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The OECD's Digital Tax Proposals Explained

by Ulrika Lomas,, Brussels

18 September 2014

The Organization for Economic Cooperation and Development (OECD) on September 16, 2014, released its report on the tax challenges of the digital economy. Of the seven base erosion and profit shifting (BEPS) deliverables released so far, this report is unique in that it deals squarely with both direct and indirect tax matters. It aims to provide a foundation for the development of several other Actions, forming a fundamental element of the OECD's Action Plan.

At its press conference to announce the first batch of recommendations, the OECD pointed out that the report has received unanimous political backing from all high-level BEPS stakeholders – unlike other deliverables released on September 16; but it is also a work in progress. Many of the recommendations are not final, but they do, meanwhile, provide a glimpse into policymakers' intentions on what future global tax rules for the digital economy should look like.

A supplementary progress report is to be released in December 2015, to coincide with the completion of the BEPS project. The Task Force on Digital Taxation, after completing its report, will now act in an advisory capacity to other BEPS working groups in the development of their proposals into next year.

Introducing its report, the OECD said: "The spread of the digital economy poses challenges for international taxation [and] because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes."

"Certain business models and key features of the digital economy may exacerbate BEPS risks. These BEPS risks will be addressed by the work on the other Actions in the BEPS Action Plan, which will take the relevant features of the digital economy into account."

The report is divided into direct and indirect tax segments, which aim, on the one hand, to ensure tax accrues to the location where economic activities are undertaken and value is created, and, on the other, to enable countries to effectively administer goods and services tax/value-added tax (GST/VAT) on goods and services sold or rendered to consumers online.

On the VAT front, the report highlights that very few base erosion and profit shifting issues actually arise with regards to VAT; BEPS issues are generally limited to cases where countries have yet to implement the OECD's place of taxation Guidelines for business-to-business (B2B) supplies of services and intangibles, the OECD said, and the report therefore recommends that countries adopt this framework.

However, the report acknowledges, more generally, that global tax rules have failed to keep pace with technological advances, and highlights a number of circumstances in which it is presently impossible for countries to effectively administer GST/VAT, regardless of domestic tax frameworks. It says, in particular, that "the collection of VAT in business-to-consumer (B2C) transactions is a pressing issue that needs to be addressed urgently to protect tax revenue and to level the playing field between foreign suppliers relative to domestic suppliers."

VAT rules that were introduced before the advent of the internet provide for concessionary treatment for online suppliers to foreign consumers to the detriment of domestic sellers. These supplies are generally either exempt, if the supply is of low value, or taxed in the place where that supplier is based, under the "origin principle," which has in turn encouraged multinationals to establish operations in jurisdictions with a low rate of, or no VAT.

Meanwhile, on direct tax, the report highlights the importance of tax rules on the digital economy in its work on Action 7 of the BEPS Action Plan (preventing the artificial avoidance of PE Status), as well as several Actions concerning transfer pricing and controlled foreign corporation (CFC) rules.

A resounding message in the whole report is the need for enhanced rules on the taxation of, and allocation of revenues from intangibles. It agrees the urgent need to agree on the characterization of digital supplies for tax purposes, and for policy makers to respond more quickly to new business plans and structures as they emerge.

"Many BEPS structures adopted by participants in the digital economy involve the transfer of intangibles or rights to intangibles to tax-advantaged locations," the report says. "It is then often argued that these contractual allocations, together with legal ownership of intangibles, justify large allocations of income to the entity allocated the risk, even if it performs little or no business activity." These issues will be tackled by measures to resolve issues related to nexus, data, and characterizations, it says.

The report proposes a number of solutions to be further debated and investigated before December 2015, which again can be divided into direct tax and indirect tax matters.

On VAT, the report says the first challenge regarding the collection of VAT arises from the growth that has occurred in e-commerce and, in particular, online purchases of physical goods made by consumers from suppliers in another jurisdiction:

"Countries with a VAT collect tax on imports of goods from the importer at the time the goods are imported using customs collection mechanisms. Many VAT jurisdictions apply an exemption from VAT for imports of low value goods as the administrative costs associated with collecting the VAT on the goods is likely to outweigh the VAT that would be paid on those goods. The value at which the exemption threshold is set varies considerably from country to country but regardless of the threshold value, many VAT countries have seen a significant growth in the volume of low value imports on which VAT is not collected. Challenges arise from the ability of businesses to deliberately structure their affairs to take advantage of a country's low value thresholds and sell goods to consumers without the payment of VAT."

The report suggests that: "If tax authorities were to make significant improvements to the efficiency of processing such low value imports and of collecting the VAT on such imports, Governments would be in a position to lower these thresholds and address the issues associated with their operation. This could notably be achieved by requiring non-resident vendors of low value parcels to charge, collect, and remit the tax on the imports of these goods in the importing jurisdiction."

It says: "Compliance by non-resident suppliers with their tax obligations in the country of importation would need to be facilitated through simplified registration and compliance mechanisms, using the possibilities offered by new technologies (for example, online registration and filing, electronic payment)."

"The second challenge regarding collection of VAT," it continues, "arises from the strong growth in cross-border B2C supplies of remotely delivered services and intangibles."

"The digital economy has increasingly allowed the delivery of such products by businesses from a remote location to consumers around the world without any direct or indirect physical presence of the supplier in the consumer's jurisdiction. Such remote supplies of services and intangibles present challenges to VAT systems, as they often result in no or an inappropriately low amount of VAT being collected and create potential competitive pressures on domestic suppliers."

"The supplies are made mainly to consumers who can access the digital content through their computers, mobile devices, and televisions that are connected to the Internet. If the supplier is resident in the same jurisdiction as its customers, it would be required to collect and remit that jurisdiction's VAT on the supplies. However, if the supplier is a non-resident in the consumer's jurisdiction, issues may arise."

Discussing the distortions caused by the origin principle – under which supplies are taxed in the location of the supplier, rather than the consumer – the OECD says countries should look to the destination-based system being rolled out in the European Union to tax B2C sales in the location of the recipient from 2015 and initiatives such as its mini One Stop Shop, which allows for VAT registration and administration in a single country.

The report states: "It is recognized that requiring non-resident suppliers to register and account for VAT in as many foreign jurisdictions as they have consumers of remotely delivered services and intangibles may impose compliance burdens on these suppliers, which may weigh particularly heavily on small and medium enterprises. Countries should therefore ensure that simplified registration mechanisms are sufficiently clear and accessible, so that non resident vendors... may easily comply, thereby eliminating the need for registration thresholds."

"Improved international co-operation between jurisdictions will be required to address these challenges. This should include enhanced exchange of information, assistance in recovery, and simultaneous audits. The Convention on Mutual Administrative Assistance in Tax Matters, which was developed jointly by the Council of Europe and the OECD, also covers VAT matters and provides a useful platform for developing such improved international co-operation."

Concluding its chapter on indirect tax matters, the OECD said that a Working Party in charge of releasing OECD International VAT/GST Guidelines has already begun work with respect to reforming rules on remote digital supplies to consumers. It said that, in parallel to this work, the Working Party will be tasked with addressing issues concerning the exemption for imports of low value goods.

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