INSIGHT: Possible Double Taxation Behind the Italian Digital Services Tax

The Italian government has decided not to wait for the outcome of the Organization for Economic Co-operation and Development (OECD) Proposal for a “Unified Approach” and on January 1, 2020 introduced a digital services tax (Italian DST) partially aligned with the European Commission’s 2018 interim Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services.

OECD Unified Approach—a Shock for the Fundamentals of International Taxation

In October 2019, the OECD issued a new draft proposing its Unified Approach (the Report). The Report:

• proposes a formulary apportionment to allocate profits among group entities/local presence; and
• applies to potentially all industries (with a few exemptions such as banks).

Although one of the Report’s main aims is “simplicity, stabilization of the tax system, and increased tax certainty in implementation,” we believe that, as a serious deviation from consolidated international tax principles (relating to both nexus and income allocation), careful consideration of all possible drawbacks to its implementation will be necessary. Introducing new international standards (that are completely unrelated to the permanent establishment concept or to the arm’s length principle) will inevitably increase complexity, not only in the transitional period, but also afterwards.

Multinational enterprises (MNEs) will be put in the position of reviewing their transfer pricing policy that has already been amended to reflect the BEPS recommendations, and also being required to bear an extra compliance burden due to the implementation of the Unified Approach.

Further, the introduction of a holistic and simplified approach will need to take into consideration the greater complexity of business models, which increasingly operate under matrix organizational structures whose geographical and product scope are interlinked, and whose global functions at their headquarters perform value added activities (and bear the related costs).

The OECD’s proposed Unified Approach may therefore lead to disputes with and among tax authorities, increase the tax burden for taxpayers, and increase the commitment of tax authorities.

Following the recently published stakeholders’ comments on the Report and the meeting of November 21–22, 2019 in Paris, there seems to be a long way to go before a consensus on a multilateral approach may be reached. This has strengthened the unilateral measures implemented to date to tax the digital (or digitalized) economy. After two years of laws that have never been implemented, Italy has finally enacted its own DST.

Overview of the Italian DST

As mentioned above, the Italian DST is envisaged in the 2020 Budget Law and came into force on January 1, 2020. The Italian DST is expected to be aligned with both the version contained in the 2019 Budget Law (and never implemented) and the 2018 European Commission interim solution.

As envisaged by the 2019 Budget Law, a 3% Italian DST will apply to entities (“taxable persons,” whether or not tax resident in Italy) that carry on business-to-business or business-to-consumer commerce and meet both of the following conditions, individually or jointly as part of the company group to which they belong, in the same calendar year:

• total worldwide revenues exceeding 750 million euros ($838 million); and
• total “digital” revenues (see next point) generated in the Italian territory exceeding 5.5 million euros.

The Italian DST covers taxable revenues generated from supplying any of the following services:

• advertising space on a digital platform targeted at the platform’s users;
• provision of a multi-sided digital interface that allows users to find and interact with other users and that also facilitates the supply of underlying goods or services directly between users; and
• transmitting data collected about users and generated from user activities on digital interfaces.

Intragroup dealings are exempt from the Italian DST. Moreover, the 2020 Budget Law draft directly provides a list of businesses excluded from the scope of the DST (e.g., e-commerce).

The latest available draft of the 2020 Budget Law also sets out specific methods for calculating taxable revenues, and provides that taxpayers must implement a specific accounting register to keep track of monthly taxable revenues and services.

Negotiations are ongoing as to the scope and rate of the Italian DST.

A Critical Analysis of the Italian DST

The authors’ main concern is the relationship with the Report. The latest available draft of the 2020 Budget Law stipulates that the Italian DST will be repealed once the OECD implements an agreed long-term solution (i.e., sunset clause). The French government adopted the same approach with their DST.

However, we need to take into account that the Italian DST will apply on revenues (regardless of an MNE’s profits generated in the Italian market), and certain digital business only (i.e., advertising, marketplace and digital data collection). This differs considerably from the OECD’s approach regarding the allocation of profits/losses, and the extent of application (it applies also to “traditional” businesses).

Therefore, the concrete risk is that when (and if) the OECD implements an agreed long-term solution, taxpayers could be due considerable adjustments/refunds. However, details on how and when any such adjustments/refunds will apply or be due are not yet available.

Double Taxation

Another key point is that the Italian DST is not creditable against corporate income tax. This means that a resident taxpayer selling digitalized services on the Italian market will be subject to double taxation on the same business—the Italian DST plus corporate income tax.

This is completely inconsistent with the approach the OECD (and the European Commission) is developing, whereby the solution endorsed is an alternative/amendment to the existing rules. However, under the latest available draft of the 2020 Budget Law, taxpayers meeting the requirements of the DST will be subject to both the Italian DST and corporate income tax rules (among them, transfer pricing).

This could lead to two types of double taxation:

• Italy will tax the activity of the taxpayer twice; and
• the Italian DST will not be deductible/creditable in the country of the MNEs’ headquarters/regional hub (for local subsidiaries of MNEs).

This double taxation seems indisputable considering the Italian DST is not covered by the double tax treaties drafted in accordance with the OECD Model on Double Taxation.

What’s Next?

The main pillars of a reasonable solution to tax digitalized business appropriately are:

• confirm the arm’s length principle as the cornerstone for allocating income among jurisdictions (especially in complex transactions such as those entailing the exploitation of intangibles);
• avoid any form of double taxation (on resident and nonresident taxpayers); and
• maintain the same standard for all industries.

A multilateral solution at OECD level is the only option. Although unilateral rules (which can differ from country to country) have the advantage of being (apparently) easy to implement, they will lead to double taxation.

Consequently, to remain true to the other two pillars, the solution will need to be based on the arm’s length principle (to be applied regardless of whether the business has a physical or digital presence). This will result in an outcome aligned with value creation and consistent across all industries. In addition, any kind of formulary apportionment could, in a few cases, be applied only as a sanity check in order to avoid any unreasonable result (in particular in cases of absence of reliable comparables).

In the meantime, given that unilateral solutions have already been implemented (or are set to be implemented in the very near future), a local solution that allows the Italian DST to be either creditable against corporate income tax or an alternative to transfer pricing will need to be analyzed.

Stefano Simontacchi and Marco Adda are Partners and Francesco Saverio Scandone is Senior Counsel with BonelliErede.

The authors may be contacted at: stefano.simontacchi@belex.com; marco.adda@belex.com; francesco.scandone@belex.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.