The world is changing, and we witness this every day—the way in which we do business today is far away from anything we could have imagined even 10 years ago. Moving most activities online, reaching out to customers online, holding meetings online—all these might have seemed impossible a decade or two ago. But here we are today, witnessing the rise of digital technology, where there is no need for physical presence to do business in a particular jurisdiction.
The rise of digital technology has also created one of the biggest challenges of the global compliance world: the need to reconsider what “nexus” is. In short, the rise of digital technology has seen the “death” of the “physical” nexus and has created considerable debate around what “virtual” nexus is and how it must be defined.
Another significant challenge for global compliance is the rise of intangible assets that can easily be shifted from one jurisdiction to another, in the search for lower tax rates. In the traditional economy, moving manufacturing facilities from one place to another would have come with a significant cost and the benefit from lower tax rates would have been considerably diminished. Today, intellectual property rights, patents, can be easily moved and the cost of doing this is marginal.
Digital Services Tax (DST)—Background and Challenges
In this dynamic digital economic environment, the Organization for Economic Co-operation and Development (OECD) has calculated that by changing the way in which the digital economy is taxed (Pillar 1 and Pillar 2), taxes will increase by $100 billion, representing 4% of current corporate income tax revenues. The debate around taxing the digital economy has now become even more relevant because Covid-19 has forced many companies to go digital, and because of the amount of money that governments around the world have had to spend to support local economies.
Some Fundamental Questions
There seems to be a consensus that the digital economy needs to be taxed differently, but—at this stage—there are still some fundamental questions that the policy makers are required to address:
What is digital and what is not digital? What should be taxed under the digital label? In this respect, there are several trends that we can identify: a trend towards a narrow scope that considers user data as the main value creation driver, and a trend towards a broader scope, where any digital interaction would be considered in scope.
The other aspect of scope is represented by the revenue thresholds, meaning the amounts above which DST should be applied. The more that different thresholds are used for the various reporting requirements, the more challenging it will be for companies to keep track of them and to be compliant. The OECD proposed using the same revenue threshold that is applied for country-by-country reporting. However, we can see that countries that have implemented DST have deviated from this rule (as will be discussed below).
How do we determine the right place for paying the right tax? The fundamental debate here is not whether companies pay the right amount of tax but whether they pay it in the right jurisdiction. The approach under discussion is to tax the income in the country where consumers or users are located, rather than the country of residence.
How will the tax base be determined? There are debates around the accounting standards to be applied (whether to apply the accounting standards of the parent company or the local one) and around the way in which losses are going to be allocated and accounted for.
There are still many controversial issues that need to be clarified; the OECD embarked on this journey in 2015 and has still not reached consensus. The OECD still assures us that the project is on track and that it should be finalized by the end of this year, which might be valid considering the Covid-19 pressure.
DST Around the Globe
In these circumstances, many governments have lost patience and have passed their own legislation on a DST. When analyzing the provisions that have been implemented around the globe, there are some trends that we can perceive, as described below.
Narrow vs Broad Approach
There is little consistency in the scope for DST. For example, in Austria and Hungary, the scope is limited just to revenues from online advertising, while in France the tax base includes revenues from the provision of a digital interface, targeted advertising, and the transmission of data collected about users for advertising purposes. At the other end of the spectrum, countries like India and Indonesia have chosen an even broader implementation, taxing not only the online platforms but also the facilitators. Thus, in India, the scope for DST application includes (among other things): providing cloud services; providing data or information, retrievable or otherwise, to any person, in electronic form through a computer network; online gaming. It appears that in terms of approach, Western Europe (France and Italy) have focused on a broader scope including digital advertising, digital interfacing and digital transmission of data, while Central and Eastern Europe have focused on a narrower scope.
An interesting example is that of Brazil, where there is now a proposed law for the introduction of a DST. The law seems to follow the broad scope approach taken by France and Italy but does not seem to be very well-aligned with the overall taxation framework in Brazil. Traditionally, Brazil has been one of the countries with many taxes levied at all levels, and that levies withholding taxes on local deliveries. As such, the introduction of DST will create an additional burden on taxpayers and—taking into account the withholding taxes, the DST and any other applicable taxes—taxation could reach more than 50% of the value of a transaction. Obviously, this will not be the case in France and Italy where local withholding taxes do not apply.
There is little consistency in this area as well, and tax rates vary from 2% in the U.K. or 3% in Italy to 7.5% in Hungary and Turkey. In some countries, the tax rates vary depending on the industry: thus, in India, the tax rate is 6% for online advertising and 2% for online platforms. The proposed law in Brazil includes a progressive tax rate depending on the level of revenues, varying between 1% and 5%.
As with tax rates and scope, do not expect consistency! The U.K. has set a threshold of 25 million pounds ($32.6 million) for U.K. revenues and 500 million pounds for worldwide revenues, Australia has set the bar at AU$75,000 ($53,500), while India talks about 500,000 rupees ($6,750). In Italy and France, revenue is measured both at local level and group level, with different thresholds for each; 5.5 million euros ($6.5 million) for revenues incurred in Italy, 25 million euros for revenues incurred in France and 750 million euros revenue for the total worldwide amount. Hungary goes as low as 344,000 euros.
The unilateral measures enforce a revenue tax rather than an income tax. As such, companies cannot benefit from the tax losses and cannot benefit from tax credits. Double tax treaties apply only to income tax and the DST will not be in scope.
Questions Still Open
Unilateral measures are considered to be intermediary measures that will be replaced by OECD regulations once consensus has been reached. And yet, how close is the OECD to reaching consensus? The answer to this question depends on the political will but also on the number of outstanding issues, which are numerous. There are many areas to be clarified and the summary below indicates just a few of the most significant:
- How will double taxation be avoided? Will there be a need to revise the double tax treaties and will this be a feasible undertaking?
- What is going to be the tax refund mechanism and what will be the role of the tax authorities?
- How will all the rules fit together (controlled foreign corporations (CFCs), global intangible low-taxed income (GILTI), etc.) and what would be the application sequence?
- What will be the mechanism to replace the unilateral measures?
All these are questions that require clarification and all are not easy to answer, leading us to believe that reaching consensus will not be an easy task.
While there is agreement that the digital economy needs to be taxed differently and that we need to move away from the “physical” nexus, the definition of the new taxation world is still under debate because it needs to ensure tax neutrality, to facilitate a fair trade and to avoid the implementation of discriminatory taxes. Fixing the tax for everybody is not an easy thing to achieve but it is a necessity. Hopefully, policy makers will not focus only upon the current issues (how to tax the digital economy) but will move one step further and think about creating an agile tax framework that will be able to respond quickly to the challenges of the new economic world.
Many countries have announced the implementation of unilateral measures and even more countries (Latvia, Norway) have announced their intention to move in the same direction. Considering that there is no consistent approach in terms of how the unilateral measures are applied, we recommend that businesses should:
- Closely monitor the local changes and do not assume that these do not apply to your business. The implementation scope could be broader than what you are used to in other countries.
- Get ready for additional reporting requirements and for more segmentation of revenues.
- Get ready for an increased role of tax authorities, that will require even more detailed reporting to ensure correct implementation.
- Build up the right level of tax expertise. Rules are not consistent, and you need to keep track and manage all the various provisions.
- Prepare for retaliatory measures. The U.S. has already indicated that they are not in agreement with DST developments and unilateral measures, and they are looking at introducing tariffs in exchange.
- Assess the impact upon your own profitability and decide whether the cost will be passed on to consumers.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Emine Constantin is Global Head of Accounting and Tax with TMF Group.
The author may be contacted at: firstname.lastname@example.org