INSIGHT: The Italian Web Tax—Never Implemented and Already Outdated

The tax challenges raised by the digitalization of the economy are without doubt the most important addressed in the last 10 years in the international taxation field. Indeed, the next decade looks set to see far greater innovation than that achieved in the last 50 years—not only will new businesses be created, but also how business has traditionally been conducted will change dramatically.

That said, recent landmark cases involving Amazon, Apple and other web companies have made it all too clear just how difficult it is to apply the existing tax rules to increasingly dematerialized and remotely managed businesses—difficulties faced by highly digitalized businesses and traditional businesses alike (to give just one example, the e-commerce channel is now more important than ever in the fashion industry).

Dramatic change could therefore affect some pillars of international taxation, such as the arm’s length principle, which is at the basis of all cross-border intra-group dealings and relies on the comparison with conditions set in comparable transactions between independent parties. The uniqueness of highly digitalized transactions may result in a lack of reliable comparables (i.e., independent parties carrying out similar businesses) and lead to difficulties in applying the arm’s length principle.

In March 2018, the European Commission issued two proposals for a web tax; an interim one based on a withholding tax, and a long-term one based on taxation of digital presence. However, the Commission has still to decide on an appropriate solution, and is not expected to do so before 2020. The Organization for Economic Co-operation and Development (OECD) is also behind schedule on the tax challenges of digitalization: the discussion draft issued in February 2019 contained no clear position, and the work plan was only disclosed on May 31, 2019.

With governments already feeling they are constantly losing out on tax revenues, this time frame appears too long.

Unilateral Action by Countries

Some countries are taking—also based on the European Commission and member states’ efforts to develop interim actions—increasingly more unilateral (and uncoordinated) action to enable them to tax profits generated by digital business: this with a view to stretching international and domestic tax rules to be able to claim higher taxation in the countries where the consumers are based (the consumer market is considered the key factor in value creation).

However, the various actions taken appear to breach the international legal framework (i.e., double tax treaties and EU directives).

Italy issued web tax legislation in 2018 but it never came into force; this year’s Budget Law envisages a new Italian web tax that is partially in line with the European Commission’s interim proposal, but it has yet to come into force (we are waiting for the government to issue the ministerial decree setting out the detailed implementing rules, which were expected by May 2019).

Why all the hesitation? The international uncertainty (from the OECD and EU Commission) as to the appropriate milestones of a long-term solution to the tax challenges of digitalization has left the Italian government hesitant to move forward with legislation.

Overview of the New Italian Web Tax

As mentioned above, the new Italian web tax is set out in the 2019 Budget Law (Legge di bilancio, Law No. 145 of December 30, 2018, Article 1, paragraphs 35–50). The Law came into force on January 1, but will become effective only 60 days after issuance of the ministerial decree setting out the detailed implementing rules.

It applies to entities (“taxable persons”, whether or not resident in Italy for tax purposes) that carry on business either business-to-business (B2B) and business-to-consumer (B2C) and meet, individually, or jointly as part of the group to which they belong, both of the following conditions in the same calendar year:

• total worldwide revenues exceeding 750 million euros ($848.6 million); and
• total relevant revenues (see next point) generated in the Italian territory exceeding 5.5 million euros.

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

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

Intra-group dealings are exempt from the web tax.

Critical Analysis of the Italian Web Tax

Withholding Tax

The new Italian web tax implies a 3% withholding tax on payments that fall under the scope of the law.

This is consistent with the European Commission’s interim proposal and relies on a mechanism (withholding tax) that is currently among the technical alternatives envisaged by the OECD. Although this method may reduce complexity, it may also fail to meet one of the pillars of international taxation: to tax where the value is created.

Indeed, a withholding tax on gross revenues completely disregards a) the group’s overall profitability, and b) the value drivers of the business.

With regard to a group’s overall profitability, a 3% tax rate appears incoherent with value creation, as this rate applies to both businesses with a physical presence and those with a purely digital/economic presence.

A 3% withholding tax on gross revenues also seems far too burdensome, as it equates to a tax on profitability (in terms of operating income) of between 12.5% (considering a corporate income tax of 24% like the Italian one) and 20% (considering a corporate income tax of 15%) (see Table 1).

This would lead to an attribution to the market of a value far from that currently achievable with an arm’s length approach (distributors with a physical presence usually achieve a 2–6% return on sale). Therefore, the main (implicit) assumption behind a 3% rate is that more profitability exists in a highly digitalized business value chain than in others. However, this is not at all the case.

Indeed, a 3% withholding tax could lead to tax profit higher than the one achieved at group level (e.g., in 2017, Twitter Inc. and Amazon Inc. achieved a consolidated return on sales of below 3%). At the same time, a flat rate on gross revenues takes no account of a business in a loss position or more profitable businesses (e.g., in 2017 Booking.com and eBay achieved a consolidated return on sales of more than 20%).

This is further confirmation that the outcome of a withholding tax on gross profit is not aligned with value creation as:

• it applies to gross revenues and, therefore, takes no account of the significant expenses borne (particularly for research and development); and
• the same rate applies regardless of the business’s overall profitability.

Double Taxation

The Italian web tax may also trigger double taxation, as:

• for resident taxpayers, it is not creditable against corporate income tax. This means that a resident taxpayer selling digitalized services on the Italian market will be taxed twice on the same business (web tax plus corporate income tax); and
• for nonresident taxpayers:
  • it does not appear to fall under the scope of Article 2 of the double tax treaties to which Italy is a party. Moreover, Italy is not restricted by the treaty (Articles 5, 7 and 9) and could therefore apply web tax on top of other taxes, and the country where the foreign taxpayer is resident could also deny relief from double taxation; and
  • the country of residence of a foreign taxpayer—if it grants relief from double taxation in that country—generally grants foreign tax credit within the limits of the resident taxation on net profit (so-called limited credit). Therefore, the application of withholding tax on gross revenues could lead—for groups with a low overall marginality—to an excess of foreign tax credit that will never be recovered.

Additionally, the application of the same rate, regardless of whether a physical presence exists, discourages the incorporation of local entities and is completely inconsistent with the principles of Chapter I of the OECD Transfer Pricing Guidelines (TPG) (i.e., two situations with different functions, or intensity of the functions, will end up with the same remuneration).

So a solution designed to avoid the risk of double non-taxation of digital businesses (or under taxation in the countries of the customers) could lead to double taxation!

What’s Next?

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

• avoiding any form of double taxation (on resident and nonresident taxpayers);
• obtaining outcomes aligned with value creation; and
• maintaining the same standard for all industries.

The first pillar is the fundamental starting point for properly addressing all other pillars, and a multilateral solution at OECD level is the only option. Indeed, although unilateral rules (which can differ from country to country) have the advantage of being (apparently) easy to implement, they can lead only 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 coherence with all industries.

The core question is to assess whether the local presence, in terms of the value chain, has a significant role in a group’s marketing and sales function. This would allow the application of a transfer pricing method based on a return on turnover, which would capture both the local market penetration and the market share. And if more value-added services are performed locally (which is possible for businesses that have only a physical presence), the adjustments proposed in Example No. 10 of the Annex to Chapter VI of the TPG will need to be applied.

Planning Point

In the meantime, taxpayers will need to find technical solutions to grant to the presence in the markets a return on the local sales at least in situations in which a minimum nexus between local business and local sales exists.

Stefano Simontacchi is Partner and Francesco Saverio Scandone is Senior Counsel with BonelliErede.

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