Tax is undergoing a revolution as governments assess and respond to the impact of digitalisation.
Where will the future of tax lead us?
Digitalisation is often coupled with terms like ‘disruption’ and ‘revolution’. Real digitisation is both and its impact on tax is no exception. In line with many other areas tax is undergoing its own revolution as governments assess and respond to the impact of digitalisation. The implications are game changing for collection and policy, fundamentally redrawing lines for both the ‘how’ and the ‘what’ of tax.
Digitalisation provides opportunities to improve compliance exponentially, allowing tax authorities to close the tax gap. At the same time many governments increasingly view digitalised business models as a threat to the tax base because value can be derived from a market remotely with little physical presence (and therefore no ability to tax it).
Digitalisation: Simplification and compliance
As transactions become increasingly digital they also become increasingly traceable. Technological developments have opened the door to international co-operation and automatic exchange of information. This increased access to information, together with new technologies, allows tax authorities to super-charge their analysis capabilities enabling them to better identify fraudulent activities. For jurisdictions with high levels of fraud and corruption, digitisation has become a game changer for the tax authorities in improving compliance and increasing tax yields.
Most tax administrations are gradually digitalising. Changes range from providing a set of on-line tools and portals to let taxpayers file returns on-line to introducing ‘bridging’ between the financial systems of the tax authority and the taxpayer allowing real time data analysis, liability calculation and (ultimately) collection.
It is easy to see the case for digitalising the administration of a tax system. As tax compliance becomes more automated this should produce a more efficient tax authority. Anything that narrows the tax gap, whether it be due to mistake, negligence or fraud has to be a good thing. Efficiencies and reductions in compliance burdens for both taxpayer and the administration are there for the seizing.
Inevitably the increasing digitalisation of tax administration will raise philosophical concerns over the power and reach of the state and the safeguards and remedies available to taxpayers. It will rely on a healthy dose of public trust both in the capability of tax authorities to develop systems that are reliable and secure, and in the way in which the resulting data is used.
Digitalisation will also have wide ranging implications for in-house tax departments. It will transform the finance systems that are needed but it will also change the skills required within the department. Gone are the days where members of the tax department will do a line-by-line analysis of spend to determine what is tax-deductible.
But caution will be needed. Technology may take care of business as usual transactions but this does not remove the need for tax expertise. There will always be some transactions that need human intervention, both by the taxpayer and the tax authority. Getting the mix right between systems experts and tax technicians will take time and diligence.
Inevitably there are huge gains and few downsides in digitalising tax administration. The highest barrier to progress may be communication and trust. Governments need to ensure that they bring taxpayers with them in terms of embracing the agenda for change.
Moving from analogue to digital tax
Taxing international business is essentially an exercise in carving up the profit pie. It involves attributing value creation across the global supply chain and allocating that ‘value’ to specific jurisdictions so that it can be taxed.
Until the 21st century the accepted wisdom for taxing international businesses was to allocate an equivalent ‘arm’s length price’ to a cross-border service or activity. However, there also needed to be a physical presence or nexus in a jurisdiction for taxing rights to arise. These rules made sense (and broadly worked) when business was physical. But as transactions become digital and less reliant on a physical presence the rules have come under increasing strain. We essentially have an analogue tax system trying to cater to a digital world and it is no wonder that the system is fraying.
Often the discussion of how to tax an increasingly digitalised economy focusses on the tax affairs of tech giants. But the tendrils of digitalisation infiltrate all business models and limiting the discussion to this sector fundamentally misses the point. The issue is not how to tax the US tech giants of today but how to tax all business models of tomorrow. And in this fast moving area getting to the solution is becoming increasingly urgent.
There has for some time been a consensus that the international tax system needs to evolve but that is where the consensus ends. To make any meaningful changes to international tax systems it is essential to have wide-spread agreement across jurisdictions. As governments vie for tax revenues whilst also keeping control over their tax policies, the agenda for change becomes highly politicised.
FOMO (the Fear Of Missing Out)
The idea of a business operating within your borders, making profits from your citizens, without contributing to the economy in terms of jobs or tax revenues, is anathema to governments.
Frustrated at the slow pace of international reform jurisdictions are turning to unilateral measures. We have seen numerous countries introducing new measures designed to protect their own tax base from increasing digitisation. Whilst this is understandable it is, from the perspective of maintaining a cohesive international tax system, the worst possible answer. We are already seeing these unilateral measures collide.
Not only will the risk of double (or more) taxation increase, driving very real additional cost into supply chains, but compliance burdens will build as businesses struggle to meet numerous different, and possibly conflicting, requirements.
In existing international frameworks tax treaties will do a lot of the heavy lifting in terms of relieving instances of double taxation. Where gaps remain these are filled by some form of dispute resolution process. But increasingly we are seeing governments introduce taxes that fall outside of the reach of the treaty network.
For governments this may make sense. If they know their tax proposal may lead to double taxation then drafting a measure that falls within the treaty network can only dilute the effect of the tax whilst ensuring it falls outside of existing treaties maximises government revenues. But such an approach leaves business struggling as their only recourse to relieve double taxation is to go through an international dispute resolution process, which can be both costly and time-consuming.
The issue should not be underestimated. Double taxation problems of this type are already being seen as a result of the recent US tax reform. Unrelieved double taxation is leading to high effective tax rates, in some cases of over 100%. Many businesses are assessing the impact of new and proposed digital taxes and concluding that they may be facing triple (or more) taxation.
As a basic principle, tax should not distort the market to the extent that it becomes a barrier to trade. Where it does it will not be long before businesses are forced to make very real market choices.
The answer lies in an international consensus solution that has broad agreement and consistency in terms of interpretation, application and enforcement.
Progress is being made. International bodies such as the OECD and the EU are to be commended for their work to date as they attempt to bring options to the table that seek to build consensus. As new solutions are presented they necessarily flush out new concerns – the process is very much two steps forward one step back – but it is important that these efforts continue.
In the meantime, the danger will be that governments will become wedded to their unilateral measures and the tax revenues they bring. This is a zero sum game and inevitably there will be winners and losers. Critical to the success of a new international framework will be government’s willingness to sacrifice their own measures on the altar of an international solution.
Despite this uncertainty solutions still need to be pursued. The alternative is a network of tax rules that hugely distort economic behaviour and may threaten the very integrity of how we tax international business. We may not be able to see the answer clearly at this stage, but some shapes are beginning to appear through the mist and fog. Hopefully through discussion and debate they will become more defined as building blocks for a new framework are developed.
This is work we should all be invested in whether we represent governments, tax administrations, businesses or the tax profession. Yes, digitalisation is revolutionary and, yes, it will be an uphill battle. But building a tax system for the digital age is pioneering activity and it was never going to be easy.