By Karen Lynch
"The current tax rules no longer fit the modern context where businesses rely heavily on hard-to-value intangible assets, data, and automation, which facilitate online trading across borders with no physical presence," the commission said in a paper published in September 2017.1 The paper raised questions about where and how to tax in the global digital economy, with potential impacts on the pricing strategies, profit margins, and other fundamental aspects of international business and digital trade.
The commission's three draft alternatives include an "equalization tax" on the revenue of digital companies, a tax on payments for cross-border digital transactions, and a levy on cross-border digital advertising and services. The alternatives are described as short-term measures that would protect the tax bases of European Union member states while work continues on a more comprehensive approach at the OECD.
More specifically, the equalization tax would apply to "all untaxed or insufficiently taxed income generated from all internet-based business activities," the paper said. The second tax would be required on certain payments made to companies operating remotely (outside of Europe) to provide goods and services ordered online. Under the third alternative, a separate levy could be applied to cross-border digital advertising and services.
The commission's alternatives are seen as further shifting the focus of taxation away from profits and toward revenues2 – that is, from corporate income taxes to value-added taxes (VAT) and other consumption taxes on goods and services. Today, consumption taxes account for about a third of total taxes collected in OECD countries.3 Corporate income taxes account for under 10 percent.4 One rationale for emphasizing digital VAT is that it is more feasible for tax authorities to administer it.5
The commission plans to develop its three alternatives into a detailed proposal by the second quarter of 20186 – around the same time the OECD is expected to report on its four-year-old digital economy tax initiative7, at an April 2018 meeting of the finance ministers of the G-20 group of nations. The OECD typically sets global tax guidelines, which are expected to be adapted by governments around the world in their own national tax policies.
The commission encouraged the OECD to make substantial progress on its global initiative by April. "In particular, new international rules specific to the challenges raised by the digital economy are needed to determine where the value of businesses is created and how it should be attributed for tax purposes," the commission said.
Examples include how to define when a company has a taxable presence in a country, known as a "permanent establishment." "Thanks to digital technologies, businesses are now able to have a significant economic presence in a market jurisdiction without necessarily having a substantial physical presence," the commission said. Another priority is transfer pricing, which is used to internally allocate profits and costs from intellectual property and other intangible assets among the various locations of multinational companies. Such assets can be difficult for tax authorities to locate and value.
Even as regional and global tax policy deliberations continue, individual nations are also moving ahead with digital tax policy at their own pace. Some observers warn that local and global tax rules could diverge and create an unmanageable level of complexity for international businesses, while others expect them eventually to coalesce. For example, the OECD recently said that most OECD countries have implemented or announced measures to collect VAT on the online sales by offshore sellers in line with its global digital tax initiative.8
The commission identified four digital trade models that require new tax consideration. One is the online retailer model, under which digital platforms sell goods or connect buyers and sellers for a fee. Another is the social media model, with its related advertising revenue. A third is the subscription model for streaming music and video. The fourth is the sharing economy model used by ride sharing and other businesses.
For international businesses, "one thing is clear: unless you consider the make-up of your tax bills in future, you won't be geared up with the right systems and resources to manage them effectively," according to the PwC professional services firm.9
The European Commission is seeking to ensure that its member states can tax international business and trade, which have been dramatically transformed by digital technology. The commission has proposed three alternatives that would focus more on value-added taxes than corporate income taxes, while spurring the OECD to continue related work at a global level. The second quarter of 2018 will be a key milestone for both tax initiatives.
Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.
1. “A Fair and Efficient Tax System in the European Union for the Digital Single Market,” European Commission; https://ec.europa.eu/taxation_customs/sites/taxation/files/1_en_act_part1_v10_en.pdf
2. “Ireland Leads Resistance to European Tax on Digital Giants,” Bloomberg; https://www.bloomberg.com/news/articles/2017-09-16/european-tax-on-digital-giants-faces-resistance-led-by-ireland
3. Consumption Tax Trends 2016: VAT/GST and Excise Rates, Trends and Policy Issues, Organization for Economic Co-operation and Development; http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/consumption-tax-trends-2016_ctt-2016-en#.WeN_GGhSyiM#page13
4. Revenue Statistics 2016, Organization for Economic Co-operation and Development; http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/revenue-statistics-2016/tax-revenue-trends-1965-2015_rev_stats-2016-4-en-fr#.WeOqXGhSyiM#page10
5. “Ireland Leads Resistance to European Tax on Digital Giants,” Bloomberg; https://www.bloomberg.com/news/articles/2017-09-16/european-tax-on-digital-giants-faces-resistance-led-by-ireland
6. “Taxation: Commission Sets Out Path Towards Fair Taxation of the Digital Economy,” European Commission; http://europa.eu/rapid/press-release_IP-17-3305_en.htm
7. Addressing the Tax Challenges of the Digital Economy, Action 1 – 2015 Final Report, Organization for Economic Co-operation and Development; http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/addressing-the-tax-challenges-of-the-digital-economy-action-1-2015-final-report_9789264241046-en#.WeO86WhSyiM#page5
8. Consumption Tax Trends 2016: VAT/GST and Excise Rates, Trends and Policy Issues, Organization for Economic Co-operation and Development; http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/consumption-tax-trends-2016_ctt-2016-en#.WeN_GGhSyiM#page13
9. Shifting the Balance from Direct to Indirect Taxes: Bringing New Challenges, PwC; https://www.pwc.com/gx/en/tax/assets/pwc-shifting-the-balance-from-direct-to-indirect-taxes-bringing-new-challenges.pdf