Graham Busch
Identifying appropriate tax rules to deal with digital business has been designated the number one action in the Base Erosion and Profit Shifting (BEPS) Action Plan and is perhaps the hardest tax problem faced by the OECD. Addressing the challenges posed by the digitalisation of the economy continues to be tackled on the one hand by countries on a unilateral basis, and on the other hand by the OECD on a global basis. Numerous countries have announced their own versions of a Digital Services Tax (‘DST’), essentially a tax on revenues rather than on profits, which they perceive are being economically generated in their respective countries. The OECD meanwhile has published consultation documents to implement a global digital tax on nexus and profit allocation rules and set out the continuing work towards a consensus-based, long-term global solution.
G20, OECD and EC
More than five years ago, the G20 and OECD identified the challenges of the digital economy as a key part of the action plan for the ‘BEPS’ project. So key, in fact, that it was labelled as Action 1. The issue was clear: our global tax system was designed with traditional business in mind. Today, many business models can operate with very little physical presence, and exponential growth in technology has left the traditional system of taxing profits according to jurisdictional splits of functions
at best running to catch up, and at worst, no longer fit for purpose. When the initial BEPS recommendations were published in October 2015, there was no specific policy recommended to deal with this ‘digital’ problem. At the time, the OECD suggested that changes to other action areas should be implemented first and it would then revisit the issue in 2020.
The EC has also published its findings. The EC proposed a new taxable presence threshold of Significant Digital Presence (‘SDP’) which would act as a new permanent establishment concept and allocate profits accordingly. However, the EC also noted the need for an interim measure — a DST. It recommended a 3% revenue-based DST, levied on the gross revenues of certain large digital businesses. The recommendations included thresholds to ensure that only large businesses were impacted and several business models such as e-tailors, communication or payment services, and crowd funders, were excluded from their scope.
UK
The UK Government, along with other countries, feel that progress at G20, OECD, and EC level has not been fast enough. As a result, unless international consensus can be reached before implementation date, the UK will introduce a DST from 01 April 2020. Here is an outline of how the DST is intended to apply. It closely follows the EC proposals in many ways, although appears to be narrower in scope:
- DST will be levied at 2% on gross revenues of specific digital activities, where these revenues are linked to the participation of UK users.
- The three business models that will be ‘in scope’ are: search engines, social media platforms, and online marketplaces. This seems to be purposefully narrower than EC proposals.
- DST is not intended to penalise the UK user, or be a tax on online business. The tax will apply to revenues earned from the intermediation of sales where UK users have driven the value allowing for those sales to take place.
- A ‘double’ threshold will be in place to ensure DST only impacts the largest digital businesses. Only groups with global revenues from in-scope business models exceeding GBP 500 million (approx. EUR 550 million) will fall within scope, and the first GBP 25 million (approx. EUR 27.5 million) of relevant UK revenues will always be exempt.
- Safe harbours will be in place so that loss-making businesses do not suffer DST and lowprofit-margin businesses will be charged at a reduced rate.
- DST is intended to be temporary, until international consensus is reached; and there is a commitment to review its necessity in 2025 if it is still inactive by then.
More about DST
DST is a radical divergence from several well-established international tax principles. It is a tax on gross revenues (rather than profits). This completely disregards the overarching principle that tax follows profits, and that profits should be split on an arm’s length basis between jurisdictions, based on the activities carried out by the employees of the multinational enterprise. DST could apply where, under current traditional methods, profits are allocated outside of the relevant country to where they suffer less tax, and may not have a UK taxable presence, other than, critically, the customer base.
The overall aim of DST is to ensure that digital businesses pay tax reflecting the value they derive from the participation of local users. Analysis shows how interaction with users can create value for certain highly digitalised business and is a challenge to fairness and acceptability of the tax system. However, a revenue-based tax such as the DST is a blunt instrument that cannot accurately represent the tax on the profits related to user-based value on all businesses on which it is imposed and will inevitably over-tax some companies and under-tax others. Practical difficulties will arise from the tax. In practice, governments will have to rely on companies to estimate the amount of the DST payable based on a just and reasonable estimate of relevant revenue. Problems also inevitably arise from unilateral actions: potential double taxation and significant compliance burdens for businesses, which would stifle economic growth and innovation. Double taxation is a particular concern, as it is unlikely that cross-border tax credits will be granted in the ‘other’ country.
There is also a negative impact on the competitiveness of countries introducing unilateral measures.
Recent Developments: Update September 2019
It appears that the OECD may be moving faster in that discussions are already progressing around three ways of addressing their G20 mandate:
- A digital only solution;
- A broader solution that might look to more market-based taxation (including allocation to marketing intangibles); and
- A minimum tax (e.g., denial of deduction on outbound payments if a certain effective tax rate (‘ETR’) threshold of the payee is not met).
There may also be a more general study of PE concepts relating to each of these items. In addition, it is unclear what role the arm’s length standard and traditional transfer pricing will play in this. We have also witnessed the first salvo being fired in the digital tax war, in this case between France and the United States. The large US tech companies were up in arms (so far only figuratively, thankfully) with the French government regarding their proposed 3% DST. President Trump himself flexed his muscles, threatening higher trade tariffs on French exports to the US. Whilst a temporary solution appears to have been found, it is likely this is only the first of many such disputes between multinationals and DST-introducing countries.
Conclusion
There is strong support for longterm reform of the international tax system to address the perceived challenges arising from the digitalisation of the economy. All those involved should be encouraged to re-double their efforts to achieve a consensus on the way forward because we are increasingly facing an international tax landscape of unilateral actions being taken independently by countries (including the UK). Understanding that different countries have different aims and objectives in relation to the digitalised economy, unilateral measures inevitably lead to less alignment of tax bases globally, resulting in double taxation and a significant compliance burden and, consequently, stifling economic growth and innovation. This may result in retaliatory measures (the US threatening increased tariffs against France, for one), and, perversely, the differences between tax systems resulting from unilateral actions are likely to give rise to arbitrage/tax-planning opportunities, thus increasing the problems caused.
Hopefully further consultations will mean that challenges regarding business models and revenue streams that should be in or out of scope can be well defined and due thought can be given to tax collection and logistics. Only time will tell whether it takes helpful steps toward tackling the challenges of the digital economy or distorts the tax system in an uncooperative way.
XLNC MAGAZINE | No. 04 | November 2019