Globalisation and digitalisation, together with concerns over corporate tax avoidance, have sparked an international debate about whether tax rules are fit for purpose. The issue of taxing the digital economy figures ever more prominently on policy agendas around the world, while the OECD is striving to reach international consensus on the matter. We look at the key points in the debate and propose principles for effective and efficient taxation in the digital age.
The digital economy is massive and still growing. Seven tech giants are now among the top 10 public companies by market capitalisation.[1] The value of transactions facilitated by digital platforms is projected to grow by 35% per year in the coming decade.[2] And the top five e-commerce retailers have sustained annual revenue growth rates of around 32% between 2008 and 2016, while the entire EU retail sector registered on average just 1% annual growth rate in revenue in the same period.[3] The rise of digital business models is laying bare the main limitations of traditional tax systems and may well have some implications for national tax revenues.
Tax rules have been traditionally based on the principle of ‘permanent establishment’: taxation is linked to the place where all or part of business activities are physically carried out.[4] This framework of understanding economic activity subject to taxation is, however, inadequate in the digital era for at least two reasons.[5] First, it is increasingly difficult to establish the tax presence (so-called ‘nexus’) of certain companies given that digital business models allow for the provision of digital services with a minimal physical presence in a given tax jurisdiction (so-called ‘scale without mass’).[6] Second, the role of data and users and the reliance on intangible assets that characterise new digital business models bring into question how and where value is created.[7] The EU, in particular, emphasises the role of users as data content generators and value creators in the digital economy.[8]
In addition, as shown by a recent study, digital businesses benefit from better incentives such as more favourable depreciation rates and R&D credits. This may lower their effective average tax rate in comparison to more traditional, ‘brick-and-mortar’ companies.[9] The growth of the digital economy coupled with existing tax planning strategies appears to exacerbate tax avoidance.[10]
Solutions on the table range from the introduction of an ‘add-on’ tax specifically targeting the income of certain types of large digital businesses, to a ‘Copernican revolution’ for corporate income tax systems,[11] which would gravitate towards user-centred ‘value creation’. So far, the international debate on the topic has largely taken place within the framework of OECD/G20 BEPS,[12] but it is increasingly facing difficulties due to the resistance of some large members. The impasse has opened the way to individual actions.[13] On a global scale, an emblematic case is the Indian Equalisation Levy, which taxes online advertising payments. In Europe, already in 2014, Hungary introduced an advertising tax on companies with sizeable turnover from broadcasting or publishing advertisements, i.e. two sectors where digital businesses play a pivotal role.
Under the threat of unilateral measures, the European Commission put forward two proposals for fair and effective taxation of the digital economy in March 2018. First, an interim solution would introduce a 3% digital services tax (DST) applied to revenues resulting from the provision of specific services by companies with annual global revenues from certain digital services of €750m and EU taxable revenues of €50m.[14] Second, a long-term solution would require updating the concept of ‘permanent establishment’ to account for a ‘significant digital presence’.[15] This proposal entails a common reform of national corporate income tax systems and the introduction of rules for attributing profits to digital businesses. The proposed common EU approach aimed, inter alia, to prevent the creation of obstacles for start-ups, scale-ups and SMEs, avoid market fragmentation and minimise negative impacts on investments, innovation and ultimately growth.[16] It also intended to avoid member states ‘going it alone’, but fell short of securing consensus in the Council.
With the enduring stalemate at the EU level, France, one of the strongest supporters of an EU approach,[17] took the initiative in July 2019 of introducing a 3% DST on the gross income from digital services of companies with global revenues of €750m per year or more and revenues above €25m per year within the country. Digital services of targeted advertising and e-commerce intermediaries fall within the scope of the tax, while some other products and services are exempt.[18] In the absence of a shared approach, more national initiatives will soon materialise. In fact, several other EU countries are poised to introduce a digital tax.[19] For instance, Italy has recently adopted a DST, which will enter into force in January 2021, or even before.[20]
Faced with this mounting pressure, the OECD put forward a challenging work programme to seek international agreement on a comprehensive reform of tax rules by the end of 2020.[21] It published a proposal for a ‘unified approach’ in October 2019 and the comments received from the public consultation in mid-November.[22] It focuses more broadly on ‘consumer-facing’ businesses that create value by interacting with their consumer base even without a physical presence in the market, including digital business models. The proposal also puts forward new nexus rules relying on revenue thresholds as well as new profit allocation rules for corporate taxation. If and when the OECD will reach a solution is hard to predict.
Whether through individual measures or a common international approach, a digital tax is here to stay. It is therefore time to be pragmatic and focus on key principles for effective and efficient taxation of the digital economy:
- Avoid unnecessary increases in compliance costs. Complex definitions of taxable revenues and complicated parameters for apportioning global revenues or profits are likely to generate tax uncertainty as well as significant compliance costs for taxpayers. Digital companies may need to adapt their accounting systems, customer management systems and user management systems to provide data requested by national tax authorities. In addition, they will virtually have to pay taxes in any country where their services are accessible, thus multiplying costs to adapt to different tax systems. Tax rules should be simple to abide by and simple to enforce.
- Adopt proportionate rules to avoid harming SMEs and start-ups. Any tax on revenues may generate negative effects on start-ups and SMEs, insofar as these companies tend to be more fragile from a financial standpoint, have less room to pass on tax costs downstream and are often less profitable or operate at a loss. An increase in their effective tax rate may drive such companies out of the market and ultimately stifle entrepreneurship and innovation. Setting revenue and time thresholds is a sensible way of curbing this effect. A patchwork approach to digital taxation may also prevent digital companies from scaling up and going cross-border, especially if one considers that SMEs face proportionally higher tax compliance costs than large companies.[23]
- Promote legal and regulatory certainty. Any change to national corporate tax systems should minimise the room for both double taxation and double non-taxation. This requires some coordination within the EU and beyond. In the same vein, tax certainty is key to keeping costs of doing business low.[24] Finally, any new tax should still consider impacts on the effective tax rate paid by digital companies on a global scale to avoid discouraging economic activity, investment and innovation.
- Stay away from concealed state aid. Taxing the digital economy should not result in offering selective advantages to certain sectors or, even worse, certain companies over others. A ‘GAFA tax’ would certainly go against this principle. In fact, it is quite controversial that the French DST is expected to apply to only one French company.[25] EU rules generally prohibit state aid and the Commission is in charge of ascertaining that such rules are observed equally across all the EU countries. Similar safety measures should apply on a global scale.
- Mitigate the impact on small countries. Finally, as the logic of taxing rights seems to be moving towards jurisdictions where users are based, small economies could end up on the losing end. Any revenue thresholds or other indicators to determine taxing rights as part of an international solution should account for such effects.
For a global problem, the best solution is an international agreement. However, finding common ground among many different countries is not a simple feat. If the OECD does not deliver a solution by the end of 2020 as currently planned, unilateral measures are likely to proliferate. In this case, the EU should reconsider its position and intervene to avoid issues that would likely arise in the fragmented landscape. After all, the rationale for an EU intervention in the first place was to avoid distortions – double taxation in particular – that would harm the functioning of the Single Market.
An earlier version of this article was published on ISPI.
[1] Microsoft, Apple, Amazon, Alphabet, Facebook, Alibaba and Tencent (See PWC, Global Top 100 companies by market capitalization, available at: https://www.pwc.com/gx/en/audit-services/publications/assets/global-top-100-companies-2019.pdf).
[2] Dondena, IHS et al (2017), Literature review on taxation, entrepreneurship and collaborative economy, p.33, available at: https://ec.europa.eu/taxation_customs/sites/taxation/files/taxation_paper_70.pdf.
[3] European Commission (2017), A Fair and Efficient Tax System in the European Union for the Digital Single Market, p.4; figures are based on Bloomberg and Eurostat databases.
[4] As set out in Article 5 of the OECD “Model Tax Convention on Income and on Capital 2017”.
[5] See for instance: OECD (2018), Tax Challenges Arising from Digitalisation – Interim Report 2018: Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, p 171.
[6] OECD (2018), Tax and digitalization, available at: https://www.oecd.org/tax/beps/tax-and-digitalisation-policy-note.pdf
[7] For a comprehensive overview of the concept see Michael Lennard (2018), Act of creation: the OECD/G20 test of “Value Creation” as a basis for taxing rights and its relevance to developing countries, Transnational Corporations, Vol 25, No 3 Special Issue, available online: https://unctad.org/en/pages/PublicationWebflyer.aspx?publicationid=2273
[8] See for instance: European Commission, Fair Taxation of the Digital Economy, available at: https://ec.europa.eu/taxation_customs/business/company-tax/fair-taxation-digital-economy_en
[9] PwC & ZEW (2017), Digital Tax Index. Executive Summary, available at: https://www.pwc.de/de/industrielle-produktion/executive-summary-digitaliiserungsindex-en.pdf.
[10] Devereux, M. P., & Vella, J. (2017), Implications of Digitalization for International Corporate Tax Reform, WP 17/07, Oxford Centre for Business Taxation, available online: http://eureka.sbs.ox.ac.uk/6809/1/WP1707.pdf.
[11] Carpentieri, Micossi and Parascandolo detail different ways in which the corporate tax system could be reformed: Carpetnieri et al. (2019), “Overhauling corporate taxation in the digital economy”, CEPS Policy Insights. Available at: https://www.ceps.eu/wp-content/uploads/2019/10/PI2019_15_Overhauling-corporate-taxation-in-the-digital-economy.pdf.
[12] For further details see: https://www.oecd.org/tax/beps/beps-actions/action1/.
[13] KPMG (2019), Taxation of the digitalized economy. Developments Summary, available at: https://tax.kpmg.us/content/dam/tax/en/pdfs/2019/digitalized-economy-taxation-developments-summary.pdf.
[14] Tax revenues would be collected by the member states where the users of such services are located, by allotting part of the global taxable revenues to each country based on specific allocation keys. European Commission (2018), Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services, COM(2018) 148 final.
[15] A company would be deemed to have ‘a significant digital presence’ in a member state for tax purposes if it fulfils one or more of the following criteria in a given taxable year: revenues of at least €7m per year in the member state; more than 100,000 national users; or more than 3,000 business contracts for digital services created between the company and national business users. European Commission (2018), Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence, COM(2018) 147 final.
[16] European Commission (2018), Impact Assessment Proposal for a Council Directive Laying down Rules Relating to the Corporate Taxation of a Significant Digital Presence and Proposal for a Council Directive on the Common System of a Digital Services Tax on Revenues Resulting from the Provision of Certain Digital Services, SWD(2018) 81 final/2.
[17] See for instance: “Franco-German joint declaration on the taxation of digital companies and minimum taxation” (2018), available at: https://www.consilium.europa.eu/media/37276/fr-de-joint-declaration-on-the-taxation-of-digital-companies-final.pdf.
[18] The exempted cases include: the supply of digital content, communication services, and payment services.
[19] KPMG (2019), Taxation of the digitalized economy. Developments Summary, available at: https://tax.kpmg.us/content/dam/tax/en/pdfs/2019/digitalized-economy-taxation-developments-summary.pdf.
[20] Fonte, G. (2019), Italy’s economy minister sees web tax launch next year, Reuters, available at: https://www.reuters.com/article/us-italy-economy-web-tax/italys-economy-minister-sees-web-tax-launch-next-year-idUSKBN1WN1VG.
[21] OECD (2019), “International community agrees on a road map for resolving the tax challenges arising from digitalisation of the economy”, available at: https://www.oecd.org/tax/beps/international-community-agrees-on-a-road-map-for-resolving-the-tax-challenges-arising-from-digitalisation-of-the-economy.htm.
[22] OECD (2019), “OECD leading multilateral efforts to address tax challenges from digitalisation of the economy”, available at: http://www.oecd.org/tax/beps/public-comments-received-on-the-secretariat-proposal-for-a-unified-approach-under-pillar-one.htm.
[23] KPMG (2018), Study on compliance costs for SMEs, European Commission, available at: https://publications.europa.eu/en/publication-detail/-/publication/0ed32649-fe8e-11e8-a96d-01aa75ed71a1/language-en
[24] Zingari, E., Caiumi, A., Hemmelgarn , T. (2017), Tax uncertainty: Economic evidence and policy responses, Taxation papers, working paper n.67, European Commission. Available at: https://ec.europa.eu/taxation_customs/sites/taxation/files/taxation_paper_67.pdf.
[25] KPGM (2019), France: Digital service tax (3%) is enacted, available at: https://home.kpmg/us/en/home/insights/2019/07/tnf-france-digital-services-tax-enacted.html
