12 Sep TAX3 Hearing on digital taxation
On Monday 10 September, the TAX3 Special Committee met with Mr. Eric Robert, advisor on BEPS, Taxation and the Digital Economy for the OECD, and Mr. Bart Van Raaij and Eduard Folch Sogas from the Directorate General for Taxation and Customs Union (TAXUD) of the European Commission.
One of the problems when discussing the digital economy is that there is generally no recognition that the problem is broader, as it relates to economic relations and activities that have been digitalized. The problem is not necessarily within a sector (i.e. the “technological sector”), but relates to, for example, companies selling their goods and services in a country where they don’t have physical presence, companies gathering data to be sold to other companies to be used to profile customers for clients selling products from different countries, companies selling internet advertising, companies providing a digital interface where people connect to each other, and even companies working on research and development from different countries through internet.
Therefore, as it was rightly pointed by the OECD representative during the hearing, the accounting and thus taxing problems are no different than those used by other less digitalized businesses, and there are therefore few new issues raised. One of such issues is the heavy reliance on user participation or on intangibles of the digital sector, which exacerbates current tax avoidance issues.
The role of the OECD
OECD BEPS Action Plan identified, on its Action 1, some of the problems of taxing the digital economy by 2015, and recognized 3 possible options:
– Modifying double tax treaties to include a definition of permanent establishment (“PE”) based on the existence of significant economic presence.
– Modifying double tax treaties including a provision regarding the use of a withholding tax at source on gross payments,
– Introducing of an unilateral tax to compensate the inability of countries to impose a tax under the existent double tax treaties
After BEPS Action Plan, there was an acknowledgement that there was a need to further work. Such work was then decided to be coordinated by a TASK Force, in the context of the G20/OECD Inclusive Framework, oriented among other things to the discussion of how should the nexus concept of linking taxation to a significant economic presence be applied to the digital economy and how to generate consensus among different countries.
For this purpose, the OECD launched a consultation in October 2017 to which a lot of people, organizations and companies replied. The BEPS Monitoring Group noted that the failure to agree on principles for allocation of profit ‘where economic activities occur and value is created’ has led to the proliferation of unilateral measures such as diverted profits taxes and equalisation levies; and special taxes for internet based firms are being considered in many countries. However, all these are clearly only partial and interim solutions, as it is necessary to think more broadly.
Jeffery Kadet (an expert member of the BEPS Monitoring Group) noted that it was clear that an accumulated user base and the accumulated data on that user base are identifiable assets that could be used to identify a sufficient enough presence to justify a taxable nexus. Mr Kadet recommended that the Task Force consider practical “best practice” approaches for determining some minimal level of digital presence that would be treated as a PE; and also that user base and/or the accumulated data on that user base (including website content created or posted by that user base) be considered as appropriate factors in applying the profit split method.
However, even when the OECD’s public consultations have helped gathering comments from different types of institutions and experts, the OECD/G20’s Inclusive Framework is not the United Nations. Even when it gathers more than 200 countries, such countries have not participated on the decisions (BEPS Action Plan) as they are mostly non-OECD/ G20 Members, but have been pushed by the OECD to implement the solutions identified by the club of rich countries.
Eric Robert, commented that during and after the BEPS Action Plan discussion, there was an agreement that there were further tax challenges also in relation to indirect taxation of the digital economy. Therefore, after recommendations from the OECD, approximately 60 countries around the world have implemented solutions for VAT in the digital sector. Of course, when Tax Authorities are not able to collect taxes from multinational companies or the High Net Worth Individuals, Tax Authorities tend to orient to the easier targets which tend to be consumers, small and medium enterprises and workers.
VAT is a very regressive tax, as consumers of different income levels pay it at the same level, affecting proportionally more those consumers with a lower income. But also, part of the problem of VAT is that on more than one occasion, elements of the basic food basket, health products, books and educational products are taxed with VAT, while other luxury goods end up being exempted because of the incapacity of governments to tax such products if they are delivered by a company that does not have physical presence in the country of the consumer. However, not having a solution in terms of VAT for the digital products and services rendered through internet can also be regressive; as a country may end up having a VAT on feminine hygienic products, but not on an iphone5 bought online.
In March 2018, the OECD’s Task Force published its Interim Report on the “Tax Challenges Arising from Digitalisation”. Part of the work related to BEPS Action Plan implementation and in particular to the practice regarding the solutions for the digitalised business model, after monitoring what was going on in the world in respect to actions implemented in different countries, for instance:
– India, the Slovak Republic and Israel who have introduced a definition of significant economic presence;
– The United Kingdom, who broadened the source definition in certain circumstances;
– Saudi Arabia has introduced a broad interpretation of “virtual service PE”, which endorses the view that the requirement of physical presence is no longer relevant for the application of the definition of the “Service PE” rule contained in Article 5 of the UN Model Tax Convention;
– Some countries adopted a withholding tax on fees for technological services, or income from online advertising;
– Other countries have introduced different types of turnover taxes, such as India’s equalisation levy on online advertising paid to a non-resident enterprise, Italy’s levy on digital transactions, Hungary’s advertisement tax, France’s tax on online and physical distribution of audio-visual content.
The interim report was approved in the G20 meeting held in Buenos Aires in March 2018. According to the OECD representative, the different position of different groups of countries can be grouped as follows:
– For one group of countries the problem is user participation, which requires a change in global rules;
– For 7 other countries, the existent tax system is not up-to-date, but the reform should not be restricted to the digital economy but should be broader;
– Another group of countries considers that there are no specific issues regarding the digital economy
Even when consensus has not been reached, and on 16 March 2018 -after the OECD’s report was published- the US warned the OECD about any unilateral move regarding the taxation of tech giants, the OECD representative in the TAX3 Hearing was optimistic as the US is now open to the discussion of these issues. Is the US “open for a discussion” now that the EU has prepared a proposal to tax the digital companies, a majority of which are of US origin?
The European discussion in context
In July 2017, France’s “Google Tax” was ruled illegal by a Paris court. The tax authority was not allowed to assume a PE of Google Ireland in France. Following what was evidenced as a problem to tax the GAFA companies (e.g. Google, Amazon, Facebook and Apple), in September 2017, some EU Member States (France, Germany, Spain, and Italy) called for an EU Equalisation tax.
On 21 September 2017, the Commission issued a Communication. And on 5 December 2017 the Council concluded favouring equalisation tax as a quick fix; highlighting the need to find solutions at the global (OECD) level (i.e. no quick solution at all); and noting that the PE definition should be reconsidered.
In January 2018, Italy introduced a levy on digital transactions consisting of a withholding tax of 3% on digital services delivered over the internet concluded with customer resident in Italy to be applied as of January 2019. In addition, it amended its PE rules understanding that economic presence without physical presence is considered to constitute a PE.
On March 21st, the European Commission presented a proposal for new rules to tax the activity of businesses in the digital economy.
On the European Commission’s Digital Taxation Proposal
According to the European Commission, digital businesses pay an average effective tax rate of just 9.5 %, compared with the 23.3 % that traditional businesses pay.
The European Commission has proposed both a short-term and a long-term solution, as it has observed that there are several individual solutions arising in EU Member States, which in the end could have other distortive effects, and there is a need to address this problem while awaiting that the OECD reaches a consensus.
- The long-term solution:
Also called the ‘comprehensive solution’, to be applicable as of January 2020, aims to address situations where companies offer digital services in a country, but member states cannot tax those activities, because the firms do not have a physical presence in that country.
The proposal affects corporate taxpayers that are incorporated or established in the EU, as well as enterprises that are incorporated or established in a non-Union jurisdiction with which there is no double taxation treaty with the Member State where a significant digital presence of the taxpayer is identified.
For the purpose of this proposal, ‘digital services’ means services which are delivered over the internet. The mere sale of goods or services facilitated by using the internet or an electronic network is not regarded as a digital service.
The solution proposes a definition of PE that considers for the purpose of corporate tax that a PE exists if a significant digital presence exists through which a business is wholly or partly carried on.
A ‘significant digital presence’ will be considered to exist in a Member State if the business carried on through it consists wholly or partly of the supply of digital services through a digital interface and one or more of the following conditions is met with respect to the supply of those services by the entity carrying on that business:
- It exceeds a threshold of €7 million in annual revenues in a Member State
- It has more than 100,000 users in a Member State in a taxable year
- Over 3000 business contracts for digital services are created between the company and business users in a taxable year.
The profits attributable to or in respect of the significant digital presence shall be those that the digital presence would have earned if it had been a separate and independent enterprise performing the same or similar activities under the same or similar conditions, in particular in its dealings with other parts of the enterprise, taking into account the functions performed, assets used and risks assumed, through a digital interface (i.e. the arm’s length principle is applied).
The measure could eventually be integrated into the scope of the Common Consolidated Corporate Tax Base (CCCTB) proposal that is still awaiting trilogue negotiations in order to see the light.
- The short-term solution:
Also called the “targeted solution”, to be applicable also as of January 2020, consists of a Digital Service Tax (“DST”) arising to a 3 % on gross revenues (a turnover tax) based on where a company’s users are located rather than where its headquarters is. This tax would apply to approximately 120-150 big tech companies that have a global turnover of more than €750 million and generate at least €50 million of taxable revenue inside the EU.
The following services by an entity shall qualify as ‘taxable revenues’ for the purposes of the Directive:
- The placing on a digital interface of advertising targeted at users of that interface when the entity placing the advertising does not own the digital interface, that entity, and not the owner of the interface, shall be considered to be providing a digital service;
- The making available to users of a multi-sided digital interface which allows users to find other users and to interact with them, and which may also facilitate the provision of underlying supplies of goods or services directly between users; though not including the making available of a digital interface where the sole or main purpose of making the interface available is for the entity making it available to supply digital content to users or to supply communication services to users or to supply payment services to users;
- The transmission of data collected about users and generated from users’ activities on digital interfaces, though not including the transmission of data by a trading venue, systematic internaliser or regulated crowdfunding service provider.
The revenues resulting from retail activities consisting in the sale of goods or services which are contracted online are outside the scope of the DST.
Member States are expected to allow businesses to deduct the DST paid as a cost from the corporate income tax base in their territory, irrespective of whether both taxes are paid in the same Member State or in different ones.
Where the users with respect of a given taxable service are located in different Member States or non-Union jurisdictions, the relevant taxable revenues obtained from that service should be allocated to each Member State in a proportional way on the basis of certain specific allocation keys. Such keys should be set out depending on the nature of each taxable service and the distinctive elements triggering the receipt of revenues for the provider of such a service.
The information shall be transmitted by the entity nominated by the multinational group to be responsible for fulfilling the obligations in one Member State, which shall afterwards transmit any notification received to the competent authority of each Member State where DST is due.
What can be said about the Proposal
- On the long-term solution:
The long-term proposal is still not broad enough as it is only targeted to companies rendering digital services, and therefore does not address the broader issue of a definition of “PE” that is otherwise still based on the existence of a physical presence.
The proposal should aim to better define where profits are actually made and where they should be taxed, as currently the proposal on profit attribution is based on the definition of functions, risks and assets, something which has been used in the context of the arm’s length principle to contractually allocate profits in the most convenient jurisdictions for tax purposes.
Moreover, as the proposal is not aimed at enterprises that are incorporated or established in a non-Union jurisdiction with which there is a double taxation treaty in force, the proposal may end up pushing for more double taxation treaties. Double taxation treaties have as an objective avoiding double taxation, and for that reason they have been used for double-non taxation.
- On the short-term solution:
As has already been mentioned by Oxfam, there are significant problems with the short-term solution proposed by the Commission. The measures proposed by the Commission – including a 3% turnover tax on tech giants – only target a handful of big tech companies, and will not prevent businesses exploiting our outdated tax system to systematically dodge billions of euros in tax every year. There are also concerns that governments will focus all their energy on delivering short term ‘headline grabbing’ wins at the expense of making progress on the long-term solutions that will deliver lasting change.
It is important to note that the entire economy is currently being digitalized. Even companies in more traditional sectors can quickly shift their profits or relocate intangible assets such as patents to tax havens in order to avoid paying their fair share of tax. Therefore, a broader solution needs to be thought, which considers a change in the definition of PEs; and such global solution can only be addressed in an empowered UN Tax Committee for it to be of value to all countries affected.
The OECD is manifestly against the EU setting an interim solution, as was observed by the position of the OECD representative speaking at the TAX3 hearing. While the European Commission notes that even when many have raised their voices against it, there are no any other alternatives on the table.
In this context, MEP Martin Schirdewan (DIE LINKE), GUE/NGL Coordinator on TAX3 and Shadow Rapporteur following the Digital Tax proposal in the ECON Committee inquired the speakers, among other things, on whether the OECD had determined a minimal level of digital presence that should be treated as a PE; and on the material incidence of the DST proposed by the European Commission.
The OECD representative replied that their interim report identified potential modifications to the nexus criteria in order to make it less constrained by physical presence. There is a recognition that the problem is not necessarily nexus, or the digital presence, but rather on profit allocation, and what changes are needed there. However, he did not specify more on the level of digital presence or non-physical presence that should be triggering a PE.
On their side, the European Commission representatives remained silent.
However, what became evident in this meeting were the huge lobbying efforts that the tech giants are making with both the OECD and the European Institutions, and with some political groups who aimed their questions more at the risks of double taxation than at the lack of a broader perspective that would allow to close the remaining loopholes available for tax avoidance in the current system.