Tax Challenges of the Digital Economy – Part II

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Tax Challenges of the Digital Economy – Part II

A CLOSER LOOK AT LOCAL MEASURES ALREADY IMPLEMENTED OR PROPOSED

 

In the article “Tax Challenges of the Digital Economy – Key milestones at a glance”, Intaxify provided a general outline on the developments in the OECD and EU on tax challenges in the digital economy. In that first article, Intaxify observed that some countries already implemented some unilateral and uncoordinated local tax measures pending the implementation of the OECD and EU initiatives. In this follow up article, Intaxify will zoom in to some of these local measures.

Are you engaged in (digital) business activities abroad? Take a look at the below fact sheet to identify whether you may be at risk for a potential foreign tax exposure. 

The below fact sheet is however not exhaustive, so if you are doing digital business in other countries, Intaxify may assist you on establishing your tax position. Please reach out to info@intaxify.nl for questions or more information.

Tax Challenges of the Digital Economy - Part II

Local measures at a glance

Background

The OECD Interim Report 2018, four categories of local measures are recognized:

  1. alternative applications of the permanent establishment (PE) threshold;
  2. withholding taxes;
  3. turnover taxes;
  4. specific regimes targeting multinationals.

Although these initiatives are rather uncoordinated, there are some common grounds to be identified. One of the common factors is that the measures for example tie in to the country where the customer is located. Others include elements linked to sales revenue or the place of use.

Below, Intaxify will share some further insights and examples for each of the four above mentioned categories.

1. Permanent Establishments

Alternative thresholds to identify a taxable presence

Some countries adjusted the traditional PE definition to capture “new” business activities carried out in their jurisdiction. While certain digital activities are not captured by the traditional PE threshold, these may now be captured under some extended PE rules. Consequently, such digital activities may give rise to a local taxable presence. Below are a few examples.

Israel

Online services provided by a non-resident from a remote location to domestic customer may create a taxable presence in Israel if these activities constitute a “significant economic presence”. Examples that may constitute a digital presence include online contract conclusion, the use of digital products and services or a local website aimed at the Israeli market.

Another important aspect is that businesses that meet the “significant economic presence” requirement, may also become required to register themselves for VAT purposes in Israel and meet the local compliance rules.

India

India also implemented the concept of “significant economic presence”. While certain digital activities were not captured by the traditional PE concept, India may now consider a taxable presence for foreign businesses if they exceed a threshold for local revenue or local users. 

Slovakia

Slovakia expanded the definition of a “fixed place of business” – the more traditional definition of a PE. Certain digital platforms may now also constitute a taxable presence. The measure is targeted at specific activities via online platforms, such as intermediate services for transportation or accommodation.

Italy

Italy updated it’s permanent establishment definition by introducing the “Digital PE”. Under the new measure, a foreign business that has significant and continuous economic presence in Italy may be considered to have a taxable PE there, even if the business does not have a physical presence in Italy. Taxable presence may be triggered by revenues earned from Italian customers or by having an online platform in Italy. Furthermore, the frequency of digital transactions or the number of users is relevant. 

2. Withholding Taxes

Source-based taxation is a common method for certain types of income (dividends, interest, royalties). Some jurisdictions would like to impose a similar source-based taxation on certain digital services or products, even when the non-resident company has no physical presence in that jurisdiction.

Some “new” digital services and products may not be fully captured under the existing rules, or it is unclear how to classify them. For example, certain services may be classified as business profits, royalties or even the provision of technical services. Different taxation rights tie in to these different categories.

This may in particular be relevant for infrastructure-as-a-service (IaaS), software-as-a-service (SaaS) or platform-as-a-service (PaaS) transactions.

Malaysia

Expansion of “royalties” definition

Some jurisdictions wanted to expand the definition of “royalties” to also capture items of income that may traditionally have been classified as business profits under double tax treaties (in the latter case, the taxing rights may be more restricted for the source country). In Malaysia, for example, payments for the use of software, payments for the right to use software or payments for visual images or sounds transmitted to ICT may be classified as “royalties” subject to withholding tax. 

 

UN

“Fees for Technical Services”

A number of countries have updated their tax frameworks to facilitate taxation on “fees for technical services”. The 2017 update to the UN Model Tax Convention also considered this to tackle the issue of non-taxation rights in case of no physical presence. The “fees for technical services” are generally described as fees for management services, technical services or consultancy services. Although the update is not specifically aimed at digital activities, the new definition may definitely be relevant for these types of activities.

UK

“Specific Royalty Tax”

The UK proposed a specific new royalty withholding tax that may apply to royalties relating to IP, paid by a non-resident to a related party in a low-taxed jurisdiction. Such withholding tax may apply when profits out of which the royalty is paid relate to the use of such IP in the UK (such as the sales of products or services to UK based customers). Similar to other new measures, this withholding tax also tends towards the concept of where the user/customer is based, rather than where the business carrying out the operations has its physical presence.

3. Turnover Taxes

In addition to adjustments to local income tax frameworks, some countries also introduced new measures in the field of turnover taxes to tackle the tax issues associated with the digital economy developments. Below are a few examples.

India

“Equalization Levy”

India introduced the Equalization Levy in 2016, which effectively works as a 6% charge deducted from payments from India for online advertisement services rendered by non-residents. The tax base ties in to the value of the transaction and not the income derived by the advertisement. As the Equalization Levy is not a traditional tax on income, it is unlikely that double tax treaty relief is available. Therefore, this tax may result in double taxation if the foreign enterprise providing the services is also subject to corporate tax for the advertisement income.

Italy

“Tax on Digital Transactions”

In addition to the new PE concept, Italy also adopted a transactional-based tax on digital transactions for businesses that do not meet the PE requirements. It is expected to become effective as per 1 January 2019. The levy on digital transactions is imposed on the payments for certain digital services supplied electronically. The measure focuses on the destination of the supply and applies to B2B transactions with customers located in Italy.

A threshold however is available: in case less than 3,000 taxable transactions are carried out, an exemption may be available. The customer is responsible to deduct the tax and remit this to the Italian tax office, unless the supplier declares that the aforementioned threshold is not met.

Hungary

“Advertisement Tax”

Hungary introduced a tax applicable to net sales revenue generated from advertisements in Hungary (i.e. publishing companies who derive income from selling advertising). The supplier of these services should register with the tax authorities and is responsible for fulfilling compliance requirements. A secondary tax obligation has been put in place to improve enforcement of this tax. Customers become liable for the advertisement tax if they cannot provide the authorities with a declaration from the supplier in which the tax liability is recognized by that supplier.

4. Specific measures targeting multinationals

The fourth category includes more general measures to address tax avoidance schemes that are (mainly) used by the larger multinational enterprises. Although these measures are not specifically targeted at the digital economy, they may affect large businesses engaged in these types of activities.

UK

“Diverted Profit Tax”

The UK introduced the Diverted Profit Tax (“DPT”) regime to tackle artificial structures aimed at avoiding UK taxation by diverting UK profits overseas. Although this regime is not specifically aimed at digital companies, it may affect large multinationals engaged in digital activities. DPT may be imposed if the UK consideres that profits have been diverted for tax avoidance reasons. In such case, the UK may “re-characterize” certain transactions within the supply chain and impose the DPT, especially if it is reasonable to establish that these transactions would not have taken place absent of tax avoidance motives. 

Australia

“Diverted Profit Tax”

In 2017, Australia also introduced a Diverted Profits Tax. The measure applies to specific inter-group cross border transactions, mainly involving IP licensing or IP transfers, leasing of equipment, loans and management services. It tackles both excessive deductions and understated income, provided that the arrangement was set up for the principe purpose of obtaining a tax benefit. There are however a few safe harbors (exemption for small companies, for companies with economic substance or for arrangements where sufficient tax is imposed abroad). If an arrangement falls in the scope of the regime, a special 40% tax rate (compared to 30% regular tax rate) in principle applies on the tax benefits. Nonetheless, a reduced tax rate may be available  under certain circumstances. The benefits are determined by the tax authorities based on the arrangements that would have taken place without the tax drivers. 

US

“Base Erosion and Anti-Abuse Tax”

As part of the 2017 tax reform, the base erosion and anti-abuse tax (“BEAT”) was adopted. The measure applies to US taxpayers (part of a multinational group) whose revenue exceeds certain high thresholds (average annual US domestic gross receipts exceeding USD 500 million over a three-year period).

If 3% or more of the total tax deductions consists of certain “base eroding payments”, the measure may apply. To assess if this measure applies, the ratio between “base eroding payments” and the total tax deductions (for example including losses) should be determined. A base eroding payment is any amount paid to a foreign related party for which a deduction is available. However, certain payments are effectively excluded as base eroding payments. The measure effectively applies a 10% minimum tax on taxable income adjusted for base eroding payments.