Taxing the digital economy: A realistic goal for 2020?

By Piergiorgio Valente, Chairman of the IAFEI Technical Committee

From an international taxation perspective the resolution to reach in 2020 is a clear and an urgent one: worldwide consensus on how to tax the digital economy. It is all but a new project considering that the discussion started five years ago. But 2020 has been set as the landmark deadline here to find a common solution. Indeed there is no more margin and no excuse for extensions.

The business world knows well why. Uncertainty in taxation can be costly and is certainly risky. Since the rise of the international debate in the context of the Base Erosion and Profit Shifting (BEPS) Project, many countries introduced local digital taxes, others are in the process of doing so and others wait for the international response. The burden is then on business to find its way through this complex puzzle, with many pieces missing and with further changes lying ahead.

On the one hand there is wide agreement on the urgent need to reach international consensus on the matter. On the other this is not reflected in the actual stance of many highly influential countries. It is there for questionable if a consensus solution on digital taxation is a realistic goal for 20/20.

OECD’s unified approach: Background

As mentioned above it was 5 years ago in 2015 in the context of action one of the Base Erosion and Profit Shifting (BEPS) Project that taxation of digital business was officially identified as a problem. It was also recognised that this problem merited to be studied independently from the BEPS project because its implications go much beyond base erosion.

The tax revenue at stake is quite high and therefore countries’ intention to compromise low; as a result progress in the debate had been rather slow. 2018 saw an interim report by the Task Force on Digital Economy and then a number of country-initiated proposed solutions.

The Unified Apporach suggested by the OECD in autumn 2019 seeks a compromise of these proposals to the extent they deal with allocation of taxing rights on digital business. To this and it underlines the points where mines worldwide seem to meet:

First it is recognised that in the digital economy some taxing rights should be granted to the market or user/consumer jurisdictions.

Second, digitalization renders unnecessary physical presence for a business to generate income in a jurisdiction. Hence, a new nexus should be identified, focusing on economic presence.

Third, the fact that physical presence has become irrelevant and necessitates the identification of new transfer pricing rules beyond the arm’s-length principle.

In forming its proposal, the OECD also sought to take into account the need for tax certainty.

The Unified Apporach: Brief Overview

Considering that the Unified Approach shall be the base for the discussion on the taxation of the digital economy, it is worth summarising its key features, keeping in mind that many practical issues, such as tax rates, remain open questions.

First, in terms of scope, the new tax rights are suggested to apply to consumer-facing businesses . this would include (i) business that exploits new technologies to remotely interact with users and consumers as well as (ii) any business that has a consumer-facing element, for example, markets its products or provides services to consumers. The rationale of the approach is that user engagement is important for value creation in all these cases. Where this is not the case the business may be considered out of scope (extractive industries, for example oil and gas).

Second, the relevant factor for a business in scope to be taxable in a jurisdiction (nexus) should be related to the income such business is generating from the jurisdiction. In other words, economic presence would substitute physical presence for the business in scope. This recognises that income can be generated remotely. But this does not imply that jurisdiction of the potential user/consumer has not contributed to its generation. It is the jurisdiction that ensures the infrastructure for users/consumers to be users/consumers and should be fairly remunerated for that.

Third, transfer pricing rules should be adapted to the new context, that is to the potential absence of physical presence. This means that they should be maintained to the extent they can apply to routine transactions and new rules should be agreed for transactions not reasonably covered by the existing rules. These new rules should require:

(i) a certain part of the business profit that remains after calculation of the profit from routine transactions to be taxed in market jurisdictions;

(ii) market jurisdictions would also have taxing rights over the income-generating activities of the business there.

To ensure tax certainty, targeted dispute resolution mechanisms should ensure smooth and effective resolution of any disputes between the taxpayer business and the market jurisdiction.

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