Last week, the European Commission (EC) made two proposals regarding the taxation of digital businesses. Firstly, it introduced revenue tax as an interim measure. Secondly, it proposed profit tax as a long-term solution for the current issues in taxation of the digital economy. The profit tax would include thresholds designed to capture value creation in highly digitalised businesses.
First proposal European Commission: an interim tax on certain revenues from digital activities
This interim tax ensures that those activities that are currently not effectively taxed would begin to generate immediate revenues for Member States. Unlike the common EU reform of the underlying tax rules, this indirect tax would apply to revenues created from certain digital activities that escape the current tax framework entirely. This system will apply only as an interim measure until the comprehensive reform has been implemented and has built-in mechanisms to alleviate the possibility of double taxation.
The tax will apply to revenues created from activities where users play a major role in value creation and which are the hardest to capture with current tax rules. Tax revenues would be collected by the Member States where the users are located and will only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million. This will help to ensure that smaller start-ups and scale-up businesses remain unburdened. An estimated €5 billion in revenues a year could be generated for Member States if the tax is applied at a rate of 3%.
Second proposal European Commission: a common reform of the EU’s corporate tax rules for digital activities
The first proposal represents the Commission’s preferred long-term solution to the current issues of digital business taxation. The proposal would enable Member States to tax profits of the companies that have a ‘digital presence’ or a virtual permanent establishment in the country if it fulfils one of the following criteria:
- It exceeds a threshold of €7 million in annual revenues in a Member State;
- It has more than 100,000 users in a Member State in a taxable year; or
- Over 3000 business contracts for digital services are created between the company and business users in a taxable year.
The new rules will also change how profits are allocated to Member States in a way that better reflects how companies create value online: for example, depending on where the user is based at the time of consumption.
Definition Highly Digitalised Business
On 16 March 2018, the OECD released a draft Interim Report on Tax Challenges arising from Digitalisation and presented the summary findings during the following OECD Tax Talk webcast. Pascal Saint-Amans, Head of Tax Policy at the OECD, noted that there is a common will to work on a global framework of taxation, however the countries’ perspectives on long-term solutions are different.
In order to narrow the scope, the OECD’s draft Interim Report provides a definition of a highly digitalised business (HDB). The OECD has identified three key factors prevalent in HDBs:
- Cross-jurisdictional local scale without local mass – HDBs are often highly involved in the economic life of a jurisdiction without any significant, physical presence;
- Reliance on intangible assets, including IP – intangible assets crucial support of business models of HDBs;
- Data, user participation and their synergies with IP.
Currently, there is a general agreement between the countries that data and user participation are common characteristics of HDBs. However, there are different views on whether and the extent to which they represent contribution to value creation by an enterprise. In other words, the debate remains if collection and usage of customer data is an activity that should be taxed in the country of the customer.
Independently, various countries have already developed tax policies relevant for HDBs:
- Alternative PE thresholds such as the Significant Economic Presence test in Israel and India;
- Withholding taxes;
- Turnover taxes;
- Specific regimes for large MNEs including Diverted Profit Tax in the UK and Base Erosion and Anti-Abuse Tax in the US.
Currently, the different views of the countries participating in the Inclusive Framework on BEPS can be divided into three groups:
- Group 1: User participation is a unique feature of the digital economy. Non-consideration of user-generated value in the current tax framework has led to misalignments between taxable profits and value creation;
- Group 2: The challenges represented by digitalisation and globalisation to the tax framework are not exclusive or specific to the digital economy. Any changes made to the international tax framework would need to be applied broadly;
- Group 3: Generally satisfied with the existing tax system.
The OECD seeks for optimal multilateral agreement between the countries to address current tax challenges arising from digitalisation. Pascal Saint-Amans stressed that it is essential to ensure optimal solutions for the international tax policy, as over-taxation of the digital economy might undermine innovation. The OECD is committed to delivering the final report by 2020 and has promised an update in 2019.
See the full Interim Report here.
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If you have any questions on how these international measures will impact your transfer pricing structure or need to reassess your value chain in the light of the new developing framework, please contact us! As your trusted transfer pricing specialists, Quantera Global is happy to help!