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Home >> TII EDIT
Digital economy to the fore again
By D P Sengupta
Nov 18, 2017

TAXATION of digital economy is still making headlines in policy circles all over the world. The OECD is working on it again; the EU is working on it. Most of the giant digital companies being American, the Trump/Republican tax reforms on which there is no consensus as yet in the USA, will also have effect on the same.

Most of the EU members being also members of the OECD, one would have thought that there was congruence amongst their views. But EU is proposing to have a digital single market and continuing with its own efforts. And what about the developing countries? Well, the OECD claims that they are now part of the inclusive framework working 'on an equal footing' with the others. We had earlier occasion to examine the issues from the perspective of India and the developing countries and it was obvious that it was the developed countries that prevented consensus from being reached under the OECD action plan1 and a final solution was deferred to 2020. Now, it seems that the G20 has asked the OECD to give an interim report by 2018. To that end, the OECD recently held a marathon public consultation at Berkeley, USA on the 1st of November 2017. The video of the discussion is available on the OECD website and it lasts for 7 hours. Following is

But before giving a brief account of some of the main interventions and issues raised, it would also be interesting to note the work of the EU in this area. It is worth recalling that the whole BEPS project started with the complaint that the giant US multinationals were paying very little taxes in Europe taking advantages of various loopholes and it was necessary to close some of these. Public opinion in the EU is, for the most part against such MNCs although there are some jurisdictions that acted as facilitators and are still holding out. Some deliberate facilitation of tax avoidance were considered by the EU as being akin to state aid that is against the EU rules. Thus, we have this funny situation whereby the EU commissioner had asked Apple to pay a record 13 billion Euros as back taxes to Ireland and Ireland does not want the same and the Commission has dragged Ireland to the European Court of Justice for not complying with its order.

On 21.9.2017, the EU commission sent a communication to the European Parliament regarding a fair and efficient tax system in the European Union for the single digital market. It is interesting to find an echo of what India has been maintaining all along in the assertion by the EU commission that the "current tax rules no longer fit the modern context where businesses rely heavily on hard-to-value intangible assets, data and automation, which facilitate online trading across borders with no physical presence. These issues are not confined to the digital economy and potentially impact all businesses. As a result, some businesses are present in some countries where they offer services to consumers and conclude contracts with them, taking full advantage of the infrastructure and rule of law institutions available while they are not considered present for tax purposes. This free rider position tilts the playing field in their favour compared to established businesses.

As a result, the growing challenge of ensuring that the digital economy is fairly taxed has still not been adequately addressed, primarily due to a lack of international consensus and the multidimensional nature of the challenge. This is an unsustainable situation in an increasingly globalised and digitally connected world, where ever more activity is moving into the digital space. Failure to address these situations will lead to more opportunities for tax avoidance, less tax revenues for public budgets, impact on social fairness, including through erosion of the social budgets, and it will destabilise the level playing field for businesses." The paper mentions that the underlying principle for corporation tax is that profits should be taxed where the value is created. However, in a digitalised world, it is not always very clear what that value is, how to measure it, or where it is created.

Some of the new ways of doing business was analyzed. These are:

- Online retailer model, whereby online platforms sell goods or connect buyers and sellers in return for a transaction or placement fee or a commission. (A mazon, Zalando, Alibaba).

- Social media model, where network owners rely on advertising revenues by delivering targeted marketing messages to consumers. (Facebook, Xing, and Qzone).

- Subscription model, where platforms charge subscription fee for continued access to a digital services (e.g. music or videos). (Netflix, Spotify, iQiyi.)

- Collaborative platform model, that enables individuals to share "access" to assets rather than own them outright. Platforms charge a fixed or variable fee on each transaction.(Airbnb, Blablacar, DidiChuxing).

Adoption of such models make the determination of what to tax and where to tax particularly difficult. The EU paper therefore calls for changes to the rules of permanent establishment and also to the rules of transfer pricing used to attribute the profit of multinational groups to the different countries based on an analysis of the functions, assets and risks within the value chain of the group. However, since these rules were developed for traditional business models and economic environment and the digital economy relies heavily on intangible assets, which are difficult to value, the paper adds that there is the challenge of identifying and valuing intangible assets as well as determining their contribution to value creation. Therefore alternative methods for attributing profit that better capture value creation in the new business models, need to be found.

In the EU context, the Commission advocated working on the Common Consolidated Corporate Tax Base (CCCTB) proposal using the formula apportionment approach based on assets, labor and sale to allocate corporate profits to the member countries.

For the interim, the Commission proposed three options listed by the OECD also. These are-

- A tax on all untaxed or insufficiently taxed income generated from all internet-based business activities, including business-to-business and business-to-consumer, creditable against the corporate income tax or as a separate tax. (Indian Equalisation levy, as of now, applies in B2B situation only)

- A standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online.

- A separate levy to be applied to all transactions concluded remotely with in-country customers where a non-resident entity has a significant economic presence.

With this background, let us now try to summarize the discussions that took place at Berkeley, California on the 1 st of November, 2017 in the USA where most of the world's largest digital companies are situated. The meeting is also indicative of how the inclusive framework actually works. Except for a presentation by the BEPS Monitoring group that takes up issues on behalf of developing countries, all the presentations were from representatives of western businesses, law firms and an academic from Oxford. A representative from government of India was indeed present, but as a member of the task force.

At the outset, it was interesting to hear Psacal Saint Amans of the OECD mentioning that the title of action point1 of BEPS was wrong (Addressing the tax challenges of the digital economy) since digitalization encompasses the entire economy and the correct title should have been tax consequences of digitization of economy although admittedly, BEPS was exacerbated by digitization.

The presenters also broadly agreed with the OECD's view that it is not possible to ring fence the digital economy. However, there was a notable difference in the outlook amongst the presenters from the USA and those from Europe. In fact, there were some interventions from the US presenters that would suggest that international framework has worked fine for more than a century and there was no need to change the same. Some others while conceding the existence of a problem, argued that nothing should be done in a hurry; that it was ultimately a question of revenue rather than principles. There was also frequent reference to the Ottawa principles in the context of digital economy, mostly to justify the status quo. There was also reference to a destination based tax to be able to take care of the argument that consumers also create value. It was generally argued that the short term measures proposed by the OECD in the form of equalization levy or with holding tax created distortions.

According to the representative of Spotify, value in business starts and ends with talented people who are entrepreneurs and talented employees. Spotify was formed to fight piracy, and does not operate in any low tax jurisdiction. But leaving aside the specifics of the firm, according to its representative, raw data has no value. Its value come from intelligent analysis and processing by intelligent people. Products and services, if successful, will create net profit that is subject to corporate tax where the value giving rise to the net income has been created. And the value created in the individual national market is consumption that is taxed through consumption taxes and imposing revenue based taxes in addition to consumption tax will be anti-growth since taxing businesses on profits not realized is unjustified.

According to the Business and Industry Advisory Committee to the OECD (BIAC), however, value creation in the digital world has become more complicated but there should be more time to find a solution. A point made was that following the economic crisis, growth is more important and action taken to counter BEPS should not harm growth. Destination based solutions, advocated by some have also problems since adopting such methods would allocate lion's share to the large markets alone. Therefore understanding value creation is important and unilateral solutions must be avoided.

According to John Vella of the Oxford University, if under the current dispensation, it is so difficult to ascertain where value is created and how value is created then the policy principle itself is not good.He advocated a destination based tax. According to him, under the current dispensation, we allocate taxing rights where the mobile factors are thereby ignoring other immobile factors like consumers.

Bill Sample of Microsoft stated that one should not forget the incredible value that consumers get from the service providers. There is an exchange of value in the digital sphere and emerging economies not having invested in R&D, cannot ask for a share of profit.

On behalf of the Digital Economy Group, Garry Sprague of Baker McKenzie, took the view that the OECD BEPS project is having real consequences and the proposal regarding VAT in the digital economy report is being widely adopted by countries and that as a result of proposed changes in action 7, more and more reseller arrangements are being constituted. Besides, as a result of the changes in action 8-10, there is lower return to assets alone and many large groups are planning for IP ownership in operating entities.

Jesse Eggert of the KPMG asserted that one needs to take into account the overall burden on taxpayers and not get too tightly focused on direct taxes only. The VAT recommendations have been quickly implemented by countries leading to problems particularly in terms of compliance.

G.Maisto, jurist from Italy discussed the recent policy developments and merits and demerits of proposal relating to Virtual PE, Flat Tax and local markets. He cautioned that any solution should not increase the compliance burden and should also avoid double taxation that becomes a distinct possibility in the case of a flat tax. Regarding the role of market to justify source taxation, he was of the opinion that the same may apply to other business also.

GiammarcoCottani of Ludovicci, Piccore and Partners discussed the potential design features of a digital PE. According to him there are two options-1. Amend the current PE definition to capture active Monthly Active Users (MAUs) as an identifiable taxable nexus or 2. Introduce a new tax which might rely on the amount of MAU reflecting the percentage of revenue per country. He also gave a detailed description of the potential design features of profit attribution issues in such scenarios.

According to the BEPS Monitoring Group, digitalization exacerbates the flaws in the outdated rules and further facilitates MNE's tax driven restructuring. Therefore focus should be on digitalized MNCs and SMEs with only cross border sales are not the problem. It was urged that aligning taxable profits with real economic activities and value creation in a digitalized business environment should be solved by the main principles of nexus and substantiality. Nexus should be determined by close relationship with users and substantiality by significance presence test. A change will also be required in the threshold requirements. Relationship with customers or users extending over 6 months or sale of goods or services involving a close relationship with customers in the country including through a website in the local language, effecting delivery of supplies, using banking facilities of the country, offering goods or services sourced in the country, should contribute to sufficient nexus. As for attribution of profit, although formulary apportionment is the ultimate solution, in the interim, profit split can be used with the formulation of standardized allocation keys.

Robert John of CISCO representing Silicon Valley Directors group asserted that the effect of the 3 interim options given by the TFDE is that there would be shift of the corporate tax base towards the country of consumption which is contrary to the current international treaty network followed by OECD and violates longtime OECD policy of neutrality and equitability. These options cannot also be justified on the basis of value creation since commercial sale does not create value; value from user data comes from organization and analysis. Therefore there was no reasons to accelerate the BEPS 2020 timeline. According to him TFDE had reached the correct conclusion in not recommending any of the options and that US tax reforms will take care of the problems. He also warned that invoking unilateral actions on the part of countries could attract retaliation by affected countries.

Sylvan Montoro of BlaBla Car mentioned that it was a ride sharing company based in France with a business model totally different from Uber. He acknowledged the political and social reasons of a clamor for change and supported the idea of a digital PE.As for attribution, he was in favour of a profit split from now on based on factors like registration, active users, asset presence, and amount of cost, number of employees or a mix of such factors. However, if there is a profit split, some rules should also be found for a loss split and what one should do about past losses considering that startups make losses in early years. Besides a threshold is required and the CbCR threshold may be adopted in this regard. The problem of startups was mentioned by others also considering the fact that only 1 in 10 of these survive.

Passcal Saint Amans summed up the proceedings observing that the discussions revealed that any measure proposed should be pro-growth; all countries must be in, the time line should be different from BEPS project itself and that there are challenges particularly in areas of the concept of value creation, data and data mining and destination.

The discussions were indeed interesting and revealed the differences in the approaches to the taxation of digital economy from the European and American perspectives. It is also obvious that developing countries would find it hard to participate in such discussions and should therefore find alternate ways to protect their specific interests.

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