Digital Taxation: Fairer taxation or a political game?
On 21 March the European Commission proposed new rules to tax the digital economy, stating that this is being done ‘to ensure that digital business activities are taxed in a fair and growth-friendly way in the EU’.
The proposal is actually made up of two proposals:
The first proposal relates to the introduction of a Digital PE (permanent establishment) requiring companies to pay tax in each Member State where they have a significant digital presence – this is the Commission’s preferred long-term solution.
The second proposal is an interim tax of 3% on revenues from online advertising, online intermediation services and transmission of user data collected online. This second proposal will only apply to companies with total annual world-wide revenues of €750m and EU revenues of €50m.
In the interim, the OECD will present its findings of the BEPS project in 2020 in order to propose a consensus-based, global solution. The Commission, therefore, issued its proposal as it believes that waiting until the year 2020 is not feasible and will continue to distort competition.
The Commission’s proposal, particularly the introduction of a tax on revenues, seems flawed and for the following reasons it is unclear how the proposal can be seen as fair and growth-friendly:
- The Commission should be working closely with the OECD to recommend a global solution and not pursue unilateral action. The risk here is that if the Commission’s proposal, or sections of it, is approved, this will hinder OECD’s project of having a global solution by the year 2020. The OECD has made it clear that it has opposed short term fixes for a long-term problem of taxing the digital economy.
- The change in the principle of taxing at country of destination from country of establishment is not in line with international taxation principles, will result in double taxation and will no longer incentivise EU states to invest in start-ups within the digital economy.
On the second point, the Computer & Communications Industry Association stated in their position paper on the European Commission’s proposed Digital Services Tax that ‘changing this fundamental principle of taxation from country of establishment to counties of destination means that European nations that have massively invested in education and R&D to encourage start-ups would no longer be compensated when companies bring home profits made internationally’.
The core issue here is that, while the Commission wants to ensure that tax is paid where value is created, the effect of this proposal will be taxing where value is being consumed rather than created.
Today’s international taxation principles state that tax is paid in the country of residence of the company generating the income, unless the company has a taxable nexus in the form of a ‘permanent establishment’ (‘PE’) to another country. The pressure to introduce some form of taxation for the digital economy is based on the fact that digital companies do not require (or require to a lesser extent than bricks and mortar companies) a physical presence to trade in various countries, and therefore they avoid the creation of the taxable nexus in those countries in the form of a PE.
In this regard, the introduction of the Digital PE would make sense and would ensure that a PE is created, even in cases where there is no physical presence. The way profits will be allocated also still seems to be unclear, and after making extensive reference to the other EU proposal, the Common Consolidated Corporate Tax Base (CCCTB), the proposed directive states: ‘The proposed rules only lay down the general principles for allocating profits to a significant digital presence as more specific guidelines on the allocation of profits could be developed at the appropriate international fora or at EU level.’
Therefore, whilst the introduction of some form of Digital PE makes sense, it is important that we have a clear understanding as to how the profit allocation mechanism would work, prior to signing up for this solution.
The fact remains that today we do not have a specific Digital Tax, and the question as to whether we should have a specific tax which singles out the digital economy from the rest of the economy remains.
The OECD has repeated the fact that ‘it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy’ – it has now become an intrinsic part of our everyday lives. Whilst the OECD solution might be too far off, proposing a flawed interim solution on the basis that the Commission cannot wait for the year 2020 is a recipe for disaster.
In my opinion, we will continue to see countries coming up with their own unilateral approach, which will result in global consensus never being achieved. It is therefore important that the OECD ensures global consensus by 2020, whilst ensuring that countries do not continue to take unilateral action as this would jeopardise such consensus.
Having said that, we might already be too late given the fact that a number of countries have already implemented some form of Digital Tax, such as Italy’s introduction of a ‘webtax’ as from 2019. The question, therefore, remains as to whether this proposal will actually achieve fairer taxation or will simply result in an increase in the tax revenue for larger countries.