Where does your business create value? This question goes to the heart of what makes a company tick and how it generates growth. In the past this was an issue for a business and its owners. But today the OECD and tax authorities are taking a closer interest in what drives value and creates profits.
This interest comes from the changes that digital has brought to business. The arm’s length basis worked for establishing transfer prices in an analogue environment for tax purposes. But in today’s digitalised world it is no longer always clear what business value is, how to measure it – or even where it is created.
This is where the OECD’s latest proposals come in. Where initial thinking that drove the BEPS project was about taxing the digital economy, attention has now shifted to how profits arising from digital aspects of every business are recognised and taxed in the correct jurisdiction, regardless of whether the business has a physical presence there.
This leads to a series of questions: about how value is created in current digitalised models of business; how that value is measured when there is no physical presence; and what impact this has on the taxation of said business. The concept of value has expanded to include externalities – these used to be excluded when analysing a business value drivers as they were outside of the direct control of the business but are increasingly seen as an essential part of the profit equation.
Consider gaming, which at first sight appears to be a fully digital business. However, many games are designed to be played when downloaded or when players buy them on a console, both easily quantifiable and taxable transactions. Chat might be a by-product of the business model but it does not create value.
Compare this with games that are purely designed as some form of social platform. These games soak up chat data, and that data could be used, for example, to determine which adverts the users see next time they go online. That is the type of external value driving activity that interests tax authorities, particularly as no physical business presence is required to acquire and monetise the data.
In its latest Policy Note on taxing the digitalised economy, the OECD considers three proposals that could update the existing rules on nexus and profit allocation, moving beyond the arm’s length principle to something more suitable for today’s digital world:
While the three approaches differ, they all revolve around the importance of value creation and its contribution to profit. Companies have to understand what their core operating model is, where does the business really derive its value, and how has digital really affected their business.
Value chain analysis highlights what really drives the business, looking beyond the noise that surrounds digital to establish what aspects of digitalisation have a direct impact on profits. Understanding value creation in the business and what drives profit in the digital aspect of the business can help companies assess how the scale of changes in the corporate tax landscape are likely to affect them.
KPMG has developed a scalable and flexible methodology for analysing a business value chain. Our approach, which is based on the BEPS Action Plan, concentrates on the big picture of a multi-national company’s operations to assess value. Producing an end-to-end view of a company’s activities and focusing on the people and functions, our Value Chain Analysis gives us a full perspective on the way the business works and how each component contributes value.
The rise of digital, either as the whole of the business or part, is changing everything. It affects the value creation and taxation of every multinational business, from those we can easily recognise as digital to those where the digital element is more obscure. And digitalisation is accelerating – the pace of change of business models is faster than ever before. Companies need to be able to explain and justify the commercial facts of their business, aligning these with profit and tax outcomes. Value chain analysis is the way to do just that.
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