13 November 2018
There is rarely a month that goes by now without another press article of one of the major technology companies not paying their fair share of tax in a specific country. A growing feeling exists that the current system of international taxation is not fit for purpose.
The Organisation of Economic Co-operation and Development (OECD) looked closely at this when they launched their Base Erosion and Profit Shifting initiative in 2013, culminating in 15 Action Plans. Pride of place was Action Plan 1 – ‘The Digital Economy’.
Despite the prominent billing, there was in fact very little action. To date it has arguably been one of the least visible changes. Indeed, at the time the OECD concluded that they did not see that there was sufficient argument to create special measures but agreed it (the digital economy) did have the capacity to distort tax revenue results.
All that is about to change!
With recent studies showing that the average rate of tax for a digital company trading in the EU is in a range of -2.3% – 9.5%, depending on which report is read, compared with an overall average range of 20.9% – 23.2%.
The EU Commission published their proposal for their fiscal attack on larger technology companies back in March 2018. This involves two stages of action:
1. A so-called temporary measure by introducing a Digital Sales Tax (DST).
2. The establishment in the ‘longer term’ of Virtual Permanent Establishments to assess local corporate income tax on.
Digital Sales Tax
DST will be aimed at larger technology companies only. This has been defined as global group sales of €750m and with ‘digital sales’ in the EU (which will presumably then exclude the UK) of €50m.
This would be calculated as 3% of ‘digital sales’ by each territory. It sits therefore as a half way house between being an indirect tax and a direct one.
What are Digital Sales?
This very question will undoubtedly exercise many fine minds in the years to come.
However at this stage there are just three areas that the Commission have focused on:
1. Sales of online advertising
2. Sales of user data
3. Use of a digital platform to create an online market place
So the focus of attack is clear – Google, Facebook and Amazon!
The method of calculation is likely to depend on the type of service. It will be very difficult to make a generic rule apply to any digital sale. Each category will require specific rules to calculate the tax but each presents its own difficulties e.g. in 1 is it where the advert is shown or where the click takes place (which may be later in another country)? In 3 is it based on buyers or sellers or both?
Virtual Permanent Establishments (VPE)
Cross border taxation has long been based on the concept of territorial rights to tax profits which includes the use of permanent establishments (‘PEs’ – effectively a branch). The attributable profits to be taxed would be largely based on where people within the organisation are physically located. This has obvious shortcomings with digital businesses, which can be located anywhere where file servers can be stored and switched on. The number of people required to do that would be very small and no physical presence is therefore required in the country the business is trading in.
To overcome this, the long-term solution of the EU is to instead establish the principle of a virtual PE – a VPE. A VPE would then largely be based on number of users rather than employees, although again this needs to carry a number of carefully crafted definitions. Profits would then be attributed to each jurisdiction using transfer pricing methods (the Profit Split Method – see my guide on Transfer Pricing) and then taxed using the local corporate tax rate.
The thresholds for this to operate is proposed to be much lower then with DST.
This is scheduled to be:
• Turnover of €7m in digital sales per Member State
• Users of 100,000+ per territory
• At least 3000 business contracts for digital services created in a year per State
The range of digital services caught by this proposal will be considerably extended by this proposal.
It will be interesting to see if Member states will still have an appetite to tax in this slightly more traditional way given that this will involve filing and agreeing tax computations possibly some years after the accounting period in question is over. Contrast this with the near simultaneous revenue raising as the sale is made with DST.
Will it happen?
The EU is very keen to be seen to be controlling the introduction of DST as several Member States have proposals or debates of their own to introduce at a local level. Indeed, the target implementation date has been set at 31 December 2018, despite being a long way from consensus. France, Spain and Italy have all progressed this and in the 2018 Budget Statement, the UK announced their own version of DST to be introduced in 2020 (but at 2% and a lower threshold of £500,000).
For the EU to get this through, all 28 Member States must vote unanimously, which is unlikely, particularly given the current reluctance of Ireland and Luxembourg to go with this (both gain from keeping the status quo). On 6 November, Denmark, Ireland, Sweden, Malta and Finland expressed their concern and opposition to these proposals and reiterated their desire for an OECD solution to this issue.Instead it is likely that a coalition of those interested will ultimately be formed.
There are enormous definition issues to overcome. Each visitor in each country performing an online transaction on their phone or even viewing an advert will be potentially caught in this arena and will form part of the data from which DST will be calculated and paid. The accounting systems of each digital company caught may need to be drastically overhauled and there could be significant data capture issues for this purpose. Theoretically each such company will have much or all of the data required but they will need to correlate their marketing department with their accounting packages to enable reporting to be accurate.
An additional issue will be those very large businesses where they are a traditional ’bricks and mortar’ business but in the process of significantly expanding their digital operations (which is arguably true of all major worldwide corporations in the 21st Century). In all likelihood they will be operating on lower margins than pure tech companies and so any attempt to hit them with further turnover-based taxes will be massively detrimental and disproportionate to them.
In the USA the principle of this tax will be seen as anti- US (it is estimated that approximately half of the companies affected by DST will be US based) and this could mean the US also focusing on Europe as well as China in “tariff revenge”.
All of those obstacles noted, this is undoubtedly going to happen in one form or another. We will no doubt see plenty of ‘scope creep’ as countries not only use the principle to raise much needed revenue but seek to extend the process as time goes on. The questions really becomes when rather than if and whether the temporary solution, with near instant taxation will prove to be more lucrative and attractive than the permanent solution, so that it remains embedded permanently within our tax laws.
Don’t forget to download your free copy of our Transfer Pricing Guide here.