Generative AI and VAT

26 September 2023

Artificial Intelligence (AI), and in particular large language models (LLMs) that create generative AI, are certain to make many changes in society and the business world over the next few years. According to RSM UK’s latest ‘The Real Economy Report’, there’s already significant adoption of the technology, with 45% of middle market businesses actively using generative AI, whilst 37% are experimenting with generative AI. Businesses also see the benefits of generative AI, with 77% of those surveyed saying they think the technology can improve their business. 

AI already affects how we deliver services, either by enhancing the quality of our written communication or replacing human interventions for highly repetitive or mundane tasks, and its use and impact in our everyday lives look set to increase rapidly. 

The significant cost of training an LLM means that such technology will usually be provided on an outsourced basis. This brings questions about the VAT treatment of the systems themselves – could VAT be due on ChatGPT support if it replaces a human being? And what happens when that support is supplied cross border?

For most (but by no means all) VAT or goods and services tax (GST) regimes, the default rule is that indirect tax on cross-border sales to businesses is the customer’s responsibility. This means that if you’re a UK business and your customer is outside the UK then there’s no need to charge them UK VAT. Instead, your business customer accounts for the VAT as a ‘reverse charge’ on their local VAT return, usually a relatively straightforward procedure. However, there are exceptions to this rule, one of which relates to ‘electronically supplied services’ which are taxed where the services are used and enjoyed. 

Of course, in some (and perhaps most) cases the customer’s location is precisely where the AI service will be used. In that event there is no issue. However, what if a US multinational organisation with branches in the UK and elsewhere in the world has outsourced its IT support to a UK company? Instead of the supply being deemed to take place in the USA, it is quite possible that there is some UK use in that scenario, creating a UK VAT risk. The question then becomes how to measure and value use, how to invoice and how to justify the approach you have adopted with HMRC.

While it is currently rare for generative AI to be used as a standalone support solution, it will usually be used to enhance quality and improve the efficiency of a service. However, it seems likely that the role of generative AI in the provision of services will increase and there may come a tipping point when the nature of the service prompts a reconsideration of the VAT treatment. AI therefore looks set to become the next battleground in the constant conflict of trying to apply the VAT rules to technology that simply wasn’t on the radar when the indirect tax legislation was first written.