OECD Digital EconomyTaxation interim report: work in progress to a consensus-based solution

Digital economy taxation OECD

Last Friday, it was made public the Interim Report (IR) on the digital economy taxation mandated in March 2017 by G20 Finance Ministers, which has now been agreed by more than 110 members of the Inclusive Framework.
The IR provides once again an in-depth and thorough 218 pages analysis of the main features observed in certain highly digitalised business models and identifies three characteristics: scale without mass, heavy reliance on intangible assets, and the role of data and user participation, including network effects.
It explains however that countries have still different views on whether, and to what extent, these features represent a contribution to value creation by the enterprise.
3 types of countries positions about a long-term solution:
• No wide range action is needed.
• Imperative need for fast action to take into account user contributions.
• Any changes should apply to the economy more broadly.

Acknowledging these divergences, the key 2 points of the report are:

o That members agreed to undertake a coherent and concurrent review of the “nexus” and “profit allocation” rules and seek a consensus-based solution by 2020, as a formula to cover the long-term.

o A framework of design for short-term digital tax measures. There is also no consensus on the need for interim measures, with a number of countries opposing to such measures and others demanding specific ones, nor a recommendation towards, but the IR describes the framework of design considerations identified by countries in favor of introducing them in the form of an excise tax on the supply of certain e-services within their jurisdiction that would apply to the gross consideration paid for its supply.

On the value creation fundamental discussion, the papers brings 3 types of value creation processes from the non-tax literature to inform the analysis:

The Value Chain / The Value Network / The value shop.

The IR highlight progress made in the implementation of the BEPS package, which is curtailing opportunities for double non-taxation, making some multinationals changing their arrangements and strategies to better align with their business operations, but recognizing that some of the BEPS required treaties changes are not happening at a fast speed.
The OECD suggested indirect tax measures are already delivering increased revenues for governments, (over 3 billion euros EU alone as a result of the new International VAT/GST Guidelines).

Last, the IR identifies new areas of work that will be undertaken without delay:

o International cooperation among tax administrations to share the information on the users of online platforms as part of the gig and sharing economies and review the changing nature of work from tax angle.

o Tax consequences of crypto-currencies and blockchain DLT.

An update on ALL this work will be provided in 2019, towards a consensus-based solution by 2020.

In essence, despite the herculean work to coordinate more than 110 different country positions, a high level joint roadmap is defined but still deep difficult work is ahead for a consensus based solution path.

Considering the overall situation summarized at the November 17 UCLA public hearing closing, the international political scene pressure and the EU current determination, there is no doubt OECD will continue setting re-doubled maximum focus, printing an even faster speed to reach the 2020 required common decisions.

2019 will be a critical temperature-take year, as many of the related unilateral passed measures departing most from general Treaties framework  come into force in different parts of the world, while the OECD updates on progress made on the above.

SPANISH ECONOMY DIGITAL TRANSFORMATION AND DIGITAL ECONOMY TAXATION

Spain digital economy taxation 2

Digital Transformation and Digital Economy Taxation: Spanish Prime Minister Mr. Rajoy noted in its party forum on entrepreneurship the recent creation on February 16th, 2018 of an inter-ministerial group to work on the Spanish economy digital transformation, highlighting two capital objectives:

• Promoting digitalization of the productive Spanish network.
• Reinforcing the educative system with deep digital skills.

On top of that he made a reference to the Digital Ecosystems as source of tax evasion, making a connection to the impact on the competition framework between traditional and digital businesses, highlighting that “digital businesses will pay taxes in Spain for the activities and profit they are receiving in Spain, regardless where their tax address is”.

Spain was one of the 4 European very determined countries that jointly requested the EU council a rigorous study about Digital Economy Taxation  and more immediate actions.
It is known that at technical instances the Spanish Tax Administration is balancing the options around a potential temporary digital tax based on digital revenue at local market level rather than profit, although Spain Finance Minister Mr. Montoro recently pointed that this battle can’t be win by any country on stand-alone basis.

INDIA TWO STEPS AHEAD IN DIGITAL ECONOMY TAXATION REGULATIONS

India Digital Economy Taxation

Through its Finance Bill 2018 India make use of one of the doors left open by the OECD BEPS Action 1 on Digital Economy Taxation, by introducing the new SEP concept in their internal tax regulations.

India Government considers that as a result of foreign enterprises interact with customers in India through advanced technology and new business models without having any physical presence, “the rights of the source country to tax business profits derived from its economy is unfairly and unreasonably eroded”.

The internal PE definition is therefore amended with effect from April 2019 to provide that ‘significant economic presence (SEP)’ in India shall also constitute a business taxable connection.

SEP definition:

(i) any transaction in respect of any goods, services or property carried out by a non-resident in India including provision of download of data or software in India if the aggregate of payments arising from such transaction or transactions during the previous year exceeds the amount as may be prescribed; or

(ii) systematic and continuous soliciting of its business activities or engaging in interaction with such number of users as may be prescribed, in India through digital means.

The foreign Co activities shall constitute SEP in India, whether or not the non-resident has a residence or place of business in India or renders services in India.

A minimum “revenue” and/or “users” threshold will be decided at a later stage after consultation with the relevant stakeholders.

DET3 comments: During almost the last century, PE nexus has been based on regular physical presence that was a fundamental proxy to attract the source country taxing rights over a non-resident, both in the Fixed Place of Business, Dependent Agent, and ultimately in the Services PE where passed.

We all knew that digitalization of the economy was changing the fundamental shape of international business and India is the first country in introducing the SEP principle in their internal regulation, leading the way once again on digital economy taxation for a country where mobile penetration has just reached 420 Million users in 2017 and is still far away from European average.

At current date, India is the first country with 2 of the 3 OECD BEPS Action 1  Digital Economy Taxation alternatives left open already implemented, with Italy following close behind.

Their aim with this measure is not only capturing the big digital giants within their tax sovereignty, but also smaller foreign companies with no-low local physical presence.

They accept that until the corresponding modifications to PE rules are made in the DTAAs, the cross-border business profits will continue to be taxed as per the existing treaty rules.

A delicate issue will be defining what it means “interaction with a number of users”, also in relation to any expected SEP income attribution as user does not mean revenue.
Not only for India, but a general consideration over SEP will be how to embed its co-existence with the rest of the international tax pre-existing rules, many of which were equally designed for the traditional economy and value creation processes.

Despite the huge hurdles that isolated country positions will generate on international digital trade, what is clear is that the Indian Government has taken the Digital agenda seriously not only on digital economy taxation but in other areas like digital payments, e-Government and Digital-skills.

Posted Feb, 9th,2018

 

UK DETERMINED TO CLOSE CLAMP AROUND DIGITAL SECTOR TAX APPROACH

UK digital economy taxation

The two recent UK HM treasury initiatives of publishing a Position paper on Corporate Tax and Digital Economy, dated Nov 22nd,2017 and the later Consultation document on Royalties Withholding Tax published December 1st, 2017 are aiming to organize a set of tools primarily addressed to increase the tax collection of “businesses primarily in the digital sector” and make sure tax does not contribute to generate competitive distortions in the local market.

Summarizing both papers affecting Digital Economy Taxation:

• The Cornerstone position is giving countries right to tax profits that derive value from MAUB (Material and Active User Base), even in the absence of physical presence.
• OECD needs to put forward solutions that build up on the EU space discussions.
• Suggest targeting the big reform at specific business models level.

Immediate action: against MN Groups, primarily in Digital Sector, that allocate IP income to low/no tax countries where they have limited substance.

Interim options:
o A new Tax on UK market digital revenues.

o Extension of UK withholding tax to cover royalties paid in connection with sales to UK customers to no or low-tax jurisdictions.

The consultation paper suggests this WT could apply even when the royalty payer has no UK taxable presence, and the text considers a “reference to payments for the right to distribute specified goods or provide specified services in the UK”. The aim seems to have been moved to capture broader than digital sector cases of IP placed at a low tax country related entity at second or third level above the UK in the MNE legal org chart.

The potential integrated effect of all these measures is certainly far, far reaching, requiring a thorough analysis in connection with what is happening at the EU, US and OECD level from this angle.

DIGITAL NEXUS PE LANDING IN ITALY: FIRST STEP INTO A DIFFERENT NEW WORLD

Italy digital economy taxation PE

The 2018 Financial Bill added a new item to the local regulations PE definition, covering a non-resident company that has a “…significant and continuous economic presence in the territory of the State arranged in such a way that does not result in its physical consistency in such territory.”

Following the significant economic presence theory, this new PE would be created even without any physical presence of the company in the market territory. There is no explanation about how economic presence must be understood and at what level of the market it would play or what happens when there is an applicable tax treaty in place.

In the Digital Economy Taxation arena, Italy becomes therefore one of the first tax administrations to break in it’s internal law a long lasting fundamental international principle that was based upon common consensus: recognizing corporate profits taxing rights only when real physical activity happening through significant people functions was identified in the country.  A long set of OECD arguments surround this concept, some of them develop only in 2010.
The further elaboration of this new rule targeting internet giants in principle, requires close follow up; the uncertainties it currently opens are many. To be seen if this is the first fracture of the international tax status-quo, or the first brick in to the future of modern economy taxation.

ITALY PASS WEB TAX

Effective from January 1, 2019, the 2018 Financial Bill passed a new B2B tax on digital transactions (so called Web Tax), a provision obliging companies to pay a 3% tax on some internet transactions made in Italy.

According to Reuters, such tax is projected to bring in 190 million € / year for the Italian Government.

Market level: B2B

Transactions “in-scope”: Services provided via electronic devices to Italian-resident corporations, government bodies, partnerships, sole proprietorships, and self-employed professionals, as well as to Italian permanent establishments (PEs) of non-Italian resident persons.

The Financial Bill defines such services as “services provided by means of internet or any other electronic networks, the nature of which makes the provision of the service mainly automatic and characterized by a minimum human intervention and with no possibilities to be provided without information technology support”. This definition drinks from the text of the current EU VAT directives.
The Ministry of Finance will release a ministerial decree by April 30, 2018 developing additional detail regarding the Web Tax and which concrete digital services subject to it.

Web Tax rate: 3%, applied to service cost base, net of VAT.
Tax-payer: due from Italian and non-Italian resident service providers.
Threshold: Taxpayers performing more than 3,000 transactions during a calendar year.
Service recipient duties?: it must withhold the Web Tax and deliver it to the tax authorities by the 16th day of the following month, unless service provider attests in the invoice that it has not exceeded the 3,000 transactions limit during the calendar year.
Creditable in seller income tax?: No
Entry into force: Beginning January 1st, 2019 once the Minister of Finance has published the specific decree on this topic.

DET3 perspective:
Despite the considerations about inter-play of this local tax measure and the also passed augmented local PE definition with the international tax world, to clarify the specific nature of the digital transactions in scope will be a question of imperative need considering the range of digital activities that could fall within the definition provided.
While indications suggest they do not target “e-commerce transactions”, the reference to mainly automated transactions seem to point to highly repetitive transactions closed and executed electronically between the parties under structured pre-defined conditions. In the modern economy, an increasing number of services are not concluded electronically but executed just electronically under an umbrella agreement.

One simple example: studies from trustable sources say that A.I. and Robot Process Automation will eliminate 9% of white collar / admin/ back office jobs in 2018 in some relevant countries…. Clearly, more precision is required.