Digitisation of Tax – a multilateral problem needs a multilateral solution
The issue of how to tax digital companies has been a source of irritation for governments in recent years especially given the size of these businesses and the level of profits generated. The existing tax system, much of which was designed over a century ago is not set up to deal with today’s globalised structures. It was based on taxing entities operating within a nation’s borders. However, many of today’s organisations are multinational, mobile entities where national borders have little significance and whose stages of production operate across different countries and whose customers are global.
OECD and BEPS
The OECD began its Base Erosion and Profit Shifting (BEPS) initiative in 2013 with a series of 15 actions as a worldwide way of tackling tax avoidance and dealing with such problems. As part of that Action 1 sought to address the tax challenges in the digital economy specifically the tax planning of multinational enterprises (MNEs) that makes use of different tax systems in tax jurisdictions to artificially shift profits to low-tax jurisdictions despite there being little or no economic activity in those territories.
It did, however, draw a distinction between the digitisation of tax and the digital economy, a distinction many governments have failed to draw (at least with regards their tax policies). They recognised that as the ‘digital economy’ is increasingly becoming the economy itself, it would be virtually impossible to ringfence the digital economy from the rest of the economy for tax purposes.
Status of OECD initiative
The OECD/G20 Inclusive Framework on BEPS met in January 2019 and set out a timetable to step up efforts towards reaching a global solution over how best to tax MNEs in our digitised economy. They set out a policy note which focussed on two pillars, one addressing the broader challenges of the digitised economy and the focuses on the allocation of taxing rights, and the second pillar addresses remaining BEPS issues
This will focus on how the existing rules that divide up the right to tax the income of MNEs among jurisdictions, including transfer-pricing rules, could be modified to take account of changes that digitisation has brought to the world economy. Specifically, the ‘nexus’ rules and how to determine the connection has with a given jurisdiction and how much profit should be allocated to the business conducted there.
The Inclusive Framework will look at proposals based on concepts of marketing intangibles, user contribution and significant economic presence and how they can be used to modernise the international tax system to address the tax challenges of digitisation.
This aims to resolve remaining BEPS issues and will explore two sets of interlocking rules designed to give jurisdictions a remedy in cases where income is subject to little or no taxation.
A consultation document has been issued and a public consultation will be held in March to discuss thus document.
A multilateral solution
In response to public and media pressure, many government responses have been in the form of tax grabs that barely touch their intended targets but can have significant consequences for other businesses. Short term measures have been appearing all over the world. India and Hungary have introduced a tax on online advertising, France and Austria have stated their intention to introduce a Digital Services Tax this year, Spain already have one and the UK announced such a proposal for 2020 in their most recent budget.
All of these measures tend to have specific targets in mind and whilst there is the attraction of some short-term tax revenue, I believe they are unhelpful political measures rather than clear tax strategies. Indeed, even the EU has engaged in such activities. Billed as ‘Fair Taxation of the Digital Economy’, it appears to be a tax-grab against the US tech giants. This has been condemned by the US government (unsurprisingly) but also by businesses who will be hit by the measures, specifically Europe’s own start-ups and digital businesses.
Gillian Tans, CEO of Booking.com believes that taxing businesses based on revenue rather than realised income will result in an intolerably heavier tax burden for enterprises with low profits and high turnover. She believes that rather than hitting the tech giants, this tax will most likely be a hinderance to many European tech start-ups. It will distort competition, undermine enterprise and harm domestic economic growth.
A key challenge, identified by Deloitte tax partner Alison Lobb is finding solutions that strike a balance between the needs of large and small countries and developed and developing countries.
Taxation will always be a complex area with different stakeholders looking for different outcomes, but the creation of a system that fairly taxes business and maintains government income in the ever-increasingly digitised world must be done on a multi-lateral basis. Thus, we must hold our nerve and support the OECDs initiative. A patchwork of digital taxation measures introduced by individual nations or blocs such as the EU will only increase the risk of double taxation, confusion and tax avoidance – the exact thing they were created to reduce.