Will nations agree on digital tax?
With jurisdictions unable to agree on how to tax cross-border digital transactions, Donald Drysdale asks whether the OECD and G20 will find a global solution by 2020?
In two articles last November, I commented first on initiatives by the UK and other countries aimed at taxing the global digital economy. Then I considered how Britain’s proposed new digital services tax (DST) might work.
I spoke of widespread concerns that long-established transfer pricing principles would have to be modified. Tax systems would need to be reformed to deal more effectively with cross-border digital transactions, but there was no consensus on how this should be done.
Many countries and other influential organisations had indicated a strong preference for a coordinated global solution. Others including the UK and EU were considering unilateral action. For example, New Zealand is currently consulting on introducing such a tax.
If a global consensus approach can be reached, it will involve changing the current international rules for taxing business income to allow ‘market countries’ (i.e. those where the customers are based) to impose more tax. This option is currently being discussed by the OECD and the G20.
Inclusive Framework on BEPS
The OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) brings together 129 countries and jurisdictions to collaborate on the implementation of the BEPS Package.
On 31 May the Inclusive Framework published its ‘Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy’, which it saw as an essential element of a fair and sustainable international tax system.
Programme of Work
The programme sets out proposals grouped into two broad ‘pillars’ which could form the basis for consensus. These pillars involve the re-allocation of taxing rights among jurisdictions and the need to address remaining BEPS issues.
Pillar One would revise the existing nexus rules and allocate greater taxing rights over a multinational’s profits to market countries, even if the enterprise had no physical presence there. One of the following possibilities might emerge, or a different solution perhaps containing some elements of these:
- A limited proposal for digital services only, focussing on the impact of user participation in social media, digital advertising, multi-sided online platforms and data.
- A broader proposal – extending beyond the digital economy and applied independently of pre-existing transfer pricing rules – giving greater taxing rights to market countries based on certain marketing intangibles created there by multinationals.
- An apportionment of a digital multinational’s profit to market countries where it has developed a significant economic presence through technology or other automated means, based on an agreed formula dependent on certain factors such as sales, assets and user participation.
- An alternative, formulaic approach proposed by pharmaceutical and healthcare company Johnson & Johnson – offering simplicity and certainty by allowing market countries to tax a fixed benchmark return of (say) 3% of a multinational’s sales, perhaps variable depending on certain factors such as overall group profitability and marketing expense.
Pillar Two would be a ‘minimum tax’ measure, applying beyond the digital economy and ensuring that multinationals pay a minimum level of tax on profits earned in low tax countries. This addresses some remaining BEPS issues and is not specifically directed at the digital economy – although it would also apply to digital companies.
The OECD has said that these pillars will form the basis for detailed analysis over the next 18 months, as the Inclusive Framework works towards delivering a proposal to the G20 by the end of 2020.
When the G20 Finance Ministers and Central Bank Governors met in Fukuoka, Japan, on 8 and 9 June, a communiqué issued at the end of their meeting included the following:
“We will continue our cooperation for a globally fair, sustainable, and modern international tax system, and welcome international cooperation to advance pro-growth tax policies. We re-affirm the importance of the worldwide implementation of the G20/OECD [BEPS] package and enhanced tax certainty. We welcome the recent progress on addressing the tax challenges arising from digitalisation and endorse the ambitious work program that consists of a two-pillar approach, developed by the Inclusive Framework on BEPS. We will re-double our efforts for a consensus-based solution with a final report by 2020.”
It would have been reassuring if the above wording had been endorsed by the G20 leaders on conclusion of their summit in Osaka on 29 June. However, other world issues grabbed the headlines.
The issues involved in cross-border digital transactions are complex, and the timetable for reaching an international consensus on how they should be taxed is ambitious.
At OECD meetings in 1998 and 2005, it was concluded that the international tax framework that existed at those times was sufficient to address the digital economy.
In 2012 the G20 first resolved to address BEPS issues, and in 2013 the OECD reported that domestic and international rules on the taxation of cross-border profits had not kept pace with changes in business practices brought about by globalisation and digitalisation.
In 2015 the OECD and G20 reported on Addressing the Tax Challenges of the Digital Economy as Action 1 of their 15-point BEPS action plan. That document noted problems with taxing the digital economy and considered three possible solutions:
- Widening the definition of a PE to include a non-physical significant economic presence.
- A withholding tax on payments to internet companies.
- An ‘equalisation tax’ – effectively a DST.
No action was taken to adopt any of these possible solutions from the 2015 report, but the OECD and G20 committed to reporting by 2020 on the outcome of continued work in relation to the digital economy.
The pace of change accelerated, and in 2018 a further Interim Report was published, noting important advances in the way business models and value creation were being affected by the process of digitalisation. However, there was no consensus for interim tax measures.
Given the slow progress at the OECD, some jurisdictions are now pursuing unilateral solutions, but these may impose unwanted short-term compliance burdens on companies when the greater need is for global action on digital tax matters.
The UK plans to introduce a 2% DST from April 2020. Austria, Czechia, France, India, Italy, New Zealand and Spain have also enacted or announced DSTs. The European Commission has proposed a DST, but this is not yet supported by all member states.
With the possible exception of India, all the above DSTs are intended as interim measures which would be repealed once the OECD’s global solution has been achieved. But they reflect the fact that the jurisdictions in question are sceptical of the OECD’s ability to deliver its solution within a reasonable timeframe.
For now, this scepticism seems justified. Before a global solution is found, it is likely that we will see an increase in the number of individual jurisdictions imposing unilateral DSTs.
Article supplied by Taxing Words Ltd