Tax challenges from digitalisation: where are we at?

Seed's Nicky Gouder addresses the tax challenges arising from digitisation

In March 2018, the European Commission (EC) proposed two rules to tax digital activities in ‘a fair and growth friendly manner’. The first proposal related to the creation of a new permanent establishment where companies have a significant digital presence. This proposal would result in companies having to pay tax in each Member State (MS) where they have a significant digital presence, should any one of the following thresholds be met:

  1. Revenues from supplying digital services exceeds €7m in a tax period;
  2. Number of users of a digital service in a MS exceeds 100,000 in a tax period;
  3. Number of business contracts for digital services exceeds 3,000.

The Commission also proposed an interim digital services tax of 3% on revenues, which would be applicable to companies with total annual worldwide revenues of €750m and EU revenues of €50m.

In parallel, the OECD has been working to achieve a global solution on how to tax the digital economy. The OECD has always stated that it didn’t want a fragmented approach, but that it would like to achieve global consensus to change the current international tax principles to be relevant in today’s digital world.

In order to avoid different systems at EC and OECD level, in March 2020, the EC stated that it is committed to support the work of the OECD, but if no solution is found by the end of 2020, it will again make a proposal for its own digital tax.

ZD Academy - Accountant CoursesWhilst the EC and the OECD have been working on their proposals, a number of countries have taken unilateral action, and have introduced domestic tax laws specifically to target companies within the digital economy.

A number of countries have introduced a Digital Services Tax (DST); Austria introduced a 5% tax on online advertising as from January 2020; Italy introduced a 3% tax on a number of digital services, also applicable as from January 2020; France has also introduced a similar 3% tax, which was implemented as of January 2019, but agreed to suspend the collection of the DST until December 2020. A number of other countries have also introduced similar DSTs.

Naturally, one will need to see how these unilateral actions will co-exist once (and if) global consensus is achieved, and what risks of double taxation do companies operating in these counties have.

Earlier this month, the OECD issued a Cover Statement to explain what the current status of the 2020 consensus-based solution is. In its statement, the OECD announced that the members of the OECD/ G20 Inclusive Framework on BEPS (Inclusive Framework) have made substantial progress towards building consensus. The IF released a package consisting of the Reports on the Blueprints of Two Pillars.

Although no agreement has yet been reached, these pillars are meant to provide a solid foundation for future agreements. Pillar One tackles the issue that digital businesses are able to generate profits in a number of jurisdictions with or without having a physical presence. The solution, which is being presented in this pillar, would be to allocate a portion of residual profit to the market/user jurisdiction. A new multilateral convention would need to be developed to implement this solution.

The amount of residual profit which will be allocated to the market/user jurisdiction, will be computed using consolidated financial accounts as the starting point, with a limited number of tax adjustments.

Double taxation: Council agrees its position on dispute resolution  proceduresThe issue of double taxation is an important one to consider, particularly in view of the fact that a number of countries have already introduced their own DST. This solution would contain effective means to eliminate double taxation in a multilateral setting.

The Report on Pillar Two Blueprint is presented as a solution that would address remaining BEPS challenges and provides a right to jurisdictions to ‘tax back’ where other jurisdictions have not exercised their primary taxing right, or payment is otherwise subject to low level of taxation. One of the aims of this proposal is to ensure that all large internationally operating businesses pay at least a minimum level of tax.

Whilst the Report provides a solid foundation, there are a still a number of technical matters which would need to be agreed on, these include:

  • The Income Inclusion Rule (IIR), the Undertaxed Payment Rule (UTPR), the Subject to Tax Rule (STTR), the rule order, the calculation of the effective tax rate and the allocation of the top-up tax for the IIR and UTPR, including the tax base, definition of covered taxes, mechanisms to address volatility, and the substance carve-out.

One needs to understand what type of consensus will be reached next year, if any, and how this will fit with existing measures which a number of countries have taken on a unilateral basis. As more companies become digital and sell their products/ services in a number of jurisdictions, without requiring a physical presence there, the proposals could impact a number of digital companies.

What is certain is that we need to watch this space, as this could result in a complete overhaul of international tax principles which we have been used to for the last years. We have been used to an international tax system where companies pay tax in the country of residence, unless it has a taxable nexus in the form of a permanent establishment in another country. This could all change in the coming months, not simply because of a possible extended definition of a ‘permanent establishment’, but also because we could be moving towards a destination-based tax principle.

For further information on the development of taxation in the Digital Economy, please contact Nicky Gouder or Luana Farrugia.

Words by Nicky Gouder, Partner at Seed. Nicky specialises in international taxation with a focus on Malta's tax legislation. He has a vast experience in handling a wide portfolio of local and international clients operating in various industry sectors. Nicky is also a lecturer of the advanced taxation module for the ACCA courses, regularly participating in a number of tax conferences, both locally and internationally.

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