The digitization of our economy creates unprecedented opportunities for entrepreneurs and users. The search for a balance between taxing digital companies fairly and offering them growth opportunities in a globalized online economy remains a challenge. Over recent months, the privacy issue in a digital economy has dominated - the scandal at Facebook and the introduction of the GDPR - while a redrawing of our tax system has caused much less noise. The stakes are high and the challenges are far from small.
In March, the European Commission launched two proposals to ensure fair taxation in a digital economy. Today, online businesses pay relatively few tax on the services they offer. For the sake of clarity: this has nothing to do with tax evasion or avoidance. Like all other companies, digital companies are subject to taxation in the country in which they are established. What's more, online businesses are mainly based in countries with a normal tax regime and therefore do not benefit from a low tax rate.
The Commission's proposals must ensure that, even in a digital economy, businesses pay their fair share of taxes on the digital services they offer in the EU. Under current tax rules, online businesses can earn income in a country other than the one where they are located without actually paying taxes there. After all, Tax law is not designed for companies that operate globally and online.
Brick and mortar companies operate abroad through a physical presence. The country in which the company is located can tax the profits. An online company obviously works completely differently. Take the example of an online platform managed and maintained by a digital company in country A - whose end users are located in country B. The data and information uploaded by the end users (country B) to the online platform is then sold by the online company (country A) to advertising agencies. In this example, the online company only has a physical presence in country A. As a result, under the current rules, all value creation and profit is allocated to its location in country A, meaning that this digital company only pays taxes in country A.
Under current regulations, country B therefore loses revenue, since part of the value – and therefore the profit – is created based on the data and information from the end users in country B. Conclusion: value creation for online businesses is fundamentally different from that of brick and mortar companies. In online businesses, value derives from a combination of algorithms, user data, sales functions and knowledge. Part of the value can also be created by the end users, but this is not always the case and is different for each digital service.
One of the European Commission's proposals to respond to this is the introduction of a "digital service tax" – also known as the "GAFA tax". This is a provisional tax of 3% on turnover from certain digital services. More specifically, this concerns the sale of online advertising space, intermediary activities where users can get in touch or sell each other goods/services and the sale of users' data.
In the Commission's proposal, companies will have to pay the digital service tax to the EU Member States where the users of their digital services are active. This tax only applies to online companies with a global turnover of at least EUR 750 million and a turnover of at least EUR 50 million within the European Union. In this way, SMEs and start-ups will be excluded from the tax.
For the European Commission, this digital service tax is only an interim solution to ensure fair taxation of digital businesses and to prevent Member States from drawing up their own legislation that may disrupt the internal market. Spain and Italy have already started down this path. The European Commission's ultimate objective is a unilateral reform of the foundations of current tax legislation through the introduction of a taxable "significant digital presence".
A "significant digital presence" in a country other than the one where the online company is established, allows a part of the value creation – and thus the profit – to be attributed to this digital presence. These profits can then be taxed by the country where the digital presence is located. In concrete terms, an online company is eligible for this tax in an EU Member State if it achieves more than 7 million euro in turnover annually on its offered digital services, when there are at least 100,000 users of these services each year or when more than 3,000 business contracts are concluded each year. The introduction of this concept by the various Member States of the European Union will, of course, also mean the abolition of the provisional "digital service tax".
Both proposals from the Commission offer the advantage that the debate on fair taxation in a digital era is opened. The Austrian EU presidency already considers an agreement on the digital service tax as one of its priorities for this autumn. Member States such as Germany, Ireland, Luxembourg and Sweden – with an important digital economy – have their doubts on the current proposals. These developments are also being closely monitored on the other side of the ocean. The major tech companies – Google, Amazon, Facebook, Apple – are based in the United States. Needless to say, at a time when trade relations are already very tense, the introduction of the digital service tax may generate additional tensions.
Political reality will show the direction of the EC's proposal. Yet, there are also important substantial remarks – or even flaws – in what lies before us today. The European Commission considers all online services equal, assuming that the most important value is created by the end users of the online services. But is that always the case? For certain services, the majority of the value lies with the underlying software and algorithms. It is also perfectly possible that end users of online services produce no or limited data or that their data does not represent economic value. Conclusion: a further subdivision is necessary to speak of a "fair" tax, something that is not mentioned in the current proposals.
A second ambiguity arises over brick and mortar companies that also offer digital services, as many companies offer their goods or services via an online platform or a website. Do these companies have to pay their fair share? The Commission's proposals do not go into this.
Moreover, the introduction of the “digital service tax” creates a risk of double taxation. Online businesses already pay taxes in their country of residence. In future, they would also be taxed on their turnover by the various EU Member States where they operate. In order to avoid double taxation, the European Commission expects the European Union Member States to regard the paid "digital service tax" as a deductible professional expense. However, the latter is not included as a mandatory provision in the European Commission's proposal and thus depends on the goodwill of the various member states. The risk of double taxation therefore remains a reality.
One final fundamental observation is that the “digital service tax” is also due when an online enterprise is making a loss, as the tax is calculated on the realized turnover instead of profit. In addition, online companies will pay the same level of “digital tax” regardless of whether they achieve high or low margins. Do we think this is "fair"?
Both proposals are, of course, not yet final legislation. All member states will have to approve the proposals unanimously. But Europe does not stand alone. Online companies operate, by definition, globally: ideally, the aim should be to design and implement a measure on a global level, or at least within the OECD. If this does not happen, a solution within the European Commission is the best alternative if you meet the abovementioned flaws. Otherwise, Member States will introduce a digital tax on their own, which will stifle the functioning of the internal market and further digital development.
© 2020 KPMG Tax and Legal Advisers, a Belgian Civil Cooperative Company with Limited Liability (burg. CVBA/SCRL civile) and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.