What We Know Now About Taxing the Digital Economy
By John Bostwick, Managing Editor, Radius
The interim report is an extension of the OECD’s 2015 Action 1 Final report, Addressing the Tax Challenges of the Digital Economy, the first of 15 actions, or measures, intended to curb base erosion and profit shifting, or BEPS (basically, tax avoidance by multinational corporations). It’s significant that the groundbreaking BEPS measures begin with tackling taxation of the digital economy. This is a contentious, evolving regulatory area, but a critical one to address and gain consensus on, given that many existing tax laws still don’t account for cross-border electronic commerce.
Last March, G20 finance ministers required that the OECD’s Inclusive Framework on BEPS members deliver an interim report on “the implications of digitalization for taxation” before April 2018. The result is the interim report published this month.
The interim report addresses a number of areas, including how “highly digitalized business models” operate and the concept of value-creation in the digital economy, along with the “potential implications for the existing international tax framework.”
At the heart of the report are the concepts of nexus — or a tax connection to a jurisdiction — and profit allocation, or how much a multinational’s profits will be subject to tax in a given jurisdiction, as well as how profits should be allocated among countries. The Inclusive Framework members indicate that “at present, there are divergent views on how the issue should be approached."
The members have pledged to publish an update to the interim report in 2019 and a final report on the subject in 2020. During that time, they will “seek a consensus-based solution” to applying nexus and profit allocation rules “to the different activities carried out by multinational enterprises.”
The report indicates that there are a number of “areas of work that will be undertaken without delay,” such as enhancing cooperation among tax authorities in different countries in the age of big data. In particular, members want to ensure that participants in the gig and sharing economies pay taxes when they’re due. They’ll also look to examine how new advances like blockchain distributed ledger technology can be incorporated into the international tax system.
The subject of the report is deeply complex in part because of the evolutionary nature of the digital economy, and because business models of highly digitalized organizations vary significantly, as do the views of the countries that seek to tax related activities. On the business-model side, the report outlines three frequently observed characteristics of digitalized organizations: “scale without mass, heavy reliance on intangible assets and the role of data and user participation, including network effects.”
As for country perspectives on the tax challenges of digitalization, the report indicates that views can be separated into three groups. The first group of countries acknowledges there may be “misalignments between the location in which profits are taxed and the location in which value is created.” They feel, however, that these misalignments are limited to particular business models. As a result, they don’t “see the case for wide-ranging change” to the existing international tax framework.
The second group of countries believes the ongoing digitalization of the economy, combined with globalization in general, “present challenges to the continued effectiveness of the existing international tax framework for business profits.” These challenges, the second group believes, are not unique to highly digitalized business models. They therefore feel that “any changes should apply to the economy more broadly.”
The third and final group of countries believes that existing BEPS actions largely address concerns related to double non-taxation, at least for the time being. These countries “do not currently see the need for any significant reform of the international tax rules.”
In light of these differing viewpoints, the report concludes (a little gratuitously) that “developing, agreeing and implementing a global, consensus-based solution will take time.” In the meantime, some countries are calling for immediate interim measures to “address the tax challenges arising from digitalization.”
Predictably, other governments oppose the introduction of interim taxation. They believe that such measures could have “negative impacts on investment, innovation and growth, the possibility of over-taxation, distortive impacts on production and increasing the economic incidence of tax on consumers and businesses, and increased compliance and administration costs.”
Echoing these concerns, the report cautions that any interim measure “should be in compliance with existing international obligations, temporary, targeted and balanced, minimize over-taxation, as well as designed to limit the compliance costs and not to inhibit innovation.”
Additional Context, Including a European Commission Proposal
Reuters explains that the impetus for scrutinizing digitalized business models and related tax codes springs largely from “big digital companies like Google, Apple and Amazon [that] have for years been able to exploit current rules to legally slash their tax bills in some countries, leaving other governments furious.” Reuters adds that some countries such as India and Australia have begun implementing changes to close these loopholes. In a major move, the European Commission will — under pressure from Germany and France — propose that “large companies with significant digital revenues in the European Union … face a 3 percent tax on their turnover.”
While the European Commission’s proposal is not directly related to the OECD’s interim report, the two documents (of course) address the same contentious issues. The Wall Street Journal says that the European Commission’s proposal calls for “a short-term charge on the revenues, rather than the profits, generated by some digital companies, most of which are American.”