The effects of digitalisation are reaching every part of every business. Three disruptive digital forces are at work: digitalisation of the business, of the back office, and of tax and regulation. All three forces apply to everyone. The problem is that businesses often don’t embrace all three with equal enthusiasm. But they need to. In particular, tax policy is changing, and companies need to keep up.
Two types of tax gaps are driving government policy. The first is the quantum gap – the difference between what tax authorities receive and what they have calculated is due. Digital records and returns, such as Making Tax Digital, are among the solutions that could close this gap. The second tax gap comes from how digital businesses are taxed. Internal tax systems should tax value in the jurisdiction in which it is created, something which is relatively easy to identify for physical business models.
But digital business models enable value to be created in places where a business has little physical presence; and in the current international tax system some form of physical presence is needed before a business can be taxed. What’s more, users are increasingly helping to create that value, often in a place where the business has no physical presence. The upshot is that a digital business may pay lower tax. The European Commission estimates that digital businesses pay an effective average tax rate of only 9.5%, compared with 23.2% for more traditional firms.
A comprehensive system doesn’t exist for taxing that value – yet. But pressure is mounting. The UK started the ball rolling when it introduced the diverted profits tax in 2015, and the seriousness with which the UK is committed to ensuring digital business pay the right amount of tax is underlined by the introduction of the profit diversion compliance facility in January 2019. Now the EU has proposed a 3% revenues tax on companies’ digital activities once they reach a certain number of customers, level of contracts or a threshold for data collection.
Clearly tax policy and regulatory regimes need to keep up with changes in business models. The question policymakers are asking: where is the value being created, and how? The non-physical attributes that drive value and the best way in which to tax it are at the heart of this problem. This is made more troublesome by its international nature and the need for global consensus. And while business craves certainty and predictability, the ground on which it is being taxed is shifting under its feet.
Taxing value or revenue will happen in some form. But this will take a long time and be messy. The challenge for policymakers is to come up with a direction that fits the times and works everywhere. In the absence of international consensus, countries are getting frustrated and are implementing unilateral measures to ensure they get their share of the profits they believe is due to them, leading to fragmentation and the potential for double taxation, particularly where counties act unilaterally and encourage over-compliance. The more fragmented the system becomes, the less likely that international consensus will be reached, as countries become loath to potentially forfeit their tax revenue in favour of a wider solution.
Given these changes, what should companies be doing to make the tax function fit for future purpose?
First, understand that the tax function as we know it is history. The tax function now starts with safeguarding the information that will be transmitted to tax administrations; ensuring its accuracy and that it best represents what the company does. Fewer people will be doing basic tasks – these will be automated. The traditional compliance team will be replaced by a third line of defence to make sure the company is controlling its data and understands it.
The future of the tax function is about new skills – many of them have as much to do with data and tech as tax. But it’s also about a convergence of skills. While the tax function will need a head of data to manage and control data, and a head of dispute resolution to deal with the tax authorities, it’s quite possible that this will be one and the same person.
Second, digitalisation is the key to managing competing pressures. As more governments digitalise their tax administration, the obligation is on the taxpayer to ensure the data is managed properly, putting more pressure on regulatory compliance teams. At the same time, complying with the increasingly complex regulations is becoming more difficult and time consuming. Companies are starting to realise the only way to control and manage their compliance effectively is by investing in digital resources – just as tax administrations are.
Finally, don’t assume that the rise of technology means a fall in human input. More senior tax professionals have to understand the technical issues – but they also have to understand the capability and possibility of technology. And with the introduction of technology that’s fit for purpose, some people still need to do the heavy mental lifting, cope with non-digital transactions, and apply a critical lens to ensure the digital output makes sense.