Taxing the digital economy - KPMG Global
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Taxing the digital economy

Taxing the digital economy

Taxing the digital economy

Interim measures for taxing the digital economy allow time for global consensus

Global consensus may be derailed by proliferating interim measures

How to tax the digital economy is one of the difficult questions to be tackled under the Organisation for Economic Cooperation and Development’s base erosion and profit shifting (BEPS) project. As countries worldwide work to adopt OECD proposals on most items under the Action Plan on BEPS, global consensus remains elusive on whether and how to tax businesses with a substantial digital business footprint but no physical presence in a jurisdiction — new business models that create what many countries see as a mismatch between taxation and value creation for digital activities.

In March 2018, the OECD released an interim report on digitization’s tax challenges, building on an earlier BEPS report under Action 1. Endorsed by the 113 countries in the Inclusive Framework, the report analyzes the characteristics of digitalized business models, including their remote presence, reliance on intangibles and data, and heavy user participation. The report delays making any recommendations as the OECD works toward finding long-term, consensus-based solutions for taxing the digital economy, which it intends to deliver by 2020.

As part of that long-term work, the report notes that the OECD will review the impact of digitization on the economy on two key aspects of the international tax system, namely the nexus for taxation and the methodology for allocating profit to that nexus. For the short term, the OECD note that no consensus was reached on the need for interim measures, with a number of countries expressing concern that such measures could run counter to international consensus as it develops and may be difficult to undo.

Nevertheless, recognizing that other countries believed it would be necessary to introduce interim measures to shore up their tax bases more quickly, the report lists common principles that those countries believed should be followed to minimize the negative consequences of such measures.

Indeed, many countries are already acting unilaterally to address taxation of digital economy businesses. For example:

— Countries like Israel and India have introduced significant economic presence tests for creating permanent establishments.

— Specific tax regimes for multinational enterprises have been introduced, for example, by the UK and Australia with diverted profits taxes and by the US with its base erosion and anti-abuse tax.

— Turnover taxes have been introduced for targeted sectors, such as Hungary’s tax on digital advertising and Italy’s levy on digital transactions.

More recently, the European Union’s (EU) digital tax strategy proposes both interim measures and a long-term solution. The European Council has stated its preference for a coordinated tax policy response to the challenges raised by the digitalization of the economy at the global level. However, the EC also believes interim measures are needed due to the lack of consensus and the limited progress made at the OECD level in implementing a global standard.

Under the interim measure, the EU’s proposed new 3 percent digital service tax would apply as of 1 January 2020 to revenue from certain services, including selling online advertising space, creating certain online marketplaces, and transmitting collected user data. There is far from consensus in the EU that this is the right approach with many arguing that (1) a global consensus is first needed and (2) “digital” should be treated the same as other businesses.

Passing these proposals will require unanimity from all EU member states, which is by no means certain. Some member states have already expressed concerns about the DST (Digital Services Tax). For example:

— The DST is a revenue tax, so it must be paid even when the company is loss making.

— For the same reason, companies would pay the same level of tax regardless of whether they have high or low margins.

— The DST is not a profits tax, so double tax could arise since no offsetting foreign tax credit would be allowed in the company’s home country.

The other major question is how the United States will react to these proposals. The EC estimates the new rules would apply to 120–150 companies, about half in the United States and a third in the EU. During the G20 leaders’ meeting in March 2018, the United States already expressed concerns and could decide to introduce countermeasures if the EU were to adopt these proposals.

It is possible that the EU will adopt the digital service tax in the short term, if only to forestall the further enactment of other, disparate interim measures by its member states. In turn, this may spur more non-EU countries to respond with their own unilateral interim measures.

Longer term, the prospects seem dim for achieving consensus among EU member states on the EU solution, or among countries more broadly on an asyet-unknown OECD solution:

— Some countries believe the previously agreed BEPS solutions are enough to address the challenges of digitalization.

— Other countries want to put focus on where value is created and try to adapt agreed concepts of value creation to the digital environment.

— Still others want to change the balance of source versus revenue taxation, focusing on where value is created but even more so where revenues are generated.

If a long-term global solution is out of reach, there is a risk that the proliferating interim measures will become permanent, leaving us with even more complexity and potential for double taxation and disputes.

Achieving consensus will require careful consideration, openness and collaboration on all sides — but worth the considerable effort. A uniform global approach is likely to offer better outcomes for both governments and businesses in the long run.

Questions to consider

— Does your business have digital economy attributes, such as significant online scale without physical mass, reliance on intangible property or high user activity?

— If enacted, would the 3 percent digital services tax apply to your business’s online activities in EU countries, starting in 2020?

— Do you have business concerns about the debate over the digital economy that your KPMG advisers can help
raise with policymakers?