Daily Tax Report: International

INSIGHT: Digital Services—Tax Implications (Part 1)

Feb. 4, 2019, 11:34 AM

Numerous tax jurisdictions have undertaken to ensure internet companies pay their share of tax: new regulations are being implemented, such as a digital services tax (“DST”) in the EU, the equalization levy in India, and other similar taxes. Part 1 of this Insight looks at the new business models and the challenges they pose to traditional tax regulation.

Digitalization is transforming many aspects of our everyday lives, as well as the way our economy and society is organized and functions. The breadth and speed of the change brought about by the digital transformation is notable and raises many public policy challenges. It is also changing the nature of policy-making itself, through the emergence of a new range of tools to support the development and implementation of policies.

Information and communications technology (“ICT”) has become part of the foundational infrastructure for business and society, evidenced in heavy reliance on efficient and widely accessible online communication networks and services, data, software, and hardware. An enormous amount of data is now generated by these constantly connected users and devices. This data is being collected by businesses and governments, and combined with advances in data analytics and technology diffusion, is providing the insights necessary to transform and shape the way people behave and organizations operate.

New Business Models

The digital economy has given rise to a number of new business models. Although many of these models have parallels in traditional business, modern advances in ICT have made it possible to conduct many types of business at substantially greater scale and over longer distances than was previously possible. These types of business include e-commerce, app stores, online advertising, cloud computing, participative networked platforms, high speed trading, and online payment services.

Common Revenue Models

The diversity of businesses in the current digital economy is illustrated by the variety of ways in which businesses turn value into revenue. The most common revenue models include the following:

1. Advertising-based revenues: one version of this model offers free or discounted digital content to users in exchange for requiring viewing of paid-for advertisements. Other models rely on providing advertising through mobile devices based on location or other factors. A third type concerns social media websites or platforms which typically build up a large online user community before monetizing their captive audience through advertising opportunities.

2. Digital content purchases or rentals: users pay per item of download—for instance, e-books, videos, apps, games and music would fall into this category.

3. Selling of goods (including virtual items): this category, which overlaps to a degree with 2. above, would include online retailers of tangible goods but could also cover online gaming, where users are offered a free or discounted introductory product but are also offered purchasable access to additional content or virtual items to enhance the experience.

4. Subscription-based revenues: examples include annual payments for “premium delivery” with online retailers, monthly payments for digital content including news, music, video streaming, etc. It could also include regular payments for software services and maintenance such as anti-virus software, data storage, customer “help” services for operating systems, and payment for access to the internet itself.

5. Selling of services: this category overlaps with 4. but would include traditional services which can be delivered online such as legal services (e.g., e-conveyancing), financial services (e.g., brokerage), consultancy services, travel agency, etc. It would also include a large range of business-to-business services linked to enterprises which provide core internet access and act as internet intermediaries (web hosting, domain registration, payment processing, platform access, etc.).

6. Licensing content and technology: again, this category overlaps with 4. and 5. but might typically include access to specialist online content (e.g., publications and journals), algorithms, software, cloud based operating systems, etc., or specialist technology such as artificial intelligence systems.

7. Selling of user data and customized market research: examples include internet service providers, data brokers, data analytics firms, telemetrics and data gained from non-personal sources.

8. “Hidden” fees and loss leaders: there may be instances in integrated businesses where profits or losses may be attributable to online operations but because of the nature of the business, cross-subsidy with physical operations occurs and it is difficult to separate and identify what should be designated as “online revenue.” An example might include online banking, which is offered “free” but is subsidized through other banking operations and fees.

Current International Tax Rules not Adequate

Today’s international corporate tax rules are not fit for the realities of the modern global economy and do not capture business models that can make profit from digital services in a country without being physically present.

Current tax rules also fail to recognize the new ways in which profits are created in the digital world, in particular the role that users play in generating value for digital companies. As a result, there is a disconnect—or “mismatch”—between where value is created and where taxes are paid.

The EU will also continue to actively contribute to the global discussions on digital taxation within the G-20 and Organization for Economic Co-operation and Development (“OECD”), and push for ambitious international solutions.

Digital Services Tax

Most countries continue to lead efforts with partners in the EU, G-20 and OECD to reach international agreement on reforms to the international corporate tax framework, and will disapply the DST when an appropriate international solution is in place. Some countries have introduced DST as an interim measure to ensure the corporate tax system is sustainable and fair across different types of businesses.

Rajeev Agarwal is Head of Global Tax with Qatar Navigation QPSC. He may be contacted at: rajeagar2012@gmail.com.

Disclaimer: The content of this article is intended for general information purposes. You should always seek professional advice before acting. No responsibility is taken for any loss because of any action taken or refrained from in consequence of its contents.

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