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Our flagship series will propel you to the forefront of the global ecommerce revolution. From analyses of breaking current events to the intricacies of navigating cross-border sales and regulations, Business over Borders entertains and informs any audience who wants to learn more about how international ecommerce works.
Hey, everybody. Welcome to the world of tax miniseries where we help you navigate the complex world of tax compliance. I'm joined with my co host here, Gregory Schichkho. Gregory, welcome.
Grigory Schichkho:Hello.
Leo Tucker:So I, came across an interesting post that you made on LinkedIn a while back. I think Forbes put out a list of the top 50 AI companies around the world, and you went and did a deep dive on their tax compliance. Am I getting that right?
Grigory Schichkho:Yeah. Absolutely. So it actually was a quite spontaneous decision, for me just to to analyze what the situation is with, tax compliance for in this very modern, area of artificial intelligence. But, my findings were actually astonishing even to myself.
Leo Tucker:So before we get started, what what made you dig into this article, generally, more specifically, AI startups? What, what made that something interesting worth diving into?
Grigory Schichkho:Well, as you know, AI is new black. Right? So everyone is is is talking about AI at the moment, and there are a lot of rumors that, AI might replace lots of jobs. And, I wanted to analyze it from slightly different perspective then you as a consumer purchases some AI services from those companies, actually, what you consume is digital services. And I wanted to understand what the situation is with, tax compliance for these top 50, startups.
Leo Tucker:Right. Right. So they're all they're all digital service startups, which and they're hot in the media. That makes total sense.
Grigory Schichkho:Yep. And the important point here is that we are talking about indirect taxes. So taxes such as VT, GST, or sales tax. Right? And, in case of the US sales tax, the average rate is roughly between 6 7% depending on the state.
Grigory Schichkho:But if we talk about, VT or GST, like, globally, the average rate would be much higher. So we can ballpark this figure at 15%.
Leo Tucker:Yeah. Much higher than the general state's sales tax. Yeah. Okay. So let's dive into that a little bit.
Grigory Schichkho:They they actually surprised me a lot. So I I carefully reviewed all the 50 startups from the Forbes list. I focused exclusively on startups that, offered some services b to c, so directly to consumers. And Okay. I so there were 18 startups, out of these 50, which offer a b to c services.
Leo Tucker:And so what did you find of of these, these companies that were digital companies selling directly to consumers?
Grigory Schichkho:The findings that I, got, they were actually, I would say, a little bit scary because only 16% of these b two c AI startups were fully compliant with, with indirect taxes globally.
Leo Tucker:16, 16%,
Grigory Schichkho:Yep. That's that's that's true. So and out of the of the rest, more than 50% were like should I use this word, like, completely? But they were basically noncompliant in all the jurisdictions I I analyzed. Wow.
Grigory Schichkho:So and the rest of the start up, like, roughly 30%, they were partially compliant. So they were compliant in some markets, but they were non noncompliant in in many others.
Leo Tucker:So when you're saying, you know, 16% of them were compliant and, that leaves 84% partially compliant or not compliant at all. So we're talking about them not charging taxes in the right jurisdictions or undercharging, overcharging, or something along those lines.
Grigory Schichkho:I am talking about not calculating and collecting taxes in the jurisdictions that they're supposed to.
Leo Tucker:That's kinda hard to believe that the number's that big. And this is I mean, this isn't just your mom and pop digital service stores, but they these are I mean, this is the Forbes top AI companies right now. So that's, I find that kinda hard to believe that's that's something else. So, I mean, what's let's take a step back here. So if we have a large number of these big companies that are not tax complied or partially tax compliant, I mean, what are the consequences of that?
Leo Tucker:I mean, let's say the tax man comes knocking. What sort of issues are they coming are gonna come in contact with?
Grigory Schichkho:First of all, we are talking not just about one particular taxman. Right? So as we know, at the moment, almost 100 countries, all around the world require digital service providers to calculate and collect taxes if they if those providers supply their services cross border to consumers in those countries. So
Leo Tucker:Right.
Grigory Schichkho:In my opinion, the risk of getting attention from tax authorities is actually stacks up, because it's just not not a single market. It's it's, like, almost a 100 of countries. The obvious consequences of that is that if any of the companies I'm not talking just exclusively about the findings from my research, but if any digital service provider who is not compliant with indirect taxes get caught by any tax authority, sir, the consequences would be obviously calculation of tax that was supposed to be collected but, haven't been collected, and else, interest and penalty for not paying this tax than it was supposed to be paid.
Leo Tucker:Right. So once once they get caught by any number of jurisdictions, potentially, not just one, it could be multiple, you know, they'd be responsible for back taxes essentially and penalties up to I assume there's some sort of statute of limitations, you know, if they've been doing it for a long time. Yeah. That brings up kind of an interesting thought then if I mean, you you've got nobody wants to have a visit from the tax man, for sure. But I know for these companies that are relying on investor funding, I imagine that has to be a concern when due diligence comes into play.
Leo Tucker:So, you know, getting around to funding, perform due diligence, make sure the t's are crossed and their i's are dotted. I mentioned they're starting to look more closely at tax compliance from an investment standpoint. Like, if I'm investing in this company, I wanna make sure that all the countries you're selling into, you're compliant from a tax perspective because that could put a you know, we see, in that case of $1,000,000 at 15%, you know, a $150,000 tax bill that really changes the, you know, the commercials of it all. Right?
Grigory Schichkho:So any investor, especially new investor thinking about putting money into a startup, they would like to be sure that there's no any skeletons in the in the in the wardrobe. Right?
Leo Tucker:Right. Yeah.
Grigory Schichkho:Maybe during, like, the seed round, companies are not tested thoroughly. But, going forward, from my experience, usually, these due diligence is handled by consultants. And, obviously, tax aspect would certainly be on the on the list. I don't want to scare everybody, but new investors or existing investors, adding more money into the company would like to understand that the company is going the right way also from the compliance perspective.
Leo Tucker:Right. Well, you and I didn't start the world of tax miniseries to shy away from scary topics here. So I think we're being just scary enough.
Grigory Schichkho:True. So, basically, our idea is with this miniseries to educate people and make them aware of of things that they might not know because they focus on their core business. Right? We we shouldn't expect that everyone should be expert in taxes. That's why we're
Leo Tucker:here. Yeah. Absolutely. And, you know, selling physical goods, which we're all incredibly familiar with, you know, you walk to the store, you you buy a Kit Kat bar, you're gonna pay tax on it. You see it right there.
Leo Tucker:And whether, you know, whether you see that tax included in the price or, you know, you see it after the price. You know, we're familiar with it. And I think in this digital world, it just feels different. You know? Like, when I go and subscribe to Netflix, you know, I just see one price.
Leo Tucker:There's tax. They're paying tax on that. But it's just it's just something you'd is almost don't think about. I imagine business owners probably encounter that a lot as well. You know, it's a digital service.
Leo Tucker:We're selling overseas. You know, do we need tax? I don't know. And that's why it's so important to have, you know, a tax expert help you set up your business so you don't get that knock on the door that nobody wants to get. Do they actually come to your house?
Leo Tucker:I don't know how that works, but, it's, makes a little scarier imagery for sure.
Grigory Schichkho:That's true. And I can give you so, actually, some tax authorities, in some countries, they have power to shut down your, to I mean, to restrict access to your website to users in that country if, the website is found to be nontax compliant. Mexico, by the way, is is a good example of that. It's specifically written in the tax legislation.
Leo Tucker:Oh, yeah. So there's you know, it's not just having to deal with a big tax bill. They can they can shut down the the moneymaker, so to speak. And I imagine they could probably freeze funds if you're holding in that country as well. There's probably a number of number of ways that that could affect your business negatively.
Grigory Schichkho:And, we are not even talking about some of these bad public information, right, that that might be visible. I mean, nobody probably would be would like to be associated with, something with some of our undoings. Right?
Leo Tucker:No. And it could really hurt your reputation as well beyond just the the financial and, logistical things that can get in the way too. You know, nobody wants to visit a product whose website gets shut down or they end up in the paper for not paying their taxes. You know, it's a it's a bad look. Let's talk about how you found that information.
Leo Tucker:So, you know, obviously, the list of companies was made in the article by, by Forbes. But what did you do to find out that you know, to get the information you found out about the compliance, noncompliance?
Grigory Schichkho:Right. So there is no there is no magic here. And, actually, everyone who is listening to this podcast can, can repeat my exercise. It would certainly take, some time, but it's known as a customer journey. So you need to register on those, resources.
Leo Tucker:Right. So you sign up for an account. Okay.
Grigory Schichkho:Yes. Sign up for an account, and then, you don't necessarily need to make a purchase. You just need to add something into your, like, ad subscription and then go to the checkout page. And here, you will get all the information you need. At the checkout, you will clearly see where the tax is calculated and applied to your purchase.
Grigory Schichkho:Right.
Leo Tucker:So you're following the customer journey. You go and you sign up for an account. You walk all the way through the checkout. You can see your taxes listed there, any any VAT, any any, you know, other taxes. And then and then you do your research and you say, okay.
Leo Tucker:Well, I'm from this country and they're selling in this country. The taxes should be blah, blah, blah, and you compare the 2. Is am I understanding that correctly?
Grigory Schichkho:Yep. That's that that's correct. But you need to know what what countries to check. Right? So some countries, they do not they still do not require to, foreign, vendors to collect, taxes on digital services.
Grigory Schichkho:Right? Other countries might have registration threshold, but, lots of countries, they require, digital service providers supplying services cross border to be registered from the 1st sale or even before the 1st sale.
Leo Tucker:Right. Okay. So that's where the expertise comes in. And, again, back to our earlier point of, you know, if you're selling internationally, even at even at the scale, you know, small time or big enough to make it in the Forbes list. You know, it's important that you have your taxes right and consult an expert to make sure you're compliant.
Grigory Schichkho:This is where all the complexity kicks in, I guess. First of all, you need to understand what rate you need to charge depending on what country you are selling to. Right? And if we talk about, startups, especially AI startups, obviously, they they try to sell globally. Right?
Grigory Schichkho:They are not focused usually on any specific market. Right? Maybe
Leo Tucker:Sure.
Grigory Schichkho:When you're there in, like, an alpha stage or beta stage, but then they they they they intention is obviously to become global global supplier of their unique unique, value proposition. But Right. For the US, as we discussed earlier, it's not just a single rate for for the for the whole country. It's literally thousands and thousands of different rates depending on the particular location, not even the state, but even, like, the particular location inside the state. So you need something.
Grigory Schichkho:Usually, it's called, like, a tax agent, which would help you to, determine the correct tax rate.
Leo Tucker:Right.
Grigory Schichkho:Some people might think that this is the hardest part. Right? But, actually, it's not. Once you calculate the tax or even before you start calculating the tax, you need to obtain tax registrations in the countries that, you you have to. Right?
Grigory Schichkho:Depending on the country, the time needed and the effort required to obtain a tax registration can range from literally 15 minutes to more than a year. And if you multiply it by, like, even not all 100 countries, you can specifically restrict, countries you are you are selling to, which obviously might hurt your revenue. It's, again, about, whether those startups, which are usually have very lean teams, whether they can spend so much time, right, when they actually need to compete with with other players in their industry, spend, so much time to become tax compliant. And after updating those tax registrations, calculating and collecting tax, you need to report and remit those taxes.
Leo Tucker:Right. So in the ex in the example with the Forbes list, that 84% are, like let's take the other side of it. The 16% of the compliance companies, they're only compliant from a user checkout perspective. We have no idea where they're registered. We have no idea where they're not registered if they're filing the taxes, if they're remitting the money correctly.
Leo Tucker:So at best, we have a 16, you know, 16% are doing at least some of it right.
Grigory Schichkho:Let's hope for the best. Yeah. Let's let's assume that, once they calculated taxes and they collected it, that they actually did all the other steps.
Leo Tucker:Yeah. Point being, it's really complicated, and there's a, you know, a lot to consider here. It's not, not for the faint of heart. How would a company find out they're not tax compliant? And what can be done to avoid that in the first place or remedy that if they find out that they're not in tax compliance?
Grigory Schichkho:There might be questions from their from their users, from the from their customers. Right? Because customer consumers are familiar. Like, you rightly mentioned, then your purchase Netflix subscription, you will see some taxes on your bill from Netflix. Right?
Grigory Schichkho:So, customers might might question, why it's not happening, or it might be investors. It might be VC funds. It might be consultants performing due diligence on those startups. And, obviously, the worst case scenario would be, if this is brought to their attention by by a taxman.
Leo Tucker:Yeah. The, least fortunate of the scenarios. Okay. So, I mean, what's a good way to mitigate this? You know, how how do how to how is a company to get potentially set up in a 100 countries, you know, for a variety of products, how do I navigate the ins and outs of that?
Leo Tucker:Like, what's what's what should what should they do proactively?
Grigory Schichkho:There are several potential options, but if we consider 2 probably, like, opposite ends of this range, then the first option would be to handle everything in house. Right? So to hire someone or I would say even to hire a team of people who has sufficient expertise in taxes for digital services, who would then build compliance in house, create all the policies, procedures, obtain tax registrations, do some, like, automation that would obviously be required because all sales are done, via via the Internet. Right? You cannot just calculate taxes manually.
Leo Tucker:Right. Right. Right.
Grigory Schichkho:You may try to get some, like, you know, a number of solutions, from different providers and try to integrate them, internally. The quickest way, in my opinion, would be to use companies known as merchants of records. Companies who have already solved this problem and who's built this, if I may call it, tax infrastructure
Leo Tucker:Right.
Grigory Schichkho:To support sale of, digital services globally.
Leo Tucker:Yeah. Which I imagine costs some small fraction of sales versus, you know, hiring and scaling up an entire team to do it, which is advantageous for a number of reasons.
Grigory Schichkho:Absolutely. And we are also talking talking about, implementation time. Right? So as we discussed, those companies, they are they've already been operating. Right?
Grigory Schichkho:For them, it might be essential to fix issues sooner rather than later. So building all the infrastructure in house, obtaining the necessary expertise in this field might take time. Is it doable? Yeah. Yes.
Grigory Schichkho:How much time, would it, would it take? Nobody knows.
Leo Tucker:Yeah. Yeah. Absolutely. It sounds like merchant records, you know, the way to get up and going quickly. It's a permanent solution, not just a stop gap.
Leo Tucker:And, you know, and if you have the resources to build your own internal tax team and hire and stay up to date and compliant, great. But if not, there are solutions out there that do that a little bit quicker and cheaper. Here's a thought. So if if one of these companies finds themselves noncompliant, the tax man didn't come knocking. Thank goodness.
Leo Tucker:But, you know, they got a tip-off from a customer that says, hey. You know, normally, I I pay some, GST or VAT on this on this service here and just wanna just wanna make sure you guys are doing the right thing. And you look at it and say, oh, wow. We are not compliant. What is a company to do to protect themselves, you know, for back filing and to just make sure that they don't get in a world of trouble?
Grigory Schichkho:Approaching approaching someone who who has expertise, like tax adviser or, again, a merchant of record who can do a thorough study and analysis together with the with the company, with factory company, to calculate carefully, how much is it on stake. Right? So what countries are affected, where, say, registration thresholds were triggered, how much tax was supposed to be collected but hasn't been?
Leo Tucker:Right. A bit of a postmortem. Yeah.
Grigory Schichkho:And then create a plan, like a rectification, plan on, what can be done, going forward.
Leo Tucker:Right. So best to hire a 3rd party to come in, take a look at, you know, your compliance to date, where you filed, where you haven't, how much you filed, and make sure you're compliant there, and then work on sort of a remediation, plan to to get in a good standing with the governments where you're selling products.
Grigory Schichkho:Let's imagine that there is a magic wand, and you can waive this wand and become compliant next day.
Leo Tucker:Oh, I like that. Let's get one of those.
Grigory Schichkho:Even if, everything is fixed, say, from tomorrow, previous periods are still at risk. Right? So every country has so called, a statute of limitation. It means that the period that tax authorities can look back and assess and, also calculate or, like, adjust, taxes if needed. Those statute of limitation, they differ from country to country, but I would say that on average, very, very average, it's about 4 years.
Leo Tucker:I've always heard the, you know, keep things on file for 7 years. I don't know if that's an old wives' tale or not, but that's,
Grigory Schichkho:It's slightly different thing, that else exists. It's important to save all your records for a certain period of time, and this period might match the digit of limitation or it might differ.
Leo Tucker:Yeah. That makes sense. And since they're all different, the statute of limitations is different per country than just add that on the pile of unique things to do for each jurisdiction. You know, whether it's statute of limitations, whether it's, de minimis amounts, whether it's VAT import taxes, the list goes on. Gregor, this has been great.
Leo Tucker:Thanks for joining me on our first episode of, World of Tax. Look forward to doing several more. Until then, talk to you soon.
Grigory Schichkho:See you soon, Leo.
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