TAX3 Hearing on digital taxation

Photo by Arthur Osipyan on Unsplash

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 issue is far broader, encompassing economic relations and activities that have been digitalised. 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 out by the OECD representative during the hearing that the accounting and thus taxing problems are no different from those used by other less digitalised businesses, and therefore fewer new issues are raised. One such issue is the heavy reliance on user participation or intangibles of the digital sector, which exacerbates current tax avoidance issues.

The role of the OECD

OECD BEPS Action Plan identified in its Action 1 some of the problems of taxing the digital economy by 2015, and recognized three 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 a unilateral tax to compensate for 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 for further work which would  be coordinated by a TASK Force as part of the G20/OECD Inclusive Framework. Amongst the discussion needed is how the concept of  nexus 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 many people, organisations and companies responded. The BEPS Monitoring Group noted that the failure to agree on the principles for the 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 feasible ‘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 thoughthe OECD’s public consultations have managed to gather enough comments from different types of institutions and experts, the OECD/G20’s Inclusive Framework is not the United Nations. Even if it manages to gather more than 200 countries, many of them countries have not participated in the process (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 consumers with a lower income. Also part of the problem with 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 which are soldby companies that do 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 on the solutions for the digitalised business model, having monitored what was going on in the world in respect to actions implemented in different countries.For instance:

– India, the Slovak Republic and Israel have introduced a definition of significant economic presence;

– The United Kingdom has 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 categorised as follows:

– For one group of countries the problem is user participation, which requires a change in global rules;

– For 7 other countries, the existing tax system is not up-to-date, but the reform should not be restricted to the digital economy but be broader;

– Another group of countries considers that there are no specific issues regarding the digital economy

Even when consensus has not been reached, 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. Evidently, as it was 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 Communiqué. 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 based on the 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. There is also a need to address this problem while awaiting the OECD to reach a consensus.

  1. The long-term solution:

Also called the ‘comprehensive solution’, to be applicable as of January 2020, it aims to address situations where companies that 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-EU 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 be applicable 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 EU trilogue negotiations in order to see the light.

  1. The short-term solution:

Also called the “targeted solution”, to be applicable from January 2020, consists of a Digital Service Tax (“DST”) arising to 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. 

With regards to where the users of a given taxable service are located in different member states or non-EU 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

  1. On the long-term solution:

The long-term proposal is still not broad enough as it is only targeted at companies rendering digital services, and it therefore does not address the broader issue of a definition of “PE” which is otherwise still rooted 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-EU jurisdiction with which there is a double taxation treaty in force, the proposal may end up pushing towards more double taxation treaties. Double taxation treaties have as an objective of avoiding double taxation, and for that reason they have been used for double non-taxation.

  1. On the short-term solution:

As has already been mentioned by Oxfamthere 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 from 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 digitalised. 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 considered including 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 in setting an interim solution, as was observed by the OECD representative speaking at the TAX3 hearing in the European Parliament. While the European Commission notes that even when many have raised their opposition to it, there are no other alternatives on the table. 

In this context, German MEP Martin Schirdewan (DIE LINKE.), GUE/NGL Coordinator on TAX3 and Shadow Rapporteur following the Digital Tax proposal in the ECON Committee asked the speakers 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 lead to 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. The same goes for some political groups which mostly directly their questions  towards the risks of double taxation rather than the lack of a broader perspective which would otherwise have led to the  closing of the remaining loopholes for tax avoidance in the current system.