, it is impossible to calculate the correct tax base and tax payable.
Develop straightforward tax administration rules for international companies selling goods in the domestic or foreign markets, including tax non-residents.

Working with tax non-residents is especially difficult. Tax authorities have limited ways to influence them, so they must look for individual approaches. For example, many foreigners use Airbnb or Booking.com when looking for accommodations to stay abroad. Following their internal procedures, these services do not report local rental providers and their income to local tax authorities.

In such cases, tax authorities should not use coercion and pressure. Instead, they should create the right motivation. For example, by getting buyers to pressure marketplaces by requiring tourists to provide receipts for their hotel or rental accommodations when leaving the country.

Marketplaces must compete with traditional retailers, illegal online businesses, and C2C (consumer-to-consumer) transactions between individuals. Tax pressure on online platforms will push a significant part of transactions into the gray zone and out of the reach of tax authorities.

Tax Administration of Participants in the Marketplace Ecosystem

The tax administration of participants in the online economy and marketplace ecosystem requires a thoughtful approach, the creation of a dedicated analytical working group, and direct communication with the largest market players. This approach will enable the effective administration of online marketplaces, service aggregators, and C2C sales.

To effectively administer online marketplaces, we recommend adhering to the following principles.

Each financial transaction with a buyer within the country’s borders must be accompanied by the fiscal receipt.

This must be an obligation for all sellers, regardless of whether they have tax residency. A local buyer must know the state may verify the transaction if the purchase took place in its territory and collect all relevant taxes from the transaction.

Buyers play a separate role in fulfilling tax obligations. Information from buyers may be used in checks to identify tax evaders among service providers, retail outlets, hotels, or other areas of business activity. The state can exempt non-citizen customers from taxes by introducing a tax-free program.
Financial transactions with a buyer must consider the agent-based business model. Marketplaces may act as agents, and transaction items must show the principals on whose behalf an agent is acting and for whom the tax base is formed.
If a country uses a “revenue minus expenses” tax regime, the tax administration should consider commissions, product returns, e.g., via receipts, bonuses, and penalties to suppliers. A marketplace typically settles with a supplier using a single total amount without breaking it down into line items.
Each receipt with the commission itemizations must be submitted to the tax authorities.
Not only marketplaces but also other organizations that work with retail consumers in the country must issue receipts.
Tax authorities calculate the tax base for marketplaces (agents) and suppliers (principals) using the data from receipts and commission itemizations.
Tax authorities use the tax base information to calculate taxes payable. They compare fiscal receipt data with the tax returns submitted by marketplaces (even if they are not tax residents) and principals (suppliers). The ideal scenario is to automate the entire process of receiving and processing data and then switch to return-free tax regimes.

Tax authorities should establish the same rules for taxation and work for all online ecosystem participants. Don’t impose quick, ill-conceived decisions on those who are visible and operating in the market. For example, the decision to designate entities in certain online segments as tax agents. Carefully playing the long game will yield a much greater effect and better results.

[1] Order fulfillment is in the most general sense the complete process from point of sales inquiry to delivery of a product to the customer. Sometimes, it describes the more narrow act of distribution or the logistics function. In the broader sense, it refers to the way firms respond to customer orders. Wikipedia. URL: https://en.wikipedia.org/wiki/Order_fulfillment