The European Commission (EC) will set out a “strong and ambitious” vision on how to tax the digital economy in early 2018, targeting companies such as Google, Amazon, Microsoft and Apple.
Technology companies have an effective tax rate less than half of that of brick-and-mortar businesses, according to a new communication from the EC. The question for policymakers around the world is how to hook these companies that aren’t paying their fair share of tax in the jurisdiction where the revenue is gained.
"Digital technologies are transforming our world and having an important impact on taxation systems," said the EC. "However, they transform business models, with intangibles playing an increasingly important role, putting pressure on Europe’s taxation system."
Most digital businesses are able to transcend the international tax system to some degree: they do not have a permanent establishment in most jurisdictions in which they operate, negating the need to pay corporate tax; much of their value is tied up in intellectual property (IP) and other intangible assets, diluting the effectiveness of transfer pricing rules; they have far fewer staff than brick-and-mortar businesses of similar scale, reducing the personal income tax take from their employees; and without the need to have physical stores in prime locations they avoid the bulk of property taxes.
These features are not tax-motivated, but savvy companies are able to exploit them to legally slip through large parts of the international tax net. Amazon, for example, pays 11 times less tax per pound of turnover than physical bookshops do in the UK, according to the Centre for Economics and Business Research.
In the EC’s communication, it set out the scale of the problem and the objectives for a reform it wants to begin working towards in early 2018. It identifies the key policy challenges as nexus – where to tax, and value creation – how to tax.
"Discussions on a revised definition of a permanent establishment moving away from the 'fixed place of business’ test and towards a 'value creation’ test, would potentially have a significant impact on the domestic taxable basis for corporate income tax purposes," said Elina Filippou, senior associate of Zepos & Yannopoulos in Greece.
The EC identifies the common consolidated corporate tax base (CCCTB) as the best framework to build upon and tackle the issues the digital economy throws up.
Of course, the CCCTB also affects non-digital businesses. As the OECD asserted in the BEPS project (Action 1), the digital economy is the economy, so all businesses should be aware of coming changes which target the economy.
"There is scope within the current CCCTB proposal to examine further enhancements to ensure that it effectively captures digital activities," says the communication. "Discussions are already underway on this in the [European] Council under the Estonian Presidency and in the European Parliament."
"The Commission stands ready to work with member states in examining these options within the ongoing CCCTB negotiations, to find an ambitious and EU-law compatible approach for the single market."
On September 29, European leaders will meet in Tallinn, Estonia, for the Tallinn Digital Summit. Tax is sure to be one of the key subjects of discussion.
Short-term plan with possible long-term consequences
The EC communication also proposes three potential short-term options: An equalisation tax on turnover of digitalised companies, a withholding tax on digital transactions, and a levy on revenues generated from the provision of digital services or advertising activity.
Of these options, the withholding tax was already mentioned in BEPS Action 1, and the equalisation tax is believed to be supported by key member states including Germany, France, Italy and Spain.
"Nevertheless, in the same communication it acknowledges that a number of questions remain pending with respect to each and every one of such short-term proposals, in terms of (i) practical application; and (ii) compatibility with EU law," said Filipa Correia, partner at Valente Associati GEB Partners in Italy.
"It is arguable whether the above measures are realistically implementable in the short-term and in general before certain progress with the long-term approach illustrated in the communication is made," she added.
"We would therefore doubt that they will be implemented as announced, i.e. to tax gross income. Should this be the case, their impact on the [European] single market will depend on the level of taxation introduced. There would however be a clear risk to its competitiveness and the evolution of the digital economy therein."
Taxpayers in the EU, in any case, will be wary of any 'transitional’ or 'short-term’ measures designed to increase tax take from online businesses. The EU introduced a transitional VAT system in 1993 and is still using it today, despite well-documented flaws and numerous efforts to reform it.
Therefore, International Tax Review has gathered a collection of views on these short-term options.
"The above measures, at their current stage, as briefly described in the communication, refer to gross income," said Correia. "As a result, expenses related to the effect of the relevant transactions do not seem to be taken into account for the calculation of tax. Such concept is not in line with the existing tax framework."
"As regards the temporary measures proposed by the Commission and leaving aside potential violations of the fundamental EU freedoms, as well as state aid rules and restrictions: Greece has traditionally been one of the states that interpret the term 'royalties’ in a very broad manner, for withholding tax purposes," said Filippou.
"For instance, the Greek Ministry of Finance has recently issued a ruling adopting the view that payments made for advertising space in the internet may be classified as royalties for withholding tax purposes. This is by treating the payment as equivalent to a 'rental’ of scientific equipment. Although it is questionable whether such an interpretation is aligned with international tax treaties, as currently in force, it seems to be close, in context, with the second suggestion made by the Commission."
The withholding tax (WHT) option is one that has garnered concern on several points.
"It is worth highlighting that with respect to WHT on digital transactions, the OECD had noted two main points raising concern and demanding further elaboration if it is to be implemented: (i) application on gross payment; and (ii) need for agents to withhold and remit the tax," said Correia.
Filippou said: "The imposition of a withholding tax at source, however, could potentially lead to treaty shopping among EU member states, based on the maximum withholding tax rate for royalties, set out in each double taxation treaty signed between Greece and other EU member states."
"For instance, the withholding tax rate on royalties paid to Germany, according to the Greece-Germany double taxation treaty, is zero, whereas the withholding tax rate on royalties paid to Ireland is 5%," she added.
"All of the suggested measures are underpinned by the so-called destination principle," Correia said. "Its purpose is to increase the taxing power of the jurisdiction of consumption. As a result, adoption of such measures may be expected to change the existing balance in taxing powers between residence and source countries, in favour of the latter. Subsequently businesses may be expected to restructure their activities taking into account the new balance."
The above article was published on www.internationaltaxreview.com on 27 September 2017 and has been republished with the approval of the Publisher.