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The Digital Tax Puzzle


By Tax-News.com Editorial
April 8, 2019


The tax challenges of the digital economy are seemingly being tackled at multiple levels. On the one hand, countries are working collectively under the umbrella of the OECD to reach a consensus on new international tax rules for a digitalized business world. But on the other, several countries are undermining this process by forging ahead with solutions at national level. And in the middle is the United States threatening legal action against those governments acting unilaterally. This article therefore attempts to make sense of the digital tax landscape, looking at the evolution of the debate, the working being done by the OECD, and developments at national level.

BEPS Action 1

Addressing the tax challenges of the digital economy is a key aspect of the OECD's base erosion and profit shifting work. This is attempting to: adapt corporate tax rules designed largely in the first half of the 20th century to a globalized and increasingly digitalized world in which national borders have become almost meaningless in the context of international commerce; and tackle the exploitation of gaps in this outdated tax system to prevent widespread (but largely legal) avoidance of taxation on cross-border transactions. This project was launched in 2013 with the publication by the OECD of a 15-point BEPS Action Plan, and culminated in the release two years later of its final recommendations. The BEPS project is now firmly in its implementation phase.

The problem, as the OECD observed in the final report for Action 1 of the BEPS project (Addressing the Tax Challenges of the Digital Economy), is that many of the key features of the digital economy, particularly those related to mobility, generate BEPS concerns in relation to both direct and indirect taxes.

The OECD has argued since the commencement of the BEPS project in 2013 that, as the digital economy is increasingly becoming the economy itself, this challenge should be tackled by changes to existing tax rules, rather than the introduction of special "digital taxes." This viewpoint was reemphasized by the Paris-based body when it issued its interim report on the topic in March 2018. Some governments, as explained later in this article, are thinking along entire different lines.

The OECD and the multilateral discussions

That the OECD is continuing to work on the digital tax problem long after the publication of its final BEPS recommendations in October 2015 is a testament to how challenging this issue has become. Nevertheless, it remains committed to announcing new proposals for the taxation of the digital economy in 2020, an objective that was restated at the January 23-24, 2019, meeting of the BEPS Inclusive Framework, which includes 125 countries and territories.

At the meeting, the Inclusive Framework agreed to focus discussions on two central pillars. First, how existing rules that divide up the right to tax the income of multinational enterprises among jurisdictions, including traditional transfer pricing rules and the arm's length principle, could be modified to take into account the changes that digitalization has brought to the world economy. This will require a re-examination of the so-called "nexus" rules – namely how to determine the connection a business has with a given jurisdiction – and the rules that govern how much profit should be allocated to the business conducted there.

According to the OECD, the Inclusive Framework will look at proposals based on the concepts of marketing intangibles, user contribution, and significant economic presence and how they can be used to modernize the international tax system to address the tax challenges of digitalization.

Second, the Inclusive Framework will seek to resolve remaining BEPS issues and will explore two sets of interlocking rules, designed to give jurisdictions a remedy in cases where income is subject to no or only very low taxation.

National developments

Problematically for the OECD however, while the majority of its members are, in the interests of certainty and stability in the international tax framework, in favour of a multilateral solution focusing on changes to existing corporate tax rules, some have grown impatient at the lack of progress towards an international agreement. Several jurisdictions have therefore proposed special "interim" tax measures that apply until internationally-agreed solutions are brought to bear.

European Union

Arguably the most significant attempt at a unilateral digital tax was the European Commission's two-part proposals for an EU-wide tax, published in March 2018.

Under this proposal, a digital platform would be deemed to have a taxable "digital presence" or a virtual permanent establishment in a member state if it fulfills one of the following criteria:

  • It exceeds a threshold of EUR7m (USD8m) in annual revenues in a member state;
  • It has more than 100,000 users in a member state in a taxable year; or
  • Over 3,000 business contracts for digital services are created between the company and business users in a taxable year.

The second, temporary, measure is intended to ensure there is at least a harmonized EU approach to digital taxation, in the absence of a global agreement. This entails the introduction of an interim tax, with a three percent rate, which would apply to revenues created from certain digital activities that escape the current tax framework entirely.

The tax is intended to apply to revenues created from activities where users play a major role in value creation and those that are the hardest to capture with current tax rules, such as those revenues:

  • Created from selling online advertising space;
  • Created from digital intermediary activities, which allow users to interact with other users and which can facilitate the sale of goods and services between them;
  • Created from the sale of data generated from user-provided information.

Under the proposal, tax revenues are to be collected by the member states where the users are located. Companies with total annual worldwide revenues of at least EUR750m (USD854m) and EU revenues of EUR50m would be required to pay the tax.

The EU was aiming for a consensus among member states on these proposals by the end of 2018. However, certain member states were strongly opposed to the idea, and talks broke down without an agreement at the March 12, 2019 meeting of EU finance ministers. A compromise proposal put forward by the then Austrian EU presidency in December 2018 that the tax target revenues from the supply of digital services where users contribute to the process of value creation was also rejected. Likewise, a recommendation by France and Germany that the tax base focus on just advertising services was also rebuffed.

According to a Council statement, "despite the broad support from a large number of member states on this text, some delegations maintain reservations either on some specific aspects of the proposal or more fundamental objections."

United Kingdom

As announced at Budget 2018 on October 30, 2018, from April 2020, the UK Government will introduce a new two percent tax on the revenues of certain digital businesses which derive value from their UK users. The tax will apply to revenues generated by search engines, social media platforms, and online marketplaces that are linked to the participation of UK users, subject to a GBP25m (USD33m)-per-year allowance. It is intended that the measure will be legislated for in the 2019/20 Finance Bill after a public consultation exercise.

Spain

In 2018, the Spanish Government included plans for a digital services tax in its Budget for 2019. Under the measure, a three percent tax would be imposed on certain digital services provided by companies with global sales exceeding EUR750m and sales of more than EUR3m within Spain. Revenue from the selling of online advertising, digital intermediary and brokerage services, and personal data would be included in the scope of the law.

However, the rejection of the Budget bill in parliament in February 2019, a move which triggered the calling of fresh elections, scheduled for April 2019, has cast considerable doubts about whether the digital tax will be legislated for.

Italy

A new tax on revenues derived from the provision of certain digital services was included in Italy's Finance Law 2019, which was approved by parliament in December 2018.

The digital tax will be levied at a rate of three percent and will apply to companies with at least EUR750m in total revenue and at least EUR5.5m in revenue from selling certain digital services in Italy, such as online advertising and personal data.

The tax, which is expected to be in place this year, will need to be implemented by decree. The Government is expected to release further details on its operation and scope.

France

With the EU digital tax talks on the brink of breaking down, on March 6, 2019, French Finance Minister Bruno Le Maire presented at a press conference new legislation for a tax on the revenue of certain companies providing digital services in France. Le Maire confirmed that a single three percent tax will be imposed on digital companies providing advertising services, selling user date for advertising purposes, or performing intermediation services. Companies with global revenues of EUR750m or more and French sales of at least EUR25m will be required to pay the tax.

The tax is intended to apply form turnover realized in France since January 1, 2019 and will remain in place until a multilateral agreement on new global digital tax rules has been reached.

Austria

Austria is one of the latest countries to announce plans to proceed with a national digital tax following the collapse of the talks on the EU measures. As such, the Government has convened an expert panel to discuss the design of a digital tax, and this was scheduled to hold its first meeting on March 19, 2019.

Commenting on the proposals, State Secretary of Finance Hubert Fuchs said: "In Austria, companies pay corporation tax depending on their profits. Now, however, it is the case that major digital corporations in Austria report only very minimal profits. These are reduced as a result of global profit shifting. Profit-based taxation of major digital corporations is therefore ineffective. To compensate for this, therefore, in future, digital corporations will have to pay a digital tax."

The Government also said that the tax rules are being examined in two other areas as part of the digital tax package recently adopted by the Cabinet. These include the taxation of companies operating in the sharing economy, and deliveries to private consumers from third countries by online mail order. "Substantive" conclusions on these discussions are expected to be reached in the coming weeks, the Government confirmed.

However, while Austria has decided to pursue a national digital tax, Loeger said in his comments that the Government continues to support a multilateral solution to the tax challenges posed by the digital economy and is engaged in "intensive discussions" with France and Germany on the matter.

New Zealand

On February 18, 2019, the New Zealand Government announced that it is considering the introduction of a digital services tax. According to the announcement, these proposals will be released in a discussion document – likely in May – to "ensure that multinationals pay their fair share of tax in the country."

Revenue Minister Stuart Nash said that the Government would prefer to find an internationally agreed solution to the challenges presented by the digital economy, under the auspices of the OECD. However, he stressed that the Government also believes that it needs to "move ahead with [its] own work." Therefore, New Zealand would "proceed with our own form of a digital services tax, as an interim measure, until the OECD reaches agreement," Nash explained.

Finance Minister Grant Robertson added: "Highly digitalized companies, such as those offering social media networks, trading platforms, and online advertising, currently earn a significant income from New Zealand consumers without being liable for income tax. That is not fair, and we are determined to do something about it."

Australia

Australia on the other hand, seems to have decided to buck what looks to be an emerging trend in favor of unilateralism, and on March 20, 2019, the Government announced that it will not pursue the introduction of a digital services tax.

The decision follows a consultation exercise last year on the merits and disadvantages of Australia pursuing an interim, unilateral approach to the tax challenges presented by the digitalization of the economy. This sought feedback on whether a tax should be applied to digital advertising and/or intermediation services.

According to Treasurer Josh Frydenberg, the Government has opted not to proceed with such measures as a result of the feedback received during the consultation period. Frydenberg said that many submissions "raised significant concerns about the potential impact of an Australian interim measure across a wider range of Australian businesses and consumers, including discouraging innovation and competition, adversely affecting start-ups and low-margin businesses, and the potential for double taxation."

Frydenberg said that the Government would continue to focus its efforts on engaging in the multilateral process.

The United States

For its part, the United States is strongly opposed to unilateral digital tax measures on the grounds that they depart from the long-held principle that taxes should target profits not revenues and target primarily US-based companies. Treasury Secretary Steven Mnuchin has also said that global tax reforms should include a wider base of companies with significant levels of highly mobile intangible income, rather than firms operating mostly in the digital domain.

Reemphasizing the importance of the multilateral discussions, Mnuchin said in a statement issued in October 2018 that: "Treasury is working very closely with the OECD and our counterparts there to address issues of base erosion and fair taxation. We believe the issues are not unique to technology companies but also relate to other companies, particularly those with valuable intangibles."

He continued: "I highlight again our strong concern with countries' consideration of a unilateral and unfair gross sales tax that targets our technology and internet companies. A tax should be based on income, not sales, and should not single out a specific industry for taxation under a different standard. We urge our partners to finish the OECD process with us rather than taking unilateral action in this area."

Interestingly, in a meeting with French Finance Minister Bruno Le Maire in late February 2019, Mnuchin expressed support for the idea of a global minimum corporate tax, an idea that is gaining traction in a number of countries, particularly France, Germany and other EU member states. However, he reiterated that the US is "not in favor of the kind of digital tax that is being proposed [in France].

Indeed, speaking to reporters ahead of international discussions on taxing the digital economy at the OECD in Paris on March 12-13, 2019, a senior Treasury official said that the US Government is now investigating possible legal remedies to national digital taxes. Describing such levies as "highly discriminatory, Chip Harter, Deputy Assistant Secretary for International Tax Affairs at the Treasury Department, said: "Various parts of our government are studying whether that discriminatory impact would give us rights under trade agreements, WTO, treaties."

Several influential members of the US Congress are also worried about the spread of proposed national digital taxes, including leaders of the United States Senate Committee on Finance. These concerns were relayed to Mnuchin in a letter signed by the leading Republican and Democrat on the committee on January 30, 2019, in which they noted "unilateral attempts at targeting US-based multinational companies with a digital services tax."

"Unfortunately, some countries are moving forward unilaterally with digital services taxes that follow similar frameworks as the previous European Commission proposal," the senators wrote. "It is important for these countries to understand the potential for long-term harm arising under these proposals and the need for each to refocus efforts on reaching multilateral consensus."

What does it all mean?

For businesses potentially caught by new digital taxation measures, all this adds up to a confusing and unpredictable future tax landscape, especially as not all digital taxes are born equal, and we cannot be certain how such levies will operate in practice. What's more, businesses themselves have warned that the proliferation of national revenue-based digital tax measures represents an alarming shift from long-established international tax norms that could distort trade and threaten investment.

On the other hand, governments, many of which are struggling to fund public services, argue that allowing large companies to continue dramatically reducing their exposure to income taxation by effectively separating value-creation from taxable profits can no longer be tolerated, hence the need for new taxes, despite the fact that an international agreement may be just a year away. However, there is by no means a consensus that unilateral measures are the way to go, as demonstrated by the US Government's harsh criticism of the French and other national-level taxes, the blocking of the EU interim digital services tax by several member states, and Australia's rejection of a national digital tax.

Another concern is that while national digital taxes are often intended to be temporary until the OECD's future recommendations are implemented, not all governments have explicitly stated as such. The UK is one example, where businesses are now urging the Government to ensure that an expiry clause is inserted into the digital legislation when it is put before parliament.

Furthermore, while it is assumed that an international agreement will be forthcoming in 2020, this is by no means a given. It might be the case that additional time will be needed for a consensus among countries to be arrived at, although just how much longer might be needed is anyone's guess at present. More worryingly, the EU's experience demonstrated that governments can be sharply divided on this matter. And, if an international agreement is reached, either on time or at a later date, there is no guarantee, either, that the recommended measures will be legislated for consistently from one jurisdiction to another, or indeed, legislated for at all. Indeed, the uneven implementation of the wider BEPS recommendations is one of the key challenges facing multinational companies today.

 

Tags: tax | services | business | BEPS | Finance | France | Australia | Austria | United States | New Zealand | Italy | Europe | Germany | legislation | European Commission | Spain | Tax | trade | transfer pricing | corporation tax | United Kingdom

 

 

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