Digital economy tax debate Digital economy tax debate

When businesses worldwide suddenly faced lockdowns and other important COVID-19 containment measures, many relied on technology to alter their business models and adapt to new conditions. For businesses forced to adjust their supply chains and connect with their customers remotely, digital capabilities proved crucial.

We believe the success of these adjustments for many businesses is accelerating a trend toward digitalized business models that’s been underway for some time. And as businesses earn more profits from digital activity and as governments dig for revenues to restore depleted finances, the taxation of digital business activity is likely to climb even higher on the agenda for policy makers and businesses alike.

In fact, the current situation seems to be adding even more momentum to the Organisation for Economic Co-operation and Development’s (OECD) project to develop a globally agreed approach to digital economy taxation. In our recent webcast, we highlighted how COVID-19 is influencing business models and the OECD’s project, and what tax leaders can do to prepare their companies for an uncertain future.

While current times are extraordinary, we expect many of the new digitalized ways of doing business could eventually become the norm. When we conducted an informal poll during our webcast, two-thirds of over 240 tax and business leaders who attended agreed that today’s economic conditions are speeding up digitalization. During the next year, they believe the biggest change to their business will be (in ranked order):

• Increased investment in technology to reduce reliance on people
• Continued focus on changing supply chain to provide flexibility in case of future economic shocks
• Increased investment in new, digital sales channels.

The tax implications of such business model changes could be profound, especially as more earnings become attributable to the digital components of products, remote sales, remote cross-border work arrangements and other digitalized activity.

But for now, the nature of these implications is uncertain. How governments will tax profits from virtual cross-border activity in the future greatly depends on BEPS 2.0’s eventual outcome.

Before COVID-19, the OECD’s Inclusive Framework seemed to be on track to achieve consensus on a global approach to taxing the digital economy. In a 31 January, 2020 statement, the Inclusive Framework affirmed its commitment to achieve this consensus by the end of this year.

That statement proposed a unified approach to taxing profits from digital business activity based on two pillars:

• Pillar 1 aimed to define a new taxing right that would allocate additional revenue to market jurisdictions for certain types of goods and services, especially automated digital services and consumer-facing businesses and activities.
• Pillar 2 would introduce a global minimum tax that all jurisdictions would adopt, along with rules to prevent base-erosion payments through other tax rules or mechanisms.

Plenty of work remains to flesh out these approaches and gain agreement on the details, however. In December 2019, the U.S. government sent a letter to the OECD supporting BEPS 2.0 in general but suggesting that the U.S. would reject a mandatory departure from the arm’s length standard, as contemplated under Pillar 1, in favour of a safe harbor approach. Many Inclusive Framework members believe that the U.S. approach could raise major difficulties, increase uncertainty and fail to meet policy objectives of the overall process. Resolving this issue will be crucial for the project’s success.

The OECD’s January statement acknowledges these concerns and identifies other areas where achieving consensus may be difficult. These include:

• whether dispute resolution prevention and resolution mechanisms should be binding
• the degree of digitalization for determining activities in scope
• whether the final proposal would be strong enough to discourage jurisdictions from imposing or adopting digital services taxes unilaterally.

Despite these challenges, Inclusive Framework members remained committed to finding mutually agreeable solutions.

After COVID-19 emerged, however, questions arose over whether the OECD could meet its original timetable — and whether it was even appropriate in these times for policy makers to devote attention to BEPS 2.0 at the expense of other matters.

Many believe the current environment actually makes the project even more urgent. The longer global consensus remains elusive, the higher the risk that even more jurisdictions will impose unilateral digital services taxes, especially as economies recover and ever more consumer and business activity moves into the digital domain. Without progress on BEPS 2.0, jurisdictions that are holding off in this area might move ahead with their own forms of digital taxation. Others could respond with increasing protectionism and trade retaliation, to the detriment of recovering economies.

With global consensus on BEPS 2.0 widely seen as the way to rein in unilateral action and prevent further splintering of international tax policy, the stakes are high. In March, statements from each of the OECD, G-20 and G-7 reiterated their commitment to addressing the digital economy’s tax challenges. Inclusive Framework members are redoubling efforts to complete the project through virtual meetings and remote work mechanisms. A revised timetable calls for political consensus among Inclusive Framework countries on final proposals in time for the October 2020 G-20 meetings. Implementation could begin as early as 2021.

With all this uncertainty over the future of international taxation, tax leaders can help prepare their organizations for the challenges ahead in three key ways:
 

1. Identify the likely hot spots: As first step, you’ll want to review all relevant jurisdictions to see which ones have or soon will take unilateral action and which ones are awaiting the BEPS 2.0 outcome. You can then begin to determine potential exposures in various locations and which jurisdictions should command more attention.
   
   
2. Model the potential impacts: Scenario modeling and analysis can show the likely impact of alternative tax proposals on cash taxes and effective tax rates, helping you determine where the company may be likely to pay more tax and whether that additional tax would be borne, for example, by the parent or in market jurisdictions. This type of analysis can help you communicate these implications to management and the rest of the company. It can also help you and your team prepare for new tax compliance needs and identify planning opportunities.
   
   
3. Stay involved: As the BEPS 2.0 consultations continue and unilateral actions are debated, tax leaders can keep up on evolving issues, raise their concerns and influence the debate by being part of the conversation. Along with directly taking part and making submissions in formal (albeit virtual) consultations, businesses can make themselves heard by speaking with local government policy makers involved in OECD working groups, working with local trade associations, and writing articles for mainstream media or technical publications that draw attention to issues and preferred solutions.

For both businesses and governments, the last point is critical to getting the proposals right. The international business community needs to be deeply involved if the Inclusive Framework is to deliver a practical, administrable and equitable set of proposals that all jurisdictions involved can agree on.