Freeconomics in the light of EU VAT Directive

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Department of Law Spring Term 2020

Master Programme in International Tax Law and EU Tax Law Master’s Thesis 15 ECTS

Freeconomics in the light of EU VAT Directive

Are free digital services supplied in exchange for personal data VAT taxable?

Author: Alessandro Sampaoli

Supervisor: Katia Cejie

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Abstract

The digital economy is growing exponentially. Companies such as Facebook and Instagram base their business model on supplying services completely free of charge to billions of users. This model of business is called “Freeconomics”.

These companies generate huge profits from the exploitation of personal data provided by Users. The peculiarity of this way of doing business, although this may seem absurd, is that the company's profit is directly proportional to the number of non-paying users.

Such situations have given rise to discussions regarding the powerlessness of the tax system of states to levy tax on such profits. Regarding the indirect taxation, the question is even more difficult if one considers free digital services and personal data.

Unfortunately, this flow of “digital” consumption remains completely out of a VAT assessment.

Exclude a priori those transactions from being assessed for VAT purposes only because it could be arduous to assess the consumption would result in a violation of the principle of neutrality. Accordingly, issues related to the distortion of competition could also arise.

The author of this thesis examines the assumption that between the Companies and the Users take place a reciprocal exchange of benefits in kind characterized by a synallagmatic relationship (quid pro quo) in the form of barter.

The results of the analysis indicate that the transactions characterized by the supply of free digital services to Users in exchange for personal data  as described in the Business Reference Model  actually fall within the scope of Article 2 (1)(c) of the EU VAT Directive and therefore must be subject to indirect taxation.

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List of Abbreviations

AG – Advocate General

BRM – Business Reference Model B2C – Business to Consumer B2B – Business to Business

ECJ – European Court Of Justice / Court of Justice of the European Union EU – The European Union

IBFD – International Bureau of Fiscal Documentation MS - Member State

OECD – Organization for Economic Cooperation and Development OSP – Online Server Provider (internet-based companies)

TFEU – The Treaty on the Functioning of the European Union VAT – Value Added Tax

VATD – Vat Directive

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1. Introduction

1.1 Background

The digital economy is growing exponentially. Growth is fueled by the continuous creation of new digital services that until recently were completely unimaginable to conceive. Companies such as Facebook, Instagram and Yahoo!Mail base their business model on supplying services completely free of charge to billions of users. This model of business is called “Freeconomics”.¹

The Freeconomics represents a new business model that essentially consists on supplying products or services free of charge with the purpose of increasing the demand for other products or services. Thus, a User can use services made available by companies without paying anything. The supplier companies, on the other hand, – instead of asking for a payment – made the use of those services subject to a mandatory registration of a personal account. This action implies that the User must also accept the provider's agreement and grant to the latter the “right of use” on his personal data for commercial purposes.

The peculiarity of this way of doing business is that the company's profit is directly proportional to the number of non-paying users. To get an idea of the profit margins that this business model can generate in connection with the digital economy, it is enough to look at the total turnover of the 25 giants of the Software and Web sector which in 2018 reached the threshold of 850 billion Euros globally.²

The large volume of profits that these companies generate have also given rise to discussions regarding the powerlessness of the tax system of states to levy tax on such profits. Possible solutions regarding direct taxation, such as a web-tax, are already being

1The term “Freeconomic” is formed from the words free + economics and was created in recent years to describe the offering of products or services free of charge (more details in section 2.1 below). However, the term took on a more concrete meaning following the book written by Chris Anderson and titled "Free: The Future of a Radical Price" edited by First Edition [2009].

2Eleonora Micheli, 'Google e gli altri giganti del web pagano solo 64 milioni di tasse in Italia' 2019 IL Sole 24 Ore

<https://www.ilsole24ore.com/art/per-giganti-web-italia-tasse-solo-64-milioni-ACfwrk1> accessed 18 February 2020.

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formalized.³ Regarding the indirect taxation, instead, just small interventions have involved the online sales sector and the web-portals that act as intermediaries.⁴ Unfortunately, as regards indirect taxation on digital services, it is very hard to evaluate and subsequently tax consumption. This is even more difficult if one considers free digital services and personal data.

It can be assumed that between the Companies and the Users take place a reciprocal exchange of services characterized by a synallagmatic relationship (quid pro quo) in the form of barter. The right to use of digital services is supplied in exchange for a consideration paid in kind in the form of personal data. Companies generate huge profits from the exploitation of personal data provided by Users. This flow of services and personal data currently remains completely out of a VAT assessment.

Establishing a value for a consideration paid in the form of personal data can actually be very arduous even if this does not mean that it is not possible. Exclude a priori those transactions from being assessed for VAT purposes only because it is hard to quantify the consumption would result in a violation of the principle of neutrality. Accordingly, issues related to the distortion of competition could also arise.

It could be argued that these barter in form of exchange of services should be considered as taxable transactions falling within the scope of VAT according to the Article 2 (1)(c) of VAT Directive. Conversely, that the supply of services could not fall within the VAT scope and it would also be very difficult, and maybe impossible, to prove that the supply of services is “effected for consideration”. On this question S.

Pfeiffer argues that due to the lack of any monetary payment, the supplier of the electronic service has to pay VAT which factually is not borne by the final consumer because at the time of consumption, no actual income is used. On the one hand, if it is considered that ―…something should be subject to VAT when it is consumed – such as

3Many of the governments in Europe are moving to stem the tax issues related to the activities of large digital companies. By way of example, France has approved in 2019 a digital services tax (3%) which will be levied on sales generated in France by multinational companies like Facebook and Google. Even Italy, in 2020, has approved - as part of its 2020 draft budget - a 3%

web tax on internet transactions.

4See the new e-commerce VAT package for “supply of goods” which comes into force on 1 January 2021 in the EU.

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the use of ―free‖ electronic services – VAT should apply even if no actual income is used."⁵

The author of this paper believes that these relationships between provider and user should be carefully analyzed. In fact, it can be argued that these operations can already be addressed by means the current VAT legislation.In this regard, a question should be asked:

Are free digital services supplied in exchange for personal data VAT taxable?

1.2 Aim

This thesis is aimed at to demonstrate that the current VAT legislation is sufficiently elastic to cover those transactions characterized by free digital services supplied to Users in exchange for the “right to use” of personal data. Hence, the author of this study aims to demonstrate that those transactions fall within the scope of Article 2 (1)(c) of the EU VAT Directive⁶ and therefore must be subject to indirect taxation.

1.3 Delimitations

The VAT treatment of free digital services supplied to private users by internet-based companies is dealt with in this thesis. The analysis is conducted only from the perspective of EU VAT legislation which is based mainly on Directives and implementing Regulations.⁷ For this reason any "domestic VAT legislation" in force in the individual Member States will be disregarded.

5S. Pfeiffer, VAT on ―Free‖ Electronic Services? [2016], IBFD, International VAT Monitor, Volume 27, No 3

<https://www.ibfd.org/IBFD-Products/Journal-Articles/International-VAT- Monitor/collections/ivm/html/ivm_2016_03_e2_3.html> accessed 10 May 2020.

6According to Article 2(1)(c) of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

7VAT Directive (2006/112/EC), Council Directive (EU) 2018/1910 of 4 December 2018 amending Directive 2006/112/EC as regards the harmonisation and simplification of certain rules in the value added tax system for the taxation of trade between Member States, Commission Implementing Regulation (EU) 2018/1012 of 17 July 2018 imposing a provisional anti-dumping duty on imports of electric bicycles originating in the People's Republic of China and amending Implementing Regulation (EU) 2018/671, Council Regulation (EU) 2018/1909 of 4 December 2018 amending Regulation (EU) No 904/2010 as regards the exchange of information for the purpose of monitoring the correct application of call-off stock arrangements.

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With regard to the supplying of digital services covered by this thesis, it must be taken into consideration that the characterizing elements of the transactions may be subject to continuous transformations and it is often very arduous to identify a business model on which an analysis may be performed for VAT purposes. Thus, some limitations are necessary.

For the purposes of this analysis, the choice has been made to focus solely on to those supplying of free digital services where:

 a mandatory registration procedure is required by the Provider, and;

 the Users must grant the “right of use” on his personal data for commercial purposes in order to use the digital services.⁸

Thus, only the reciprocal exchange of services in the form of barter are dealt with in this study, i.e. the right-of-use of digital services are supplied in exchange for the right-of- use of personal data. This choice is justified by the fact that the relationship where a registration is mandatory are more interesting for the VAT purposes. Prima facie these transactions represent those situations that mainly generate issues in relation to indirect taxation. In fact, they usually involve the biggest internet-based companies such as Facebook, Instagram or Yahoo!Mail which provide free services to billions of users and may be considered the protagonists of new tax policies currently under discussion by European governments. Furthermore, the tax relevance of the link arising between a Provider and Users is easier to demonstrate if a mandatory registration takes place. To better identify the relationship between these companies and their Users, an info-graphic of the Business Reference Model is showed in section 2.2.

For the reasons mentioned above, it follows that the use of free digital services where no registration is required are excluded from this analysis. It should be noted that these situations could hardly be defined for the VAT purposes as the use of those services, their purposes as well as the identification of the status of the recipients are almost impossible to ascertain. An example could be a free news website like Metro

8See more about the Business reference model in section 2.2 below.

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(https://metro.co.uk/) where any person can read the amount of news he prefers at any time and for any purpose.

Lastly, even the services defined as "try before buy" fall outside the scope of this thesis. These services concern transactions where a limited version of a service is supplied free of charge while the premium version is available for a fee.⁹ In these circumstances the transactions are well defined from a VAT point of view as the services are provided by a taxable person (company) at a defined price and,on the other side, the User (customer) pays that price. Due to these characteristics, no issues arise in relation to whether the transaction should be taxed or not.

It must be stressed that a taxable transaction under VAT Directive is subject to the assessment of certain requirements. In order to lay down whether a transaction is taxable for VAT purposes, the supply must be provided by a taxable person acting as such (subjective scope), take place within the territory of one of the Member States (territorial scope), and finally be effected for consideration (objective scope).¹⁰

According to the first requirement, i.e. the subjective scope, the status of at least of one the actors taking part in a transaction must be that of a taxable person. The transactions examined in this thesis involve three different types of actors and can take place in the form of B2B or B2C:

1. Provider (as taxable person) >>> User (as taxable person);

2. Provider (as taxable person) >>> User (as non-taxable person);

3. Provider (as non-taxable person) >>> User (as taxable person);

4. Provider (as non-taxable person) >>> User (as non-taxable person).

Based on what stated at the beginning of this section 1.3, for the purposes of this study only the transactions mentioned in point no. 2 will be regarded. On one hand, a

9The turnover of these companies is mainly based on the sale of a service such as software. The turnover is therefore not dependent on the exploitation of personal data for advertising purposes.

10Ad van Doesum, H W M van Kesteren and Gert-Jan van Norden, Fundamentals of EU VAT law (Kluwer Law International, 2016), para 1.13.

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VAT-registered Company (taxable person) provides its digital services, on the other hand, a private User (non-taxable person) fills out a registration form in order to use those digital services for the sole personal purpose.

Regarding the second requirement, i.e. the territorial scope, the supplies of services must take place within the territory of one of the Member States. It must be highlighted that according to the Article 58 of the EU VAT Directive, in case of digital services supplied to non-taxable person (private user), the place of supply is established where the latter is established or has his residence.¹¹ Thus, only those digital services supplied to Users who have their residence (or permanent address) in one of the EU Member States will be taken in to consideration. With regard to the Providers, it is considered irrelevant for the purpose of this study limiting the analysis only to companies with head-office in Europe for the reasons just mentioned. By virtue of this, this analysis covers all those companies that provide digital services in the manner indicated above, regardless of the place of establishment and the legal form.

The third requirement, i.e. the objective scope, which states that the supply must be effected for consideration, represents the core aspect of this analysis in order to demonstrates whether the supplying of free digital services must be subject to indirect taxation.

Finally, the arguments concerning “deductions”, “exemptions” and the calculation of the “taxable amount” in connection to the concept of “subjective value” are beyond the scope of this study and therefore are left out of this thesis.

1.4 Method and Material

As the purpose of this study is to demonstrate whether the current VAT legislation is sufficiently elastic to address the issues related to the taxability of free digital services, the analysis relies mainly on the legal dogmatic method as the core method. More

11See Article 58 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

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precisely, it has been applied a traditional approach “limiting the investigations, de lege lata, only to a taxation point of view”.¹² By the writer‟s side the dogmatic legal method represents the most appropriate approach in the context of this study as it consists in proceeding first by understanding the main concepts of current VAT legislation which makes possible a subsequent deductive reasoning oriented to the analysis of the case in question. That approach is carried out through the analysis of Directives, Regulations and Case-Law from the ECJ.

However, this analysis also covers situations, albeit marginally, where VAT legislation is unable to provide clarifications and there are still no Court's Case Law dealing with similar cases. This refers to section 3.3.2 where – addressing the question whether the consideration paid in the form of personal data is capable of being expressed in monetary terms – no definition was available and it was not even possible to carry out an interpretation by analogy with other ECJ‟s judgments. To overcome this interpretation vacuum, it has been necessary orienting the analysis towards a more dynamic interpretation, called exploratory analysis.¹³ This method differs from the dogmatic method since the latter is oriented towards a purely scholarly analysis of the law texts (as law in books) while the exploratory analysis represents a more dynamic analysis which aims to focus on the way the law is read in the course of text interpretation (as law in action).¹⁴ The exploratory legal research method is appropriate in those contexts where is necessary ascertain whether “existing theories and concepts can be applied to the subject matter”.¹⁵ Thus, this method mainly concerns the collection of information and variables related to the topic with the aim of concretizing hypothesis.¹⁶

12C. Trenta, Rethinking EU VAT for P2P Distribution (Kluwer Law International, 2015), para. 1.03

13Ibid.

14J. Jemielniak, P. Miklaszewicz, Interpretation of Law in the Global World: From Particularism to a Universal Approach (Springer-Verlag Berlin and Heidelberg GmbH Co. K, 2014), para. 1.3.

15C. Trenta, Rethinking EU VAT for P2P Distribution (Kluwer Law International, 2015), para. 1.03

16Ibid.

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The conclusions highlighted in each section as well as the thesis conclusions are drawn and supported by inductive and deductive legal reasoning.¹⁷ Therefore, it has been analyzed the jurisprudence stemming from several ECJ rulings in order to extrapolate the ratio decidendi of each one. The legal principles derived forms the basis for a general legal reasoning pattern that subsequently is applied to the specific case.

Given the particularity of the topic, the reference sources only concern the so-called

"Secondary EU legislation" and therefore include Directives, Regulations and Case- Law of the ECJ. In particular, the cornerstone principles of EU VAT derive from the Council Directive 2006/112 / EC (VAT).¹⁸ With regard to analysis of the “digital supplies”, the sources consulted concern Regulation (EU) No 282/2011 and Regulation (EU) No 1042/2013.¹⁹

However, the ECJ‟s Case Law played a key role in forming the reasoning underpinning this analysis. The VAT Directive unfortunately does not provide exhaustive elements to interpret when a supply of services must be regarded as

“effected for consideration”²⁰ and therefore subject to VAT taxation. Therefore, the Case-Law of the European Court of Justice represented the main source for interpreting the EU VAT legislation and developing a logical-deductive reasoning for the solution of the case analyzed in this thesis. Besides the well-known cases like Coöperatieve (C- 154/80), Apple and Pear (case C-102/86), NYC (case 230/87), Tolsma (C-16/93), Town

& County (Case C-498/99) and Orfey (C-549/11), two cases in particular have provided valuable help in resolving the question analysed in this thesis: the Empire Stores case (C-33/93) and the Bertelsmann case (C-380/99).²¹ All the cases taken into consideration

17Peter Nash Swisher, Teaching Legal Reasoning in Law School: The University of Richmond Experience, (1981), Volume 74, University of Richmond - Law Library Journal,

<https://pdfs.semanticscholar.org/291b/6a40382fbc6d9bcb412fd088ef0cb8dc25ea.pdf> accessed 20 May 2020.

18Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

19See Council Implementing Regulation (EU) No 282/2011 of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax (consolidated version) and Council Implementing Regulation (EU) No 1042/2013 of 7 October 2013 amending Implementing Regulation (EU) No 282/2011 as regards the place of supply of services.

20According to Article 2(1)(c) of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

21See case C-33/93, Empire Stores Ltd v Commissioners of Customs and Excise [1994] and case C-380/99 Bertelsmann AG mot Finanzamt Wiedenbrück [2001].

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in this thesis have been found by using databases such as "InfoCuria"²² and "IBFD Tax Research Platform".²³

The opinions of the Advocate General (AG) are also taken into consideration for this analysis. In particular, the opinions of the AG Van Gerven in case C-33/93 and AG Kokott in case C-36/16 are considered relevant. The opinion of the AG, even if not binding for the ECJ and often not coinciding with the decisions of the latter, are still a valid aid for “shedding light upon areas where further explanations to the reasoning from the ECJ is needed”.²⁴ Therefore, it has been considered legitimate to take into consideration those two opinions indicated above in developing this analysis.

Finally, tax law literature and doctrine have also represented an important source.

Especially authors such as B. Terra, J. Kajus, C. Trenta and P. Rendahl. The analysis carried out by P. Rendahl in the book “Cross-border Consumption Taxation of Digital Supplies“, represented a valuable aid regarding the interpretation of the ECJ rulings mentioned above.

1.5 Outline

The thesis is divided into two main parts. Following the Introduction, the first part (Chapter 2) represents a preliminary overview oriented towards the presentation of the aspects necessary for the understanding of the analysis conducted in the second part of the thesis. In the first section is explained the meaning of the “Freeconomics business model”. The second section is dedicated to laying down the general characteristics of the transactions analyzed in this study. They are described and represented graphically in order to facilitate the identification of the actors involved and the dynamics of the relationships between them. In the last section are identified the “personal data” in order to highlight what it is that the Users provide in exchange for the digital services received.

22The InfoCuria is a database which “contains all the publicly available information concerning the cases brought before the Court of Justice, the General Court and the Civil Service Tribunal.” Link to database <http://curia.europa.eu/juris>.

23Link to IBFD Tax Research Platform <https://research.ibfd.org/>.

24P. Rendahl, Cross-Border Consumption Taxation of Digital Supplies (Doctoral Series, IBFD, 2009), para. 2.4.2.

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The second part (chapter 3) represents the core of the thesis which is to lay down whether the free digital services provided by the internet-based companies should be subject to VAT according to the Article 2 (1) (c) VATD. In order to examine this matter, the structure of the analysis follows the “direct link test" which concerns the assessment of 4 different requirements developed on the jurisprudential principles derived from the ECJ‟s Case Law. Thus, the first section (3.2) it is oriented to ascertain whether the digital services in question represent actually transactions that fall in the scope of VAT Directive. Subsequently (sections 3.3.2) the analysis continues with the aim of ascertaining the existence of a direct link between the service provided by the OSP and the consideration paid in kind by the Users. The third requirement analyzed (section 3.3.3) concerns the evaluation whether that consideration paid in kind is capable of being expressed in monetary terms. Finally, the last section (3.4) covers the third and fourth requirement which regard the ascertainment of a legal relationship and a reciprocal performance between the parties involved in the transaction.

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2. Freeconomics and User Relationships

2.1 Freeconomics

The term Freeconomics identifies a new business model widely used by digital companies and which is gaining increasing success. It is not a theoretical business model and it must not be confused with the free economy, that is, that conception of a moneyless economy.²⁵

Freeconomics describes a business concept based on supplying of certain goods or services free of charge with the aim, in the long term, of increasing sales of other products at full price. Although the word "free" may be misleading, the strategy behind

"Freeconomics" is aimed solely of maximizing corporate profits. Regarding this business strategy, the journalist and editor of Wired magazine, Chris Anderson, highlighted in his book entitled "Free: The Future of a Radical Price" the thesis according to which “making money around Free will be the future of business”.²⁶

Although the maximum development of the Freeconomics is taking place in parallel with the increasing of the digital sector, in reality – albeit with a different name – it describes a marketing strategy already in use at the beginning of the last century. This business model was born in the early twentieth century thanks to a marketing strategy implemented by Mr. Gillet. He had invented the first interchangeable blade razor.

Essentially, his strategy was to give away the razor for free in order to generate a growing demand for blades. As the number of razors distributed free of charge increased, the sales of its blades also increased exponentially.²⁷

The business model invented by Gillette is based on the practice of "cross-subsidy"²⁸ which consists in subsidizing the costs incurred for the products or services provided

25C. Anderson, Free: The Future of a Radical Price (Hyperion, 2009).

26Ibid.

27Ibid.

28See J.J. Laffont, J. Tirole, Competition in Telecommunications (MIT Press Ltd, 2001) and N. Daidj, Developing Strategic Business Models and Competitive Advantage in the Digital Sector (IGI Global, 2014).

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free of charge (or at very low cost) through the sale of full price products or services. A classic example is the “take two and pay one”.

The business model created by Gillette is still used today. With the advent of the digital economy, however, it has been improved and evolved into the Freeconomics model. In fact, it should be noted that the era of digitalization and virtualization is characterized by very low marginal costs of production.²⁹ This allows companies to have a very high operating margin regarding the provision of free services.

The Freeconomics model, therefore, is no longer essentially based on the classic practice of "cross-subsidy”, i.e. supporting the costs of free products through the sale of full price products. The purpose of Freeconomics is instead to generate among the potential users a maximum diffusion of needs connected to a specific product or service.

Sometimes it takes place even without an apparent connection between what is given free of charge and what is sold. For instance, it could be a free web magazine of culinary recipes created in order to attract Users towards the purchase of certain food products. Another example is supplying a mobile phone for free in order to sell subscription services, or provide a video-game for free with the subsequent purpose of sell ancillary services without which its use would be limited.³⁰

To get an idea of the profit margins that this business model can generate in connection with the digital economy, it is necessary to look at the total turnover of the 25 giants of the Software and Web sector which in 2018 reached the threshold of 850 billion Euros globally.³¹

In conclusion, it can be said that the Freeconomics model describes that practice of free supplying of services (or goods) capable of increasing the sale of other products or

29OECD (2018), “Digitalisation, business models and value creation‖, in Tax Challenges Arising from

Digitalisation – Interim Report 2018: Inclusive Framework on BEPS, OECD Publishing, Paris. <https://www.oecd- ilibrary.org/docserver/9789264293083-4-

en.pdf?expires=1591614943&id=id&accname=guest&checksum=CE04F4369D7E0DB1902140205B9D3E62> accessed 10 May 2020.

30Opinion of the author of this thesis.

31Eleonora Micheli, 'Google e gli altri giganti del web pagano solo 64 milioni di tasse in Italia' 2019 IL Sole 24 Ore

<https://www.ilsole24ore.com/art/per-giganti-web-italia-tasse-solo-64-milioni-ACfwrk1> accessed 18 February 2020.

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services at full price. Company profit grows as the providing of products or services free of charge increases.

2.2 Business reference model and user relationships

In the previous section it was explained that Freeconomics represents a new business model that is essentially based on supplying products or services free of charge in order of increasing the demand for other products or services.

Given the wide variety of free digital services available in every type of sector – even very different from each other (social networks, instant messaging, email, VoIP, digital newspaper, telephone applications) – this study has provided a “business reference model” for the purpose of categorizing all these services and therefore allows a targeted analysis.

The transactions analyzed in this thesis involve two types of actors: on the one hand a Company (taxable person) that provides its digital services only through the internet or other telematic channels, on the other hand, an User who can be both a private user (non-taxable person) or a company. It is recalled that this thesis deals only with the transactions between the Companies providing free digital services and the private Users which register an account (B2C). Therefore, transactions where providers and recipients are both taxable persons (B2B) will not be addressed.

To simplify matters, the term "OSP", which stands for Online Service Provider, has been used to indicate internet-based companies providing digital services, whatever their legal entity (parent or subsidiary) and the digital service supplied (email, app, social networks, etc.), while the term "User" stands for a non-taxable recipient which use those services.

Trying to simplify the various sub-categories of Freeconomics, by the writer‟s side, they could be categorised in 3 simple business models. The table below schematically shows these 3 business models as well as their characteristics.

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object of analysis of this thesis Model B Model C

Mandatory

Registration YES NO YES

Need to provide personal data upon registration

YES NO YES

Service cost

Basically all content is free

+

Some even provide pro version (more features)

Basically all content is free

+ Available pro version (more features)

Free version is limited +

Pro version (unlimited)

Type of service supplied by the provider

Connect with other people, share and publish

contents, send a receive emails, freeware software,

etc.

Online Newspaper,

etc. Software (basic features)

Counter-performance required to the user

Be subjected to advertisements, concession to the OSP to

use (in whole or in part) the own data provided with the registration and during use of the services

Be subjected to advertisements

Purchase pro-version only in case of service upgrade

Corporate profit

Mainly by selling targeted advertising services

+

Reselling client lists

Mainly by selling advertising services

Mainly from the sale of the software, license, etc.

Examples

Facebook, Instagram, Linkedin, Youtube, Yahoo! Mail, etc.

The Guardian (daily

newspapers), etc. Adobe acrobat pdf, etc.

Table 1.1 ³²

The common feature of those 3 models showed above is the provision of free digital services. Diversification mainly involved two factors:

1) a mandatory preliminary registration in order to access to the services;

2) the right to use all services in full regardless of purchasing of additional payment services.

32Made on the basis of the analysis carried out by the author of this thesis.

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The Business Reference Model (BRM) taken into consideration for this study regards only the “Model A”. Thereafter, in the next chapters, this "model A" will simply be referred to as "business model” or “BRM”. The choice of “Model A” as reference model is justified by the fact that it is – by the writer‟s side – the one in which the services performed by both counterparties can be more easily identified for the purpose of an analysis of indirect taxation. Besides, the business model analyzed here includes those situations that involve companies such as Facebook and Instagram, and which are mainly generating problems related to taxation. These companies, in fact, are offering continuously free services to billions of users, apparently without counter-performance.

On the other hand, they are collecting a theoretically infinite number of personal data capable of being used to generate corporate profits.

One of the main characteristics of this business model is that Users are aware of granting the “right of use” of their personal data for targeted advertising purposes. This is done on a voluntary basis by means of a registration form. In the other two models, B and C, the relationship between Users and OSP – again in the writer's opinion – is less adapted to be analyzed from the point of view of indirect taxation. In model B, the user has full free and unconditional access to all the content supplied by the OSP without registration and without a direct providing of personal data. In practice, each user accesses the service at his own discretion.³³

In model C there is a mandatory registration by the User in order to be able to use the basic version of a service, e.g. a software. In this case, the company's purposes is to sell the software and related services. The personal data provided by the Users are not used (at least apparently) for processing targeted advertisements. In model C, the user tests a product and, if it meets his needs, he has the possibility to purchase the full version. The transactions are therefore well defined and do not give rise to controversial in terms of indirect taxation.³⁴

33See section 1.3.

34See section 1.3.

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In model A, the User can use all the services made available by the OSP even if he must necessarily register a personal account and accept the provider's agreement.

Without registration and without acceptance of the agreement the services cannot be used. Among the personal information required during registration there may be the name, email, address, telephone number, etc. (see point 1 in the info-graphic below).

An OSP, taking again Facebook or Instagram as example, generates its profits from selling targeted advertisements that will be displayed to Users themselves (see point 2 in the info-graphic below). Targeted means that advertisements can be specifically customized for a specific group of users based on their age, geographic location, personal preferences, etc. In Facebook, a paid advertiser can choose the geographical area, age, gender and interests of the recipients of its advertising. This model of advertising has a “method of execution” as well as “economic returns” different from advertisements in the classical sense where the recipients are a group of indistinct people. The advertisements found on the subway or on a television program could be used as examples.

It is therefore clear that targeted advertising has greater efficiency and therefore also a much higher return on investment. To make this advertising method effective and efficient, the OSP must have a constant increase of personal data. This is the reason why the OSP contractually reserves the right of processing and using the personal data supplied by users. A higher number of users leads to a higher sample of data to be used which in turn leads to a higher number of paying advertisers and therefore to an higher turnover. In special cases, other OSP may also focus a part of their business on the sale of this data to third-party marketing companies (data broker). The ultimate aim of using the data, however, is always to create targeted ads.

The relationship between OSP and Users as well as between OSP and its paying advertisers can be summarized in the following info-graphic model:

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BUSINESS REFERENCE MODEL³⁵

Scheme 1.1

It can be concluded, although this may seem absurd, that the OSP's profit is directly proportional to the number of non-paying users. A concept of economic model totally unthinkable at the end of the last century.

2.3 Identifying personal data

Before analyzing the relationships between OSP and Users for the purposes of VAT taxability, it is necessary to identify the personal data, i.e. understand what it is that the Users provides in exchange for the services received.

With regard to personal data, there is no precise definition or other references in the VAT directive that could lead to a unanimous definition at European level. Thus, in order to assess whether this flow of personal data can be considered “effected of

35Graphical representation of the BRM made on the basis of the analysis carried out by the author of this thesis.

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consideration” and thus subject to VAT for the purposes of Article 2 (1)(c) VATD, it is first necessary to define it.

As in the case of digital services supplied by OSP – which “by means” of the VAT directive and Regulation n. 282/2011 – they have a "univocal" legal definition in all Member States, even in the case of personal data it is necessary to look for a definition that could have an unanimous interpretation. Hence, it can be argued that the various possible definitions present in the national laws of the individual Member States cannot be considered appropriate for the formation of a common definition of personal data.

Paying attention in the official web channel of the European Union we read the following definition:

―Personal data is any information that relates to an identified or identifiable living individual. Different pieces of information, which collected together can lead to the identification of a particular person, also constitute personal data.‖³⁶

Examples include the name and surname, home address, personal email address such as name.surname@company.com, identification card number, location data (for example the location data function on a mobile phone), Internet Protocol (IP) address, the advertising identifier a phone, data held by a hospital or doctor, which could be a symbol that uniquely identifies a person. It is then specified that

―Personal data that has been rendered anonymous in such a way that the individual is not or no longer identifiable is no longer considered personal data. For data to be truly anonymised, the anonymisation must be irreversible‖.³⁷

A further definition, rather similar, but of greater legal value, as present in a European Regulation, is that found in art. 4 of Regulation (EU) 2016/679 (GDPR), the so-called General Data Protection Regulation (GDPR). This characteristic gives this definition a formal and uniform meaning in all Member States. The law states that personal data:

“means any information relating to an identified or identifiable natural person (‗data subject‘); an identifiable natural person is one who can

36European Commission website, 'What is personal data?' <https://ec.europa.eu/info/law/law-topic/data- protection/reform/what-personal-data_en> accessed 4 May 2020.

37Ibid.

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be identified, directly or indirectly, in particular by reference to an identifier such as a name, an identification number, location data, an online identifier or to one or more factors specific to the physical, physiological, genetic, mental, economic, cultural or social identity of that natural person;‖. ³⁸

Based on the definitions above, it could be notes that the characterizing aspect is that the information received from an OSP must necessarily refer to a natural person (individual). This natural person must be identified or, alternatively, it is sufficient that it is indirectly identifiable through other factors such as location data or related to physical, physiological, genetic, mental, economic, cultural or social identity. To cease to be considered personal data, those data must be made permanently anonymous by the OSP and the individual no longer identifiable.

It is therefore deduced that in addition to the more obvious data such as name, email, telephone number, Internet Protocol (IP), also more general information such as location data, personal tastes and interests, etc. must be considered personal data. Thus, the type of data provided by the Users to the OSP as expressed in the business model, undoubtedly fall into the category of Personal Data. Moreover, even in the event that the registration form does not explicitly request for the insertion of the real name and surname but instead a username and email, this is sufficient to equally define that flow of data provided to the OSP as Personal data.

38Article 4 of Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation).

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3. Are supplies of free digital services VAT taxable?

3.1 Introduction

In the previous chapters the dynamics between OSP and Users have been highlighted. On the one hand there is the OSP that provides a free digital service (hereinafter only "digital service") to an User, on the other hand the latter fills in a registration form accepting that his personal data will be used for advertising purposes.

Thus, what takes place between the two parties is a reciprocal exchange of services characterized by a synallagmatic relationship (quid pro quo) in the form of barter.

Article 2(1)(c) of the VAT Directive 2006/112/EC (hereafter "VATD" or “VAT Directive”) states that a supply of services supplied by a taxable person acting as such is subject to VAT "only" if the service is provided for consideration within the territory of a Member State³⁹. Base on a literal interpretation of that provision, it is clear that the fundamental requirements concern (i) the presence of a supply of service, (ii) necessarily effected for consideration (objective requirement), (iii) which must be provided by a taxable person acting as such (subjective requirement), (iv) and the transaction must obviously take place within a member state (territorial requirement). It must therefore be deduced that if the supplier does not receive "any consideration for the supply of goods or services, there is no transaction for consideration and therefore there is no taxable transaction". ⁴⁰

With regard to the subjective and territoriality requirements, it has already been specified in the introductory chapter that this study is based only on transactions between a provider as taxable person (i.e. the OSP) and a recipient as non-taxable person (i.e. the Users). Moreover, the latter must be considered to be resident within the European Union for the purposes of the "place of supply". Additionally, there is no even need to verify the OSP‟s status as taxable person or the existence of an “economy

39Article 2 par.1(c) of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

40Opinion of Mr Advocate General Van Gerven in case C-33/93, Empire Stores Ltd v Commissioners of Customs and Excise, para. 13.

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activity” since these two requirements are already considered to be determined and, thus, placed as the basis for the analysis. See section1.3 concerning “Delimitations”.

Other than the above, the VAT Directive does not provide further apodictic elements that can help to interpret clearly when a supply of services must be regarded as “supply effected for consideration” and therefore falls within the scope of VAT. A valid support can only be found in the case-law of the European Court of Justice (hereafter “ECJ”).

Over the years the Court has clarified that there must be a direct link between the service supplied and the consideration paid so that a supply of service (or goods) can be considered effected for consideration⁴¹. It should also be stressed that VAT "is based on the quid pro quo principle"⁴². In addition, according to the ECJ, the nature of the services supplied and the consideration received must be easily ascertainable⁴³. Moreover, the consideration must have a subjective value⁴⁴ ⁴⁵ and must be capable of being expressed in monetary terms.⁴⁶

Another requirement to be fulfilled is the presence of a "legal relationship” between the service provider and the beneficiary. On the basis of this relationship, a reciprocal exchange of performances must take place, i.e. ‖the remuneration received by the provider of the service constituting the value actually given in return for the service supplied to the recipient”.⁴⁷

41See case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen "Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 12, case C-102/86 Apple and Pear Development Council v Commissioners of Customs and Excise [1988], para. 12, case Hotel Scandic Gåsabäck AB v Riksskatteverket [2005], para. 22, case Commissioners for Her Majesty‘s Revenue and Customs v Loyalty Management UK Ltd (C-53/09) and Baxi Group Ltd (C-55/09), para.51 and case C-285/10 Campsa Estaciones de Servicio SA v Administración del Estado [2011], para.25.

42G. Beretta, VAT and the Sharing Economy (World Tax Journal, IBFD, 2018), para 4.3.

43See case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen "Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 12 and case C-102/86 Apple and Pear Development Council v Commissioners of Customs and Excise [1988], para. 14-15.

44See case C-412/03 Hotel Scandic Gåsabäck AB v Riksskatteverket [2005], para. 21, case C-33/93, Empire Stores Ltd v Commissioners of Customs and Excise [1994], para.13, case 230/87 Naturally Yours Cosmetics Limited v Commissioners of Customs and Excise [1988], para. 16 and case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen

"Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 13.

45This “subjective value” requirement is strictly connected to the calculation of the taxable amount and is therefore left out of this thesis which is only aimed at verifying the taxability of free digital services.

46Case 230/87 Naturally Yours Cosmetics Limited [1988], para. 16 ansd Case C-33/93 Empire Stores Ltd [1994], para. 17

47See case C-16/93 R. J. Tolsma v Inspecteur der Omzetbelasting Leeuwarden [1994], para.14 and C-174/14 Saudaçor [2015], para. 32.

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Through the joint analysis of all these jurisprudential principles, four parameters (or criteria) arose aimed at verifying the taxability of transactions pursuant to Article 2(1) VATD⁴⁸. These 4 criteria took the form of a verification test called "DIRECT LINK TEST" or "by consideration" criterion⁴⁹. The 4 criteria concern the following:

1. the existence of a supply of service (or goods) for VATD purposes;

2. a consideration direct linked the services supplied (functional synallagma);

3. a legal relationship;

4. a reciprocal performance between the parties. ⁵⁰

By applying the "direct link test" criterion to the business model in question, it follows that the analysis must first of all seek to establish whether the supply of digital services fall within those services covered by the VAT legislation. Subsequently, it must be ascertained whether the personal data actually represent a “consideration” paid in kind in order to get the right to use of those digital services supplied by the OSP and, thereby, establish whether there is a direct link between the supply of the digital services and the personal data. Finally, attention will be paid to establishing whether there is a legal relationship and a mutual performance between the OSP and the User. In the event that these assessments lead to an affirmative result, the free digital services supplied by the OSP will fall within the VAT legislation and must therefore be subject to VAT taxation.

3.2 Identifying the free supply of digital services in the light of the VAT Directive

Regarding the free digital services provided by the OSP, there is no direct and precise reference in the VAT directive. Article 24 paragraph 1, in fact, indicates only generically that the "supply of services shall mean any transaction which does not constitute a supply of goods"⁵¹, while paragraph 2 refers to "telecommunications

48Article 2 par.1 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

49Ad van Doesum, H W M van Kesteren and Gert-Jan van Norden, Fundamentals of EU VAT law (Kluwer Law International, 2016), para 6.6.3.

50See case C-16/93 R.J. Tolsma contro Inspecteur der Omzetbelasting Leeuwarden [1994], para. 14.

51Article 24 par.1 of Council Directive 2006/112/EC of 28 November 2006 on the common system of

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services" such as those services "relating to transmission , emission or reception of signals, words, images and sounds or information of any nature by wire, radio, optical or other electromagnetic system ".⁵²

Although through a wider interpretation those digital services covered by the business model could fall within the Article 24 of VATD, it is only with the Implementing Regulation (EU) No 282/2011⁵³ (hereinafter "Reg. 282/2011") that a clarification of the meaning of digital services is provided. In Reg. 282/2011, in fact, a clear distinction is provided between the “Telecommunications services” (already explained in article 24 of VAT D) and the “Electronically supplied” (article 7 of Reg.

282/2011)⁵⁴. In Article 6a, in the second paragraph of Article 7 and especially in the related ANNEX I of the Reg. 282/2011, different "examples" of services included in the above categories are also listed in detail.⁵⁵

A literal interpretation of these articles led to argue that services supplied by OSP can mainly constitute Electronically supplied (and only marginally Telecommunications services) since they are essentially delivered over the internet or an electronic network, automated, involve minimal human intervention and are impossible to ensure in the absence of information technology.

Below are some practical examples showed.

value added tax OJ L 347 of 11 December 2006.

52SeeArticle 24 par.2 of Council Directive 2006/112/EC of 28 November 2006 on the common system of

value added tax OJ L 347 of 11 December 2006 and Council Implementing Regulation (EU) No 282/2011 of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax.

53Council Implementing Regulation (EU) No 282/2011 of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax (consolidated version).

54 Article 6b of Reg. 282/2011 relating to "Broadcasting services" is deliberately omitted because in the case of radio or television programs the specific regulation specifies that "they are broadcast simultaneously". On the other hand, the streaming services offered via the internet that could be included in the business model only concern on -demand services and therefore not covered by that provision.

55For a detailed analysis of the list of all the services included in the VAT legislation, the reader is invited to read article 24 VATD and articles 6a, 7 and ANNEX I of Council Implementing Regulation (EU) No 282/2011 of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax

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VAT provisions Practical examples of services covered by VAT provisions

Art. 24.2 VAT D “Telecommunications services”

Art. 6a.1 (a) of Reg. 282/2011

"access to the internet, including the World Wide Web"

Supply of free internet. The user must necessarily register an account to access and use the service.

The user will be able to surf the internet.

Art. 7 of Reg. 282/2011

ANNEX I (1)(2)(3)(4)(5) of Reg. 282/2011

| TUBI |

It is a free streaming service supported by advertisements. TUBI offers to users thousand of older TV shows and movies completely free of charge. Each user must necessarily register an account to access to the service.

* * *

| FACEBOOK or INSTAGRAM | Free social network.

* * *

| YAHOO! MAIL |

It is an email service provider that offers different email plans. One of the plans includes a

completely free email service for personal use.

Each user must register an account to be able to access and manage own mailbox.

3.3 Personal data as consideration paid in kind in a context of digital bartering

3.3.1. Introduction

In the previous section, the existence of the first "direct link test" criterion has been ascertained. The services offered by the OSP fall within the services provided for by the VAT legislation.

This section deals with the analysis of the barter transaction between OSP and User from the point of view of the second criterion, i.e. verifying the existence of a direct link

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between supply of services and consideration. Applied to the present case this means assess whether personal data is the value actually given in return for the digital services supplied by OSP.

It is worth mentioning that by virtue of the agreement in place between the OSP and the User, the latter must transfer his personal data and consent to their use for commercial purposes in order to access to digital services.

As already explained in the previous chapters, what is established is a reciprocal exchange of benefits in kind (quid pro quo) where the right to use certain digital services is supplied exclusively in exchange for the right to use personal data.

Regardless of the nature of what has been supplied, each party will believe that what has been received has a greater value than that transferred, otherwise the transaction could not take place. However, it must now be assessed whether this consideration is considered to be such also pursuant to Article 2 (1) (c) of the VAT Directive⁵⁶, which is recalled as a necessary condition for the transaction in question to be subject to VAT taxation.

It should be noted, previously, that no distinction can be made between consideration in money and consideration in kind. The ECJ noted, in fact, referring to cases Goldsmiths (C-330/95), Orfey (C-549/11) and Serebryannay vek (C-283/12), that barter agreements, under which the consideration is in kind, and transactions for which the consideration is in money are, “economically and commercially speaking, two identical situations”⁵⁷. It can therefore be inferred that whether a supply of service is remunerated, in turn, through a consideration in the form of another supply of service, such a consideration in kind must be treated in the same way as a consideration in money for the purposes of the VAT Directive.

56Article 2 par.1 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax OJ L 347 of 11 December 2006.

57See case C-330/95 Goldsmiths (Jewellers) Ltd v Commissioners of Customs & Excise [1997], para. 23 to 25, case C-549/11 Direktor na Direktsia «Obzhalvane i upravlenie na izpalnenieto» — grad Burgas pri Tsentralno upravlenie na Natsionalnata agentsia za prihodite v Orfey Balgaria EOOD [2012], para. 35 and case C-283/12 Serebryannay vek EOOD v Direktor na Direktsia «Obzhalvane i upravlenie na izpalnenieto» – Varna pri Tsentralno upravlenie na Natsionalna agentsia za prihodite [2013], para.39.

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With regard to second criterion, the Court's jurisprudence identifies further "sub"

conditions to be verified in order to establish whether a supply of services is effected for consideration pursuant to Article 2 (1) (c) VATD:

 there must be a direct link between the service provided by the OSP and the consideration paid by the user;⁵⁸

 the consideration in kind must be capable of being expressed in monetary terms;⁵⁹

 the consideration must have a subjective value⁶⁰ inasmuch as the taxable amount is the consideration actually received and not a value assessed according to objective criteria.⁶¹

3.3.2. Digital services as quid pro quo for an advantage provided to OSP by users

For the purpose of verifying the presence of a synallagmatic relationship between services and consideration, it is necessary to take into account the ECJ's legal reasoning in the Empire Stores judgment (C-33/93)⁶² as well as the opinion expressed by Advocate General Van Gerven.

By the writer‟s side, the Empire Stores case deals with a situation in many respects similar to the business model. The ratio decidendi of the ECJ ruling can therefore help to form the basis of reasoning in order to deal with the analysis of the case covered by this thesis.

The facts in detail:

58See case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen "Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 12, case C-102/86 Apple and Pear Development Council v Commissioners of Customs and Excise [1988], para. 11, case 230/87 Naturally Yours Cosmetics Limited v Commissioners of Customs and Excise [1988], para. 11 and 12, and case C-16/93 R.J. Tolsma v Inspecteur der Omzetbelasting Leeuwarden [1994], para 13.

59See case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen "Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 12, case 230/87 Naturally Yours Cosmetics Limited v Commissioners of Customs and Excise [1988], para. 16 and case C-380/99 Bertelsmann AG v Finanzamt Wiedenbrück [2001], para. 17.

60This “subjective value” requirement is strictly connected to the calculation of the taxable amount and is therefore left out of this thesis which is only aimed at verifying the taxability of free digital services.

61See case C-154/80 Staatssecretaris van Financiën v den kooperativa föreningen "Coöperatieve Aardappelenbewaarplaats GA" [1981], para. 12, case 230/87 Naturally Yours Cosmetics Limited v Commissioners of Customs and Excise [1988], para.

16, and See case C-33/93, Empire Stores Ltd v Commissioners of Customs and Excise [1994], para.16.

62See case C-33/93, Empire Stores Ltd v Commissioners of Customs and Excise [1994].

Freeconomics in the light of EU VAT Directive

Department of Law Spring Term 2020

Master Programme in International Tax Law and EU Tax Law Master’s Thesis 15 ECTS