Key milestones at a glance
Date: 28 September 2018
In 2015, the OECD BEPS Action Plan 1 report on Challenges of the Digital Economy was first released. Since then, a lot of developments were made, both within the OECD, the EU and sometimes also in domestic tax frameworks. In this article, Intaxify provides a quick overview of the most important milestones.
Background – why are there tax challenges associated with the digital economy?
The developments in the digital technology have significantly changed the way businesses (can) operate. The current tax system is aimed at traditional “brick and mortar” companies. This system among others relies on physical presence for establishing a taxable presence. However, this system has become outdated as it does not fully fit businesses who rely on intangibles, data and online trading, especially considering that these businesses do not necessarily have physical presence in the places where business is carried out.
As a result, a business can be operating in multiple jurisdictions, while it is not considered present in these jurisdictions for tax purposes under the current tax framework. After all, under the traditional permanent establishment (“PE”) rules, these activities do not necessarily constitute a taxable presence.
This is a material issue because digital companies are growing fast compared to traditional companies, while they pay on average half the effective tax rate. To avoid “free riding” of such businesses and to secure fair competition, the tax system should be adjusted to fit the digital economy.
Challenges
Where to tax and what to tax?
The key principle for corporate tax is that profits should be taxed where value is created. For traditional companies, this may be relatively easy to establish (for example by identifying where a physical presence is). However, in the digital economy, this may be more challenging as it is not always clear what is creating the value, or where this value is created. These two issues (“where to tax?” and “what to tax?”) are therefore important when redesigning the corporate tax framework.
Large variety of digital activities
Considering the large variety of businesses engaged in any form of digital operations, this may not be as straight forward as it sounds. For example, businesses engaged in online sales operate in a different manner than businesses who generate their revenues through social media or businesses who rely on users for their income. To overcome the current (non) taxation issues, it is important that that the new tax model captures a wide variety of different types of businesses.
OECD Interim Report 2018
In March 2018, the OECD issued an interim report. The report shows that the Members still have a divergent view on how to tackle the issue. Therefore, no specific country recommendations are included yet. Nonetheless, two fundamental concepts – “nexus” and “profit allocation rules” – will be reviewed and the Members agreed to seek a consensus-based solution by 2020.
As this will take time, some jurisdictions have been calling for more immediate actions and therefore proposed interim measures. However, as there is no consensus on the need or form of these interim measures, no specific items are proposed here either.
Technical solutions will be further explored to test the feasibility of different options with respect to “nexus” and “profit allocation rules”, to ultimately reach the consensus-based solution by 2020. It is furthermore planned that a new update will be released by the OECD in 2019.
Two EU Directive Proposals
In March 2018, also two more detailed proposals were released by the European Commission on a fair and sustainable common EU solution (Council Directive 2018/072) and an interim “digital service tax” solution for certain specific services (Council Directive 2018/073).
For the proposals to be accepted, the EU Member States first need to reach unanimity. This may be challenging, especially considering the fact that the OECD observed that there are still a lot of diverging views (albeit that the EU Proposals would affect a smaller group of countries). Nonetheless, those in favor hope to see the Directive to be implemented by 31 December 2019 so that the new rules can become effective as per 1 January 2020.
Common EU corporate tax framework for digital services
To capture the abovementioned issue on “where to tax?”, the proposal includes that digital activities will constitute a taxable presence or virtual permanent establishment when either of the following criteria are met:
- more than EUR 7 million of annual revenues are generated in a EU Member State;
- more than 100,000 uses are active in a EU Member state in one taxable year; or
- more than 3,000 business contracts for digital services have been concluded between the company and its users in one taxable year.
In addition, new rules on how to allocate profits to Member States are included to reflect what value is created (“what to tax?”). A distinction can for example be made in income derived from user data (such as advertising), or income derived from subscription fees or online marketplace platforms.
Interim solution – “digital services tax”
As mentioned, some countries called for more immediate actions pending the implementation of the consensus-based approach. Therefore, some countries are planning to implement specific measures into their domestic legislation. This interim measure has been proposed as an alternative to the adoption of a wide variety of local interim measures. Such local measures do not necessarily align with each other and may result in fragmentation.
Under the interim measure, a 3% indirect tax would apply on revenues generated from certain digital activities that are currently not taxed at all. Activities that rely on users for value creation may fall into the scope of this measure.
Examples are revenues created from:
- selling online advertising space;
- digital intermediary services that allow users to interact with other users to facilitate the sale of goods or services between them, or;
- the sale of data generated from user-provided information.
The measure will however only apply to businesses with an annual global revenue exceeding EUR 750 million and EU revenues exceeding EUR 50 million.
Next steps
Further development is expected before a final and common set of tax rules will be enacted. During 2019, we can expect a new update by the OECD and by 2020, a consensus-based solution is expected to be available. In the meantime, the EU Proposal is pending so further developments are expected here as well.
Questions? Please feel free to reach out to info@intaxify.nl for more information.