Category Archives: digital tax

Overcoming digital divide – analysis (India)

India FlagIndia’s policies towards digital regulation are inadequate. Future policy-making must be based on economic considerations and evidence, not on myopic political considerations

In 2014, the Narendra Modi-led Government came to power with an objective of ‘minimum Government, maximum governance, aimed at showcasing the country as an investment-friendly destination. Thereafter, on various occasions, the Government announced measures to boost private sector investment in the country. To its credit, several high-level policy decisions, like the Goods and Services Tax (GST) and Insolvency and Bankruptcy Code were enacted to improve the business and investment environment. However, the major test for the Modi-led Government is yet to come.

India is on the cusp of laying the foundation stone for the next digital revolution (Industry 4.0). Industry 4.0, synonymous with the digital economy, is expected to contribute one trillion dollar to national output by 2022-23. Given the undeniable potential of the digital economy to contribute outsize growth, it is incumbent on the Government to adopt a delicate, evidence-based approach to put in place an appropriate regulatory architecture that ensures the country reaps full dividends from Industry 4.0.

However, emergent policy recommendations in the past few weeks indicate that the Government is handling the nascent digital economy with a 20th century mindset. These include recommendations of the Committee of Experts, led by Justice (retd) BN Srikrishna, the draft e-commerce ‘policy’ and the draft report of the Working Group on Cloud Computing — the latter two, as reported by the media, amply illustrate the perils of a dated mindset.

For starters, the decision-making process of all the three have remained opaque and had negligible representation from private organisation, let alone investors. Therefore, the final outcome of these groups has been skewed towards one direction, while ignoring the consideration of other stakeholders, in particular investors. For instance, despite highlighting the economic cost and concomitant adverse impact on the start-up ecosystem associated with data localisation in a white paper, the final recommendation of the BN Srikrishna committee endorses the same. Similar provisions for localisation have found their way in Cloud computing recommendations as well as the draft e-commerce policy. It is important to note that storage of data in India would not mean access to that data by local entities. Additionally, such measures can exacerbate cyber-security risks by compelling enterprises to invest in increasing data storage capacity, while apportioning fewer resources to ensure adequate security controls.

Furthermore, voices for protectionism, which are reminiscent of the discourse during the 1991 reforms, are getting louder. Particularly with respect to the draft e-commerce policy, a document, which besides guiding India’s position at the international trade fora, is aimed at promoting the domestic e-commerce ecosystem. This policy will implicate all aspects of the digital economy, and have a key role to play in India’s preparation for the emergent digital revolution.

However, protectionist voices have argued that the Government should formulate different rules for foreign and domestic companies, citing that availability of abundant capital with foreign companies could kill domestic entrepreneurship.

India has come a long way from considering investments as a bail out to solve external payment crises, to recognising that investments bring with them growth and employment, and consequently make a significant contribution to the economy at large. Constant liberalisation of the foreign investment regime in the country is an example of this approach.

Nonetheless, while dealing with digital economy, a constant international best practice which is cited by protectionist voices is that of China. The question to ask is: Can India afford to adopt the Chinese approach? Currently, India’s share in global value chains (GVC) is estimated to be less than two per cent, while China’s share is in double digits. Importantly, China’s peculiar political and economic outlook makes its policies inimitable. For instance, most Chinese players in the digital economy have been supported by state-led investments.

Unlike China, India neither has the economic footprint to deter other countries from taking restrictive reciprocal measures, nor are our entrepreneurs and businesses supported by public sector finance. On the contrary, foreign capital has played a vital role in providing India’s home-grown digital companies like, Ola and Paytm, a global stage. Introducing onerous regulatory conditions and uncertainty could impact the trust of the investors in India as a promising and stable digital market, consequently damaging the image of the country as an investment-friendly destination.

Therefore, it is important that future policy-making is based on economic considerations and on evidence rather than myopic political considerations. Additionally, the need of the hour is to take a nuanced approach with respect to policies which are expected to impact India’s economic aspirations in the coming decade. Given that the 2019 Lok Sabha election are around the corner, the Modi Government will be under pressure to succumb to various protectionist demands. It should take care to avoid such pitfalls if it is to reap economic dividends in its second-term in power which it projects to win.

source: www.dailypioneer.com

How cybersecurity and data storage laws could pull the plug on Southeast Asia’s digital economy

southeast-asiaJeff Paine says governments in Southeast Asia are keen to capitalise on the opportunity presented by the digital economy, but their rush to regulate data flows and storage will hit start-ups and small local firms hard.

Southeast Asia is one of the most diverse regions in the world, a handful of countries with thousands of languages and cultures, yet all having one thing in common – bold ambitions for their digital economies.

From the establishment of digital agencies like Malaysia Digital Economy Corporation in Malaysia and the Digital Economy and Promotion Agency in Thailand, to charting impressive road maps such as Thailand 4.0 and Making Indonesia 4.0, many governments in the region are prioritising capturing as much of the region’s US$200 billion digital economy opportunity as possible.

What isn’t clear is how these bold aspirations will be achieved.

Despite the inherent benefits of digital technologies and the internet, many governments are pursuing policies that will limit the use of these technologies. Driven by pressure to address specific and immediate challenges including cybersecurity, data protection, privacy and misinformation, governments fail to consider the long-term impact of these laws on economic growth, jobs and investment.

Vietnam’s recent Law on Cybersecurity and Indonesia’s Government Regulation 82 are examples of this, with provisions including restrictions on data flow and content, requirements for foreign companies to set up local offices and local data storage requirements. Meanwhile, proposed rules in Thailand subject over-the-top (OTT) service providers to tax, security and content regulations.

The impact of these regulations goes far beyond the information and communications technology industry, given that virtually every business today uses the internet and digital technology.

For foreign businesses, restrictive, too broad and unclear regulations create uncertainty and an unfriendly investment climate. Multinational companies unable to make long-term financial decisions are likely to shift their investments to countries with more flexible regulatory environments that support the development of a digital ecosystem.

Local businesses, like small and medium-sized enterprises and entrepreneurs that comprise 95 per cent of Southeast Asia’s economy, will bear the brunt of poor policies. Restrictions on cross-border data flows, digital tax and local data storage, will prove difficult to comply with.

Many small businesses depend on digital services and platforms such as cloud for data storage and collaboration, online marketplaces for e-commerce, social media for communication and marketing, and OTT platforms to reach customers at scale. Such laws will increase the cost of doing business, create barriers for expansion beyond borders and are likely to block small players from competing in the global marketplace.

For example, if a neighbouring country enacted similar provisions to Vietnam’s cybersecurity law, a Vietnamese software start-up would be unlikely to be able to afford data storage facilities and local offices in locations outside Vietnam – curbing regional or global expansion plans.

With significant economic prospects at stake, and the challenges of security, privacy, data and misinformation in mind, governments must find better ways to manage risk without hampering growth.

Southeast Asian governments can learn from how larger, developed economies manage emerging technology. For example, Thailand has looked towards the European Union’s implementation of the General Data Protection Regulation as a basis for their data protection laws.

On taxation, intergovernmental organisations such as the Organisation for Economic Co-operation and Development provide useful guidance in key areas such as the need to create consistency between countries on cross-border digital taxes. Unilateral moves like Australia’s goods and services taxin July 2018 on low-value imported goods is likely to pose compliance challenges and higher costs for small businesses in the long run.

Instead, a cross-sectoral range of agencies, ministries and industry players could together craft comprehensive policies that manage risk and promote growth. A good example of this is Singapore’s approach to digital taxation and preventing misinformation.

The digital economy is uncharted territory for most. There is a small window of opportunity now to ensure smart regulations and policies are in place to secure future growth. Technology companies and industry groups can work with governments, ensuring that the opportunities and benefits of the digital economy are realised and not wasted.

source: www.scmp.com

Benin is the latest African nation taxing the internet

taxationBenin has joined a growing list of African states imposing levies for using the internet.

The government passed a decree in late August taxing its citizens for accessing the internet and social-media apps. The directive, first proposed in July, institutes a fee (link in French) of 5 CFA francs ($0.008) per megabyte consumed through services like Facebook, WhatsApp, and Twitter. It also introduces a 5% fee, on top of taxes, on texting and calls, according to advocacy group Internet Sans Frontières (ISF).

The new law has been denounced, with citizens and advocates using the hashtag #Taxepamesmo (“Don’t tax my megabytes”) to call on officials to cancel the levy. The increased fees will not only burden the poorest consumers and widen the digital divide, but they will also be “disastrous” for the nation’s nascent digital economy, says ISF’s executive director Julie Owono. A petition against the levy on Change.org has garnered nearly 7,000 signatures since it was created five days ago.

The West African nation joins an increasing number of African countries that have introduced new fees for accessing digital spaces. Last month, Zambia approved a tax on internet calls in order to protect large telcos at the expense of already squeezed citizens. In July, Uganda also introduced a tax for accessing 60 websites and social-media apps, including WhatsApp and Twitter, from mobile phones. Officials in Kampala also increased excise duty fees on mobile-money transactions from 10% to 15%, in a bid to reduce capital flight and improve the country’s tax-to-GDP ratio.

Digital-rights advocates say these measures are part of wider moves to silence critics and the vibrant socio-political, cultural, and economic conversations taking place online. The adoptions of these taxes, they say, could have a costly impact not just on democracy and social cohesion, but on economic growth, innovation, and net neutrality. Paradigm Initiative, a Nigerian company that works to advance digital rights, has said it was worried Nigeria would follow Uganda’s and Zambia’s footsteps and start levying over-the-top media services like Facebook and Telegram that deliver content on the internet.

But taxing the digital sector might have a negative impact in the long run. Research has already shown that Uganda’s ad hoc fees could cost its economy $750 million in revenue this year alone. “These governments are killing the goose that lays the golden egg,” Owono said.

source: www.qz.com

German politician calls for corporate break-up of U.S. digital tech giants

Social Democrats (SPD) Hold Federal Party CongressGerman Social Democrats (SPD) leader Andrea Nahles has called for the break-up of major U.S. technology companies on Monday to prevent the formation of digital monopolies.

Writing in the newspaper Handelsblatt, Nahles urged policymakers to use antitrust regulation to “reign in internet giants” like Facebook, Google and Amazon as soon as their behavior began to “contradict the principles of the social market economy.”

Amongst others, she proposed a “data-for-all” law which would require companies which had acquired a dominant market position to give away a share of their anonymized data for free.

Furthermore, Nahles warned that digital monopolists which failed to assume their responsibility to society would have to face the prospect of involuntary disintegration at the hands of competition authorities.

“In such cases, we will have to hold discussions in the European Union (EU) over whether a corporate break-up is necessary,” the SPD leader said.

In hindsight, Nahles argued, it had been a mistake to allow the concentration of digital market power in a handful of companies as had occurred during the takeover of WhatsApp by Facebook. However, she noted that it would not be unprecedented for governments to reverse these mergers again. It was hence in the “enlightened self-interest” of the sector to take recent criticism of industry business models to heart to avoid the need for such radical steps.

The SPD leader is not the first senior German politician to demand reforms of the way data-driven Silicon Valley companies operate in the EU. Earlier, chancellor Angela Merkel (CDU) proposed introducing a tax on data in the digital economy.

“The pricing of data, especially that of consumers, is the central injustice issue of the future,” the Christian Democratic Union (CDU) leader said. She emphasized that such data had become fundamental to the business model of many companies in the digital economy which generated income with targeted advertising.

According to Merkel, ongoing discussions in the EU over how to tax large U.S. companies like Google and Amazon only underscored the urgency of problems in the current regulatory regime governing e-commerce. The situation raised the question of whether traditional corporation tax models were still appropriate, or whether policymakers should instead resort to revenue-taxing to ensure a level playing field between digital and non-digital firms.

Many online businesses pay considerably less tax in Europe than traditional industrial manufacturers or brick-and-mortar retailers. The digital companies hereby benefit from their non-locational character which allows them to channel European profits through low-tax jurisdictions such as Ireland and Luxembourg.

The EU Commission has already announced tentative plans to tax the revenue of large digital companies with at least 750 million euros in annual global revenue and online sales worth 50 million euros in Europe at a three percent rate. The taxes would be levied in the countries where users are physically based.

But the plans also require unanimous consent from EU members, which remains elusive on the issue. While Germany and France are seen as the major driving forces behind the changes, low-tax countries like Ireland, Luxemburg and Malta have warned that the reforms could open a new front in the temporarily-stalled trade war between Brussels and Washington.

Writing on Monday, Nahles insisted nevertheless that closer regulatory scrutiny of the commercial activities of major digital technology firms was required in the bloc. She argued that digitalization would only become a force for good when its potential was harnessed by society as a whole, rather than an elite circle of corporate beneficiaries.

source: www.xinhuanet.com

Tax Department’s Consultation On Digital Taxation May End Up Being An Academic Exercise, Experts Say

taxationTechnology giants like Facebook, Google, Amazon, Alibaba and other such digital companies derive considerable value from a large user base. For instance, some digital companies sell user data for targeted advertising. It’s this value that nations now want to tax.

Europe, for instance, has proposed a tax on turnover. Australia is mulling a tax on digital advertising. Singapore has announced a sales tax on digital services, starting 2020. India isn’t far behind either.

Digital advertising on foreign platforms is already under the tax net, also known as the equalisation levy. But now, India now wants to tax the business profits of digital companies, for which the taxman has reached out to various stakeholders for consultation. Experts told BloombergQuint the move will run into two problems: attribution of profits among countries i.e. who can tax how much, and treaty troubles.

Digital Services: What Gets Taxed?

Two years ago, the government imposed a 6 percent tax on digital advertising, which is attracted when an Indian resident or a non-resident with a fixed place of business in the country advertises online with a service provider with no permanent establishment in India. Permanent establishment is, in tax parlance, a fixed place of business. The levy is applicable if the transaction value exceeds Rs 1 lakh in a financial year. Reportedly, this levy has added close to Rs 3,000 crore to tax collections in the last two years.

Equalisation levy is applicable on advertising revenues and the administration of it has been smooth in the last two years, Sudhir Kapadia, partner and national tax leader at EY India, told BloombergQuint. It’s a tax on business-to-business transactions and the law has ensured there’s no double taxation, he said.

There is no income tax in the hands of a non-resident once the equalisation levy is discharged. So, it is a proxy for any kind of income tax liability that can be levied on the company concerned.Sudhir Kapadia, Partner, EY India

What About B2C Transactions?

Enter, Significant Economic Presence. In budget 2018, the government proposed to get its fair share of tax from business-to-consumer transactions by introducing the concept of significant economic presence. According to the finance minister, the idea is to tax profits of those digital businesses that don’t have a physical presence in India but derive significant economic value from the country.

India’s belief is that we follow strict source-based rules of taxation; our domestic law and treaty definitions of permanent establishment have lost their relevance because of the digital invasion, Mukesh Butani, managing partner at BMR Legal, said.

A lot of foreign luxury goods and garment manufacturers don’t have a physical presence in India. You can use an Amazon platform and order those goods, or you can go to the company’s website and order. But you can’t tax those activities in India, assuming they don’t have presence here. Under this significant economic presence, such activities will come under the tax net.

Mukesh Butani, Managing Partner, BMR Legal

What Does The Tax Department Want To Know?

In one word, thresholds. The department has asked for consultation on:

  • Revenue threshold of transactions with respect to physical goods or services carried out by a non-resident in India.
  • Revenue threshold of transactions pertaining to digital goods or services or property, including the provision of download of data or software.
  • Threshold for number of “users” with whom systematic and continuous soliciting of business activities is done through digital means.

To begin with, the phrase used in our law is significant economic presence and not just digital presence as is the case in Europe, Kapadia said. The first element on which consultation is sought is about transactions involving physical goods and so, our approach is far more overarching, he added.

The budget memorandum only talked about digital economy, but this would include all transactions of import of goods, which currently attract only customs duty. For example, EPC contracts, manufacturing, supplies from vendors etc who do not have a presence in India.

Sudhir Kapadia, Partner, EY India

If India is determined to bring this, revenue threshold for digital goods and services and user threshold can be akin to what the E.U. has proposed, he said.

Europe has proposed a three percent tax on businesses with E.U. digital revenues of over 50 million euros and total global revenues of over 750 million euros. Revenues derived from online advertising, sale of user data and online marketplaces will attract this levy.

So, What’s The Problem?

The first is profit attribution. Or, how should governments determine the revenue attributable to digital activities in their country.

It’s going to be very difficult for India or any other country to ascertain this since the conventional principles of permanent establishment won’t apply to digital businesses, Kapadia said. He explained that data about users in other countries, revenues collected in other countries arising from that user data isn’t easy to get despite the exchange of information arrangements.

 Currently, India has two provisions for attribution. Rule 10 of the Income Tax Rules which essentially says that revenues from India divided by global revenues multiplied by global profits should be the taxable base in India. This, in a brick-and-mortar space, poses enough challenges. It would be impossible to apply this principle in a digital business. Second is the arm’s length principle under transfer pricing. That can’t be the answer either since the entire functions, contractual and legal risks are outside of India in the digital business context.

Sudhir Kapadia, Partner, EY India

The second issue would be tax treaties. If the treaty problem isn’t addressed, this consultation will just be an academic exercise, Butani said.

When the law was passed in Budget 2018, it clearly said India is proposing this law in order to be prepared for the changes that occur in double-tax treaties, Butani said. This subordinate legislation that the department is proposing won’t be useful in situations where the non-resident tax payer is from a country that has a tax treaty with India, he added.

The definition of permanent establishment under the tax treaties don’t contemplate digital transactions. The only way is to amend the treaties using the multilateral instrument tool proposed by the Organisation for Economic Co-operation and Development. But if the treaty partner hasn’t signed up to MLI, the provision under the domestic law won’t help.

Mukesh Butani, Managing Partner, BMR Legal

You’re looking at a scenario where some treaties will trigger a digital permanent establishment and some treaties won’t, he said. So, how will a change in the domestic law affect the taxable position under these treaties, he added.

Difficult and contentious: taxing the digital economy (Australia)

Accountants have been urged to keep a lookout for significant changes to the tax environment as the government considers options for taxing the digital economy.

In Treasurer Scott Morrison’s budget address, he noted how the government’s crackdown on multinationals had brought $7 billion a year in sales revenue and would now be looking towards the digital economy as part of its initiatives to strengthen its tax base.

“The next big challenge is to ensure big multinational digital and tech companies pay their fair share of tax,” said Mr Morrison.

“Over the past year I have been working with counterparts at the G20 to bring the digital economy into the global tax net.

“In a few weeks’ time I will release a discussion paper that will explore options for taxing digital business in Australia.”

Thomson Reuters tax consultant Terry Hayes believes taxing digital business in Australia will continue to be a difficult and contentious issue and suggested that Mr Morrison was looking to Europe for ideas.

“Europe has been taking a lead in measures to tax the digital economy,” said Mr Hayes.

“In March this year, the European Commission proposed to introduce a digital services tax aimed at addressing the tax challenges of the digital economy in the European Union. Companies such as Google and Facebook would clearly be impacted.”

Mr Hayes believes the upcoming discussion paper announced by Mr Morrison might shadow two distinct legislative proposals put forward by the European Commission in March this year.

The proposed long-term solution would allow EU member states to tax profits that are generated in their territory, even if a company does not have a physical presence there. Profits would be registered and taxed where businesses have significant interaction with users through digital channels.

The second option, would be for an interim digital tax, roughly 3 per cent, to cover the main digital activities that currently escape tax altogether. This interim tax would apply to revenues created from activities where users play a major role in value creation.

“However, it is understood there may be some wavering on the proposals as concerns rise among European countries of possible US retaliation over the measures,” said Mr Hayes.

source: www.accountantsdaily.com.au

EU’s Taxation of the Digital Economy—Fair or Protectionist?

taxationThe EU Commission has published two proposals on the taxation of the digital economy and digital business models. Will the reform of corporate tax rules and the second measure of an interim tax lead to a fairer taxation of digital activities in the EU? Since the economic crisis of 2008-09, we live in a different world. Countries started to prioritize “taxation” in their financial agenda for sound public funding sources. Both developed and developing countries have increased the direct tax base on business profit. In this environment, important initiatives were developed by the G-20, and G-20 countries started amending their local laws and regulations. A recent example relates to the taxation of the digital economy. The OECD and EU agree that the current international taxation rules are insufficient because digitalization enables businesses operating with no physical presence.

Even though the OECD and EU agree that the current international taxation rules are outdated, their way of addressing it is different. The OECD does not conclude any recommendation because there is no consensus among the members. On the other hand, the European Commission approach digital companies differently by taking a short-term (interim) and long-term stance. While the EC’s short-term stance is 3 percent digital service tax focused on taxing advertising, digital platforms and sale of data, the EC’s long-term stance is based on “significant digital presence” focused on a broad range of digital services, i.e. the provision of films, music, software, or cloud computing.

However, “taxing digital businesses” needs a global policy consensus to be successful and eliminate double taxation. Otherwise, pre-BEPS “double non-taxation phenomenon” would result in double taxation.

Why is the Work of Tax Administrations Challenging in a Digital Economy?

Business models have changed in the digital economy. The following companies are an example of new business models being used:

* Airbnb does not possess any real estates;

* Alibaba does not carry inventory;

* Booking.com does not possess any hotels; and

* Twitter and Facebook do not produce content.

Airbnb and Booking.com provide intermediary services and Twitter and Facebook offer advertising services and acquire their revenues from these activities.

They operate without a physical entity (i.e. building, factory) based on the business models. Taxation rules based on a nexus of a business applied prior to the digital economy makes taxation difficult in the new economy.

According to public opinion, these companies do not pay a fair tax, which is proportional to their earnings, in order to provide for the state expenses. Because of this, governments have to take action in order to provide justice in their tax systems.

About 75 percent of EU citizens expect the EU to struggle against tax evasion. In a public opinion poll, 75 percent of the participants believe that the current international taxation rules allow companies operating under digital business models to benefit from specific taxation regimes and pay lower taxes.

What Types of Works are being Carried out Concerning the Taxation of the Digital Economy?

An international standard and cooperation of the countries are required in order to tax companies. The most important organization with respect to this is the OECD and the OECD’s initiatives are supported by G-20.

OECD Functions

Digital economy models complicate the place and ratio of payment of the corporate tax accrued over income. This is because it is very challenging to determine the extent of an income acquired from a certain country, which should be referred to such country, without a nexus.

Consequently, Action 1 of the OECD’s Base Erosion and Profit Shift (“BEPS”) Action Plan published a temporary report addressing the tax challenges of the digital economy (“temporary report”). However, the OECD does not propose a taxation method in this interim report. It determines what the alternatives may be and makes evaluations.

Finally, in the meeting held in Buenos Aires on March 19-20, it was declared that the Ministers of Finance of G-20 will publish an updated Temporary Report on Tax Challenges Arising from Digitalization and will work towards a consensus-based solution by 2020. The implementations of the countries in the short-term are determined in the report. However, the actual purpose of the OECD is declared as formation of the grounds for progress toward a long-term multilateral solution in the next stage.

Accordingly, many countries express that digital companies acquire high income in their own markets in the digital economy and that they are required to pay corporate taxes over these incomes. Consequently they are taking actions in order to collect tax. For example, Turkey collects 18 percent VAT over the digital services offered to the individuals by the companies residing abroad, which was brought into force as of January 2018.

The reason for the countries to make legal arrangements is that they want to collect tax over such earnings without any delay, although they do not have any taxable assets in their countries according to the current international taxation frame.

However, the common opinion in the U.S. is that the taxation right on the income is taxable in the U.S. since all the value added and the intellectual property rights are created in the U.S. This is based on an old adjudication in the U.S. related to the economy (SALT Alert, 2018-01: U.S. Supreme Court Grants Certiorari in South Dakota Case Seeking to Overturn Quill-http://src.bna.com/x6V).

In the Quill Corp. v. North Dakota case in the U.S. which is related to the distant sales, there is the Supreme Court’s decision dated 1992, stating that North Dakota does not have any authority to collect sales tax in the products delivered to North Dakota where the company does not have a physical presence.

However, the subject of “economic presence (nexus)” is again on the agenda and has been since 2016 but nowadays, the subject of “physical presence (workplace)” is being discussed and should be re-evaluated. The states enacted laws to implement the principle of economic nexus in order to apply the sales taxes against the Quill decision. In 2016, South Dakota included its own economic nexus principle in the law. With the law, the sellers, without any physical presence shall be taxpayers in South Dakota for the sales tax based on an economic nexus principle. The threshold for the tax payment obligation is determined as at least “performing 200 separate sales or sales with a total of US$100,000.”

With respect to the case litigated concerning this issue, the Courts of First Instance of South Dakota decided that the Court is bound by the Quill decision and decreed in favor of the claimants. While reaching this decision, the thesis of the state that the principle of the physical presence of Quill “was out of fashion under the light of the developments in the software and technologies,” which was the reasoning of the state Supreme Court, was rejected.

It was decreed that it was based on the reasoning of the Quill case. However, on September 14, 2017, the Supreme Court of South Dakota upheld the decision allowing South Dakota’s opposition to the Supreme Court of USA. The opposition is expected to be submitted in Spring 2018. The decision is expected to have a significant influence on taxation and the economy.

EU Functions

About one week after the publication of the Temporary Report, the EU made a press release on March 21. According to the EU bulletin, the current “international corporate tax rules do not comply with the realities of the global economy” and do not comprehend the business models which may acquire profit from digital services in a country where one is not physically present. The current taxation rules were not successful in defining the new methods of the digital economy for creation of the profit, and specifically, the role played by the users in creation of value for the digital companies. In the current system, there is disconnection or noncompliance between the place where the value is created and the tax is paid.

The EU’s digital taxation package key areas are as follows:

* For taxation of the digital economy, it enables member states to collect taxes from the earnings acquired in their own regions, even if a company does not have a physical presence. The new rules shall provide online entities to contribute to the public finance at the same level with the companies which are connected to traditional physical workplaces.

* This proposal includes a recommendation to the member states for modifying the Avoidance of Double Taxation Treaties with the third countries. Accordingly, same rules shall be applicable both for the EU member and EU non-member companies. The Commission also recommended to provide assistance to the member states in the determination discussions with respect to the application at the international level for the digital corporate tax updates.

* It recommends a temporary digital services tax until the new rules are created for the taxation of digital services.

In compliance with the new rules recommended by the EU, the member countries shall be able to collect taxes from the earnings produced in their own regions, even if such companies do not have any “physical presence/connection” there. These rules constitute a proposal which is expected to be permanent.

Details are as follows: If a company possesses any of the following criteria, then it shall be accepted to possess a “significant economic digital presence” in a Member State:

* Exceeding the threshold of an income of 7 million euros from the digital services in an accounting year, in a member state (for example, acquiring income from advertisement placement based on the user data);

* Having more than 100,000 user access to the digital services in a member state in an accounting year (for example, sharing economy and acquiring income from the services that provide access to the users on online markets); and

* Conclusion of more than 3000 business contracts between the company and the work users for the digital services in an accounting year (for example, acquiring income from providing broadcast stream to the subscribers).

With this reform recommendation of EU, a solution is provided for two of the main challenges encountered by the Member States when taxation of the digital activities is discussed:

* Firstly, “physical presence/connection” in a member state shall not be required any more in order to apply tax to the earnings of a company. A significant digital presence shall permit the member states to apply tax to the earnings acquired within the borders of its land.

* Secondly, the factors such as user data shall be taken into consideration in distribution of the earnings since these become more important gradually in formation of the company data and play a significant role.

The other proposal of the EU which is identified to be temporary is the new digital services tax (“DST”); and it shall take effect as of January 1, 2020 and shall be applied at a fixed rate of 3 percent over the gross income:

* The DST shall be applied to specific digital services including providing an advertisement area, presentation of market areas facilitating the direct transactions between the users and transmission of the user data collected, while offering digital content or payment services.

* The entities achieving certain thresholds cumulatively shall be subject to DST. DST shall be applied to the entities with annual global income over 750 million euros and annual revenue over 50 million euros in the EU originating from digital services. If this economic presence belongs to a consolidated group, then the mentioned thresholds shall be assessed on the group level.

* DST shall be in the member states where the users are. If the users are in different member states, then the proposal will also enable the calculation of the tax base to be referred to the member states depending on specific distribution keys.

* The Directive also provides cooperation between the member states in a single-time mechanism and provides the tax payers to have a single contact point in order to fulfill all the administrative obligations concerning the new tax.

As explained above, both OECD and EU agree that the current international taxation rules are insufficient concerning the taxation of digital economy. Despite this, OECD members were not able to develop a new and concrete taxation rule with respect to this issue at the international level. As a short-term solution, OECD member countries adopt the method of taxation which is applied over the sales mostly. It is expressed that the long-term solution is targeted to be achieved in the year 2020.

The EU proposed draft directives concerning this issue. One of these is tied to having “a significant economic digital presence.” And the other is DST at the rate of 3 percent, which is planned to be collected over the gross income starting from January 1, 2020. However, the application of these depends on being adopted by the parliaments of 28 countries.

If a tax at the rate of 3 percent is applied within the direction of the proposal of the EU Commission, this means the probability of acquiring an income of about 5 billion Euros annually for the member states. When applied to the EU, this single rate tax will be able to provide help for avoiding “tax exchange” and “tax distortion” in a single market. The tax of 3 percent will be applied only as a temporary measure until the corporate tax rules supporting digital economy take effect.

Are the Proposals “Fair or Protectionist”? Would the Other Countries take Counter-Measures?

Are the double taxation with the temporary tax of 3 percent and the international rules contradictory? With regards to BEPS Action Plan 1, it is observed that the governments prefer the alternative of “Reverse Charge VAT,” “withholding” or “balancing tax” as the authority concerning the taxation method with respect to the “digital economy.” Because of this, the method proposed by the EU does not constitute any contrariety to the third countries or the World Trade Organization rules and any double taxation agreement. This is because the OECD or UN member countries are yet to develop a common understanding of digital economy taxation principles. However, the proposal of the EU is parallel to the principle of “subjecting the profit to taxation where the value is created,” which emerges more apparently following BEPS and which is the basic principle agreed. As a conclusion, it is expected to remain to be in force until “final, permanent tax rules” are applied for the digital economy. The countries carried out arrangements for “VAT,” “withholding” or “balancing tax” as the authority concerning the taxation of the digital economy.

It is estimated that about 120 to 150 companies are covered within the scope of the European Commission’s proposal of 3 percent temporary tax, which means the probability of acquiring an income of about 5 billion euros annually for the member states. According to the European Commission’s Commission Staff Working Document (http://src.bna.com/xPv ) dated March 21, 2018, there is no reliable data regarding (see the European Commission’s Commission Staff Working Document, pp. 67-68, http://src.bna.com/xPw) the annual turnover of digital economy companies. But some two-thirds of turnover data is available by applying a revenue threshold of 750 million euros.

On the other hand, it is an issue of concern how the U.S. will react to the EU Commission proposals. This is because it is expected that 50 percent of the d 120 to 150 companies shall be the companies residing in the U.S. Since the U.S. discussed its concerns during the G-20 leaders meeting convened in Buenos Aires on March 19-20, 2018, it may decide to take counter-measures if EU countries adopt these proposals. However, if the arrangements brought by the U.S. tax reform are taken into consideration, we believe that such proposals of the EU are arrangements which are the subject of lesser discussions.

In response to the proposals of the EC, Business at OECD (BIAC) shared its opinion through a Media release (see The Business and Industry Advisory Committee, Media release, http://src.bna.com/xPx), dated March 21, 2018. BIAC warns against fragmentation in international taxation and calls for a broad consensus on a reliable tax framework for all companies. Unilateral action targeting certain businesses and deviating from established principles will reduce the potential for economic growth and job creation, particularly where these measures are based on the taxation of gross revenue rather than on profits. Additionally, the Chair of the BIAC Committee on Taxation and Fiscal Affairs, Will Morris, said:

“Business at OECD believes that the OECD/G20 Inclusive Framework is the most appropriate forum in which to advance tax policy addressing digital taxation. We strongly encourage the EC to work with the OECD/G20 Inclusive Framework to help develop global consensus through a broad multilateral process that includes business and all stakeholders.”

One of the main questions is whether these proposals, which require consensus shall be adopted or not by all the EU member states. Some member states expressed their concerns about DST. These concerns are, for example, DST possessing the characteristic of being an income tax since it is collected from proceeds. In other words, this is a tax collected from proceeds, not from net income and this tax shall be required to be paid even if the company is in loss. Moreover, DST shall not be considered as a tax paid abroad and this tax paid in a foreign country cannot be set off from the corporate tax calculated. However, it is understood that the probability that DST may be deducted as an expense may reduce double taxation risk at one point at a certain scale.

Planning Points

In today’s world, existing principles of international taxation is based on the “material permanent establishment” definition (Article 5/1 of the OECD Model Tax Convention). Therefore, the term “permanent establishment” means “a fixed place of business” through which the business of an enterprise is wholly or partly carried on, which is based on “a place of business,” “fixed” and “through which the business of the enterprise is carried on.” Therefore, an internet website does not constitute “tangible property in itself” and “not a permanent establishment in itself.”

In the post-BEPS world we live in the OECD recognizes “a shift in value creation” due to the digital economy. But there is no roadmap on how this should be reflected in tax policy.

In this environment, companies should identify potential foreign tax obligations (i.e. VAT or equalization tax) in cross-border sales of services and intangibles. In order to evaluate their existing indirect tax and direct tax status, companies can look at their existing structure as follows:

* Detailed functional analysis can give a first reflection with a focus on key assets and core activities;

* Where users and customers are located may constitute PE because data becomes a key resource to create value;

* Identify where real economic activities performed;

* Identify where countries at which sales are realized;

* Find out the person who is liable to comply with foreign VAT laws;

* Determine the definition of digital services;

* Find out what type of customer you have (“B2B” or “B2C”); and

* Be aware of the threshold for registration.

Finally, if the proposal is enacted, it will enter into force on January 1, 2020. Therefore, digital companies should be looking at their existing business models now.

Also, “taxing digital businesses” needs a global policy consensus. Otherwise, pre-BEPS “double non-taxation” phenomenon would result in “double taxation.”

source: https://biglawbusiness.com