Tax Implications of Cross-Border Provision of Digital Services

The Cornerstone of International Business: How to Properly Handle VAT on Digital Services?

The key to understanding VAT in an international context is the concept of the "place of supply". This determines in which country the tax must be paid. For digital services, the rules differ depending on whether your customer is a business (B2B) or an end consumer (B2C).

When providing services to another business (taxable person) within the EU, the place of supply is generally located in the country where your customer is established. Conversely, if you provide electronic services to an end consumer (non-taxable person), the place of supply is where that consumer is established or resides. This means you must apply the VAT rate applicable in their country.

Have You Become an "Identified Person"? A Hidden Obligation for Non-VAT Payers

Many smaller businesses and sole traders who are not registered for VAT mistakenly believe that cross-border VAT does not concern them. However, this is a dangerous misconception. As soon as you receive a service from a supplier established outside the Czech Republic or provide a service to a business in another EU state, you become an "identified person" (a specific type of VAT registration for non-payers).

This obligation arises immediately and with a very low threshold. It applies to you, for example, when you pay for advertising on Facebook or Google Ads, subscribe to software like Canva or MailChimp, or sell an online course to a company in Slovakia. You must register with the tax authority within 15 days and pay VAT on these transactions in the Czech Republic. 

The Prague-based legal team at ARROWS encounters these issues daily and helps clients with timely registration and the correct setup of processes to avoid penalties.

The Reverse-Charge Mechanism in Practice: Who Actually Pays the Tax?

In B2B relationships within the EU, the reverse-charge mechanism applies. As a Czech service provider, you issue an invoice to your German business partner without Czech VAT. You state on the invoice that the tax will be paid by the customer. 

Your German partner is then obliged to "self-assess" this transaction – i.e., declare and pay German VAT in their tax return. This system simplifies international trade but requires careful verification of partners' VAT numbers in the VIES system and correct invoicing.

An Invisible Trap for Growing Companies: Are You at Risk of Creating a Permanent Establishment Abroad?

While VAT is a frequently addressed issue, a much more serious and hidden risk is the unintentional creation of a permanent establishment abroad. This is not a theoretical problem, but a real threat that can lead to double taxation and unexpected administrative obligations that can jeopardize the profitability of your expansion.

What Is a Permanent Establishment and Why Should Every Managing Director Care?

A permanent establishment is not just a physical office or branch. According to international treaties, it is any fixed place of business through which a company carries out its activities. The creation of a permanent establishment automatically triggers the obligation to register for corporate income tax in that country and pay income tax attributable to this establishment.

How Can Your Sales Representative, a Home-Office Employee, or Even a Server Abroad Trigger a Tax Liability?

In the digital era, the traditional understanding of a permanent establishment is expanding. The risk of its creation does not only apply to companies with physical branches. It is enough for your sales representative in Germany to have the authority to regularly conclude contracts on your behalf, and this can establish a so-called "agency" permanent establishment. Similarly, an employee working permanently from a home office in Austria can create a tax liability for your company in Austria.

Pressure is also mounting on the assessment of digital presence. Although case law is not yet uniform, foreign tax administrations increasingly argue that even a rented server or other key digital infrastructure can, under certain circumstances, constitute a permanent establishment. This is why it is crucial to have contracts with employees and business partners set up to minimize this risk.

At ARROWS, we specialize in preparing and reviewing contracts with an international element that reflect these tax specifics.

The Consequences Are Serious: Double Taxation and Unexpected Obligations

If a foreign tax authority concludes that your company has created a permanent establishment in its territory, the consequences are immediate and significant. You will have to retrospectively register the company for income tax, allocate a portion of your profits to this establishment, and pay the tax, including high late payment interest and penalties. You may also have a 10% withholding tax deducted from payments from your clients in that country. Although double taxation treaties exist, the process of applying them is administratively demanding and can lead to lengthy disputes.

Risks of Creating a Permanent Establishment and How to Prevent Them

The Future Is Digital, and So Are Taxes: What Do the ViDA Reform and the Global Minimum Tax Bring?

The European Union and the OECD are not sleeping and are preparing extensive reforms that will fundamentally change the tax environment for the digital economy in the coming years. Companies that do not prepare for these changes in time risk losing competitiveness and incurring high costs for additional implementation.

Are You a Platform? You Will Now Be Responsible for VAT Remittance (the "Deemed Supplier" Principle)

The reform known as "VAT in the Digital Age" (ViDA) brings a revolutionary change for platforms facilitating short-term accommodation and passenger transport. From 2027 (the deadline may still be postponed), these platforms will be considered "deemed suppliers". This means that the platform, and not the actual provider (e.g., the apartment owner), will be responsible for collecting and remitting VAT on the service provided. This step shifts tax liability to major digital players and significantly alters their operating model.

The End of Paperwork: Mandatory Electronic Invoicing and Digital Reporting

Another pillar of the ViDA reform is the introduction of mandatory electronic invoicing for all cross-border B2B transactions within the EU, starting approximately in 2030. Simultaneously, Digital Reporting Requirements (DRR) will be introduced, requiring the transmission of transaction data to tax authorities in near real-time.

This change is not just a formality. For companies, it means the need to invest in compatible accounting and ERP systems capable of generating structured e-invoices and communicating with government portals. This is a fundamental technological and process transformation, and underestimating it could paralyze business operations in the future. ARROWS provides legal consultations on the selection and implementation of these systems and reviews contracts with IT suppliers to ensure full compliance with upcoming legislation.

For Large Players: The Impacts of the Global Minimum Tax (OECD Pillar 2)

For multinational groups with consolidated revenues above EUR 750 million, the OECD initiative known as Pillar 2 introduces a global minimum tax of 15%. The Czech Republic has already implemented this regulation into its legislation under Czech legislation with effect from December 31, 2023, although an amendment is still being prepared to bring the law into full compliance with current OECD interpretations. For large corporations, this means the need for a detailed analysis of their global tax position and potential tax top-ups in countries where effective taxation is below this threshold.

Comprehensive Legal Protection for Your International Growth from ARROWS

The international business environment is full of opportunities, but also legal and tax risks. Managing them successfully requires not only knowledge of local regulations but also a deep understanding of international treaties and trends. Reactively solving problems is always more expensive and stressful than proactive and strategic planning.

A Proactive Approach Is Key

Our lawyers and tax advisors at ARROWS handle cases with an international element daily. Thanks to the ARROWS International network, built over ten years, we are able to provide fast and high-quality advice not only in the Czech Republic but practically across Europe and beyond. Our experience from long-term cooperation with more than 150 joint-stock companies and 250 limited liability companies allows us to see around the corner and prepare a solution for you that is not only legally watertight but also makes business sense.

Cross-Border Tax Challenges and Specific Solutions from ARROWS

Protect Not Only Your Finances but Also Your Know-How: Legal Certainty First

An effective international strategy is not limited to taxes. When expanding abroad and cooperating with international teams, partners, or suppliers, you expose your most valuable asset – intellectual property – to risk. The protection of your know-how and trade secrets must be an integral part of your legal strategy.

Under Section 504 of the Czech Civil Code, a trade secret consists of competitively significant, identifiable, assessable, and normally unavailable facts in the relevant business circles, which are associated with the business and whose owner adequately ensures their confidentiality. This can include a customer list, pricing policy, or a unique manufacturing process.

The concept of know-how is broader, and the Czech legal system does not explicitly define it. It often involves practical, unpatented knowledge and experience that give your company a competitive advantage. We ensure the protection of these key assets through precisely formulated contractual instruments.

A non-disclosure agreement (NDA) is a cornerstone that must clearly define what constitutes confidential information and how long the confidentiality obligation lasts, even after the cooperation ends.

For key employees with access to sensitive data, a non-compete clause is essential. Under Section 310 of the Czech Labor Code, it must be agreed in writing, can last for a maximum of one year after the termination of employment, and the employee is entitled to monetary compensation of at least half of their average monthly earnings for each month of compliance. ARROWS will help you set up these tools so that they are legally enforceable and effectively protect your business.

Take the First Step Towards Safe International Expansion

Navigating the dynamic world of international taxes and law is challenging. The risks are real, but with the right partner, they are fully manageable. At ARROWS, we pride ourselves on speed, high quality, and deep knowledge of not only the law but also our clients' business environment.

Do not wait for a problem to arise. Contact us today to arrange a non-binding consultation. Our Prague-based legal team at ARROWS will assess your specific situation and propose a strategy that will protect your business and support its growth in international markets. We are also happy to listen to your business ideas and connect you with other clients if we see potential for mutually beneficial cooperation.