Taxation in digital economy, making way legally

rajendra-nayak2Digitalization of the global economy has happened at a tremendous pace and a large scale, permeating almost all areas of society. However, emergence of new business models have made it harder to tax businesses possessing a digitalized value chain. Conventional source allocation rules related to brick and mortar structures are not apt for the digital world, which operates virtually and without boundaries. Extensive efforts are being made by the Organisation for Economic Co-operation and Development (OECD), United Nations (UN) and European Union (EU) to revamp the current tax rules to deal with the issues of taxation in the digital economy (DE).

In addition, various countries such as India, Australia, China, Israel, UK, Kuwait and Saudi Arabia have already implemented unilateral actions in their domestic laws as their answer to deal with digital economy (DE)[1]. For example, India[2] was the first country to introduce an Equalization Levy (EL) at 6% of the amount received or receivable by a non-resident for providing specified digital services and facilities. Other countries have also brought about domestic law changes in varied forms to advance taxation in digital transactions.

Some of these measures are discussed hereunder.

OECD’s options to tackle DE

Taxation in the DE was discussed between OECD, G20 and other developing countries under Base erosion and Profit Shifting (BEPS) Action 1[3], which evaluates the following options to deal with tax challenges in the DE:

►   Nexus rule in the form of a “significant economic presence” requirement

►   Final withholding tax (WHT) in the nature of income tax on certain digital transactions

►   Introduction of (EL)

Flexibility was given to countries to adopt the options, subject to their treaty obligations. As a follow up, OECD released a document[4] seeking public comments on the impact of digitalization on business models and value creation, challenges and opportunities for tax systems, the implementation of the measures outlined in the BEPS package and potential options to address the tax challenges of digitalization. OECD is expected to release the final report on Action 1 by 2020 and an interim report in 2018.

The UN’s work from a developing country’s perspective

The UN has acknowledged that DE taxation requires revision of the UN Model Convention, and it is a question that developing countries may want to debate under the aegis of the UN even if it is also discussed in other forums. Further, in September 2017, the UN released a Handbook[5] that details key BEPS issues arising in the DE and the UN’s suggestions on how developing countries can tackle those issues. The various options discussed in the UN Handbook are as follows:

►   Re-defining the definition of permanent establishment (PE) in tax treaties in order to prevent artificial avoidance of PE status

►    Amending the profit attribution rules to attribute more profits to source countries

►   Deeming online services as technical services in order to levy WHT on them

►   Implementing domestic anti-avoidance measures akin to countries such as Australia and UK

►   Registering and collecting VAT from transactions in a DE

Development at EU

On 21 September 2017, the European Commission (EC) made a formal announcement of the EU agenda to ensure that the DE is taxed coherently across the EU, consistent with the EU’s philosophy of a single market[6]. It is acknowledged that patchwork unilateral measures by individual EU member states may create new obstacles and loopholes in the single market. The objective is to ensure that the tax system is fair, provides certainty for business and prevents new tax loopholes.

The EC is considering a two-phased approach for taxing the DE, viz. short-term solutions (similar to the OECD recommendations of a separate levy, WHT) and a long-term solution Common Consolidated Corporate Tax Base (CCCTB). CCCTB, EC’s preferred option, provides an EU framework for revised PE rules and for allocating the profit of large multinational groups using the formula apportionment approach based on assets, labor and sales to better reflect where the value is created.

The EC aims to release its proposal to tackle taxation of the DE by spring 2018, integrating the solutions provided in the OECD’s report in 2018.

Country developments

India introduced EL with effect from 1 June 2016. However, since India has not amended its tax treaties subsequently to include EL as one of the covered taxes, one of the major debates/criticisms around EL is whether EL is covered under tax treaties and if not, whether such levy overrides India’s treaty obligation.

Australia and the UK have introduced domestic anti-avoidance provisions to tackle DE issues. The concept of virtual service PE is gaining importance and countries such as Kuwait[7], Saudi Arabia[8] and India[9] have espoused it in the assessment of taxpayers. France and Israel have proposed to amend deemed PE rules based on significant economic presence. Italy has proposed to levy final WHT.[10]

Unilateral developments in domestic laws defeat the objectives of the BEPS initiative to implement the 15 Action Plans in a consistent and coordinated manner. Further, such amendments also create the risk of double taxation and may increase BEPS concerns around DE.

Conclusion

Though various options for taxation in the DE are being examined by international organizations, their feasibility will be evaluated by each country as per its international tax policy. Considering the activism in multiple jurisdictions and the clear indications from international organizations, taxpayers should remain vigilant, informed about the policy directions and closely monitor developments in various countries to assess potential impacts on their digital transactions across borders.

 

 


[1] Discussion note released by the UN  Committee of Experts on International Cooperation in Tax Matters titled “Tax consequences of the digitalized economy — issues of relevance for developing countries” – Link: http://www.un.org/ga/search/view_doc.asp?symbol=E/C.18/2017/6

[2] Refer India’s “Budget Connect 2016 – Highlights and impact of Indian Union Budget on EL – Fresh self-contained code on taxation of digital e-commerce transactions” at http://www.ey.com/Publication/vwLUAssets/Template_Equalisation_Levy_Alert.pdf/$FILE/Template_Equalisation_Levy_Alert.pdf

[3] Refer EY Global Alert dated 23 October 2015, http://www.ey.com/Publication/vwLUAssets/OECD_issues_final_report_on_the_tax_challenges_of_the_digital_economy_under_Action_1/$FILE/2015G_CM5819_OECD%20releases%20final%20report%20on%20Action%201.pdf

[4] On 22nd September 2017

[5] Titled ‘Selected issues in protecting tax base of developing countries’

[6] The announcement is outcome of EU member states meet held previously. Refer EY global alert at http://www.ey.com/gl/en/services/tax/international-tax/alert–ecofin-discusses-development-of-new-digital-taxation-rules

[7] Refer EY Global Tax Alert on Kuwait Tax Authorities adopt “Virtual Service PE” concept dated 21 September 2015 at http://www.ey.com/gl/en/services/tax/international-tax/alert–kuwait-tax-authorities-adopt-virtual-service-pe-concept

[8] Refer EY Global Tax Alert on Saudi Arabian tax authorities introduce Virtual Service PE concept dated 30 July 2015 at

http://www.ey.com/gl/en/services/tax/international-tax/alert–saudi-arabian-tax-authorities-introduce-virtual-service-pe-concept

[9] Refer EY Tax Alert on Bangalore Tribunal rules on constitution of service PE for services rendered virtually as well as physically dated 12 July 2017 at http://www.ey.com/Publication/vwLUAssets/Bangalore_Tribunal_rules_on_constitution_of_service_PE1/$FILE/Bangalore_Tribunal_rules_on_constitution_of_service_PE1.pdf

[10] Discussion note released by the UN  Committee of Experts on International Cooperation in Tax Matters titled “Tax consequences of the digitalized economy — issues of relevance for developing countries” – Link: http://www.un.org/ga/search/view_doc.asp?symbol=E/C.18/2017/6


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