Taxing digital giants

AS the digital economy expands, governments across the globe are striving to ensure tax fairness and protect domestic revenues. A key component of this effort is the imposition of Value Added Tax (VAT) on digital services provided by foreign suppliers such as Facebook, Google, Amazon, and Netflix. Platforms that generate substantial income from local markets without a physical presence.

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Sri Lanka will join this global trend by introducing VAT on digital services from 1 October 2025, the move marks a significant step in modernising the country’s tax framework in line with international best practices.

Why tax digital services?

In traditional economies, VAT is applied at the point of sale where goods or services are consumed. However, in the digital world, global platforms often escape VAT obligations by operating remotely. This results in a tax gap where foreign companies profit from local consumers while avoiding local tax obligations, a situation that undermines both revenue collection and competitive equity for domestic service providers.

International organisations such as the OECD have advocated for the “destination principle” in VAT systems, which states that tax should be levied in the country where the consumer resides, regardless of where the supplier is located.

The role of Reverse Charge Mechanism (RCM)

In many countries, the Reverse Charge Mechanism is used to ensure VAT compliance in Business to Business (B2B) cross-border transactions. Under this model, the buyer (recipient) of a digital service is responsible for VAT, not the foreign supplier.

Examples of Countries Using RCM for Digital Services:

UK, Singapore, India, New Zealand, South Africa, UAE, Norway

In these jurisdictions:

B2C transactions require the foreign supplier to register and collect VAT.

B2B transactions use reverse charge where the recipient business declares and pays VAT locally, often with no cash flow impact.