In the UK we have a tax called VAT (Value added tax), which Wikipedia describes as “a tax on the purchase price”. In other words, when you buy something, part of the price you pay goes to VAT instead of the company selling you the product. The standard VAT rate is currently 20% in the UK. This means if a UK company sells some software for £100, they have to pay £16.66 VAT on the sale (not £20 - because the price is really £83.33, which if you add 20% totals £100). Unfortunately, old-fashioned UK laws make this process ridiculous for modern software distribution.
VAT rates can vary depending on sector and with various schemes such as flat VAT. Startups in the UK don’t have to register for VAT immediately, but it deserves consideration since it is inevitable if the company does well. Being VAT registered also can allow you to claim VAT back on business expenses. However software startups like ours tend to sell a lot and buy relatively little, so this doesn’t favour us much at all.
Usually when you sell an item, you don’t have to pay VAT if the customer is outside the EU. However, as we distribute our Construct 2 licenses digitally, HMRC have decided we have to pay VAT on all our sales regardless of where the sale originated. We phoned up HMRC, who passed us on to their technical team, who then advised us to write in with our queries which we did to confirm all of this.
This is now where we get slapped round the face with the big moth-eaten tax rule book where the Internet has not yet been prophesised.
If we send a physical CD in the post with a Construct license on it, this would count as a physical good. We wouldn’t have to pay VAT on the sale if the customer is outside the EU. Thanks for buying Construct 2! We’ve followed AOL’s footsteps and decided to send it to you as a CD in the post!
If we were to send the license file in paper format, this could possibly also count as a physical good. Thanks for buying Construct 2, here’s your license certificate, please copy all 9 lines out to a text file without making any mistakes at all!
And if we simply send an email, we get charged significantly more tax.
Suppose it costs on average £4 to post said CDs and/or paper licenses to a customer in USA. Suppose we sell a business license there, currently £229. We could save £34 by sending a CD instead of emailing them. Not a bad saving for a few minutes work.
So we have a couple of options:
- Email the licenses, pay the VAT and suck up a big loss
- Send CDs and paper licenses to customers not in the EU
Option 1 is very expensive. Option 2 saves us a lot of money but has other downsides:
- No one wants a stupid CD with 1kb text file on it (if it takes 2 weeks to deliver this it is an average data transfer rate of 1 bit every 2.5 minutes, it’d be quicker to beep at them down the phone)
- No one wants a paper license certificate
- It wastes our time
- It wastes customers time
- It could confuse customers (why am I entering my physical address to get an email? Why do I have both an email and a CD?)
- We could actually lose sales, since customers might not want to enter their address (it shouldn’t be necessary after all)
- It’s environmentally wasteful (an airmailed CD with a 1kb text file on it)
- It’s ridiculous we’re put in this position by nonsensical laws
It’s not exactly an easy choice to make. The majority of our sales come from outside the EU. The second option is ridiculous, but could save enough money to hire someone. The first option is the most practical, but could cost us thousands of pounds.
HMRC failed to respond to a question about whether we’re allowed to email the customer a license file as a backup, in addition to posting them the CD. So there would still be a few details to iron out if we did decide to start mailing out CDs. It’s frustrating to figure out what we should do when HMRC themselves can’t tell us.
As two young and highly motivated founders, the option of moving our whole business to the US (where both culture and legislation are supportive of startups) is becoming increasingly tempting and actually seems like an exciting opportunity and adventure. New startup visas to the US are helping make the option increasingly viable.
Maybe this is why the UK is lacking well known software companies. It’s expensive, we have tax laws that desperately need updating, and HMRC don’t have all the answers (the ones they do imply silly tradeoffs). We hear a lot of noise from the UK government about how keen they are to help startups. But how can we stay competitive with US companies when we have to deal with all this, and they don’t?
Disclaimer
This is my completely unqualified opinion and should not be treated as advice or as a reliable source of information. If you have your own businesses please do not act on anything I have written here without seeking professional advice!