Global Tax Alert | 7 April 2014

OECD releases discussion draft on tax challenges of the digital economy

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Executive summary

On 24 March 2014, the Organisation for Economic Cooperation and Development (OECD) released a discussion draft in connection with Action 1 on addressing the tax challenges of the digital economy under its Action Plan on Base Erosion and Profit Shifting (BEPS). The document, “BEPS Action 1: Address the Tax Challenges of the Digital Economy,” (the Discussion Draft) contains a discussion of the key features and business models in a digital economy, the opportunities for BEPS that can arise in a digital economy, and some potential options to address the tax challenges raised by the digital economy.

The Discussion Draft is one of a series of such drafts that the OECD is releasing this spring in connection with the different elements of the BEPS Action Plan with the intent to obtain input from stakeholders. The Discussion Draft acknowledges that the proposals are in early-stage development and do not represent consensus views. It is anticipated that the final report on Action 1 will analyze a number of potential options, including options included in the current Discussion Draft and new options that may be proposed in response to the Discussion Draft.

Detailed discussion

The Discussion Draft was prepared by the Task Force on the Digital Economy (Task Force), a subsidiary body established in September 2013 to carry out the work of the OECD under Action 1. Action 1 proposes to “identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.”

The Discussion Draft is organized into six substantive sections that roughly align with focus areas identified in Action 1 of the OECD BEPS Action Plan: Information and Communication Technology and Its Impact on the Economy (Section II); The Digital Economy, Its Key Features, and the Emergence of New Business Models (Section III); Identifying Opportunities for BEPS in the Digital Economy (Section IV); Tackling BEPS in the Digital Economy (Section V); Broader Tax Challenges Raised by the Digital Economy (Section VI); and Potential Options to Address the Broader Tax Challenges Raised by the Digital Economy (Section VII).

The OECD issued the Discussion Draft to provide stakeholders with an opportunity to comment on the proposals before the OECD issues its final report under Action 1 by September 2014. Comments should be submitted to the OECD no later than 14 April 2014. A public consultation on the Discussion Draft is currently scheduled for 23 April 2014.

Information and communication technology and the emergence of new business models

The Discussion Draft first examines the evolution over time of information and communication technology (ICT), including emerging and possible future developments. Building on this discussion, the Discussion Draft provides examples of new business models and identifies the key features of the digital economy.

The Discussion Draft notes that advances in ICT have given rise to a number of new business models which, although not always completely distinct from traditional business, can often be conducted over greater scale and distance (remotely). The Discussion Draft includes a description of the following examples of such new business models:

  • Ecommerce (including business-to-business, business-to-consumer, and consumer-to-consumer models);
  • App stores;
  • Online advertising;
  • Cloud computing (including infrastructure-as-a-service, platform-as-a-service, content-as-a-service, and data-as-a-service);
  • Payment services;
  • High frequency trading; and
  • Participative networked platforms.

The key features of the digital economy illustrated by the new business models are identified in the Discussion Draft as:

  • Mobility, including mobility of intangibles on which the digital economy relies, mobility of users of the digital economy, and mobility of business functions resulting from a decreased need for local personnel to perform functions and a flexibility to choose the location of servers or other resources;
  • Reliance on data;
  • Network effects (understood with reference to where user participation, integration and synergies are important);
  • Use of multi-sided business models (a business model in which the two sides of the market may be in different jurisdictions with interaction through an intermediary or platform increasing flexibility and reach);
  • A tendency toward monopoly or oligopoly in certain business models; and
  • Volatility (resulting from relatively low barriers to entry and rapidly evolving technology).

Identifying opportunities and tackling BEPS in the digital economy

The Discussion Draft lists four core elements that it describes as associated with BEPS in the context of direct taxation. These are:

  • Minimization of taxation in the market (source) country (through the minimization of functions assets and risks or other avoidance of a taxable presence, or in the case of a taxable presence, by shifting profits or maximizing deductions);
  • Reduction or elimination of withholding tax at source;
  • Reduction or elimination of taxation at the level of the recipient (achieved through low-tax jurisdictions, preferential regimes, or hybrid mismatch arrangements) with entitlement to substantial non-routine profits often built-up via intra-group arrangements; and
  • Minimization of current taxation of low-tax profits at the level of the ultimate parent.

In addition to the specific options presented to the Task Force to address BEPS in the context of the digital economy discussed below, the Discussion Draft discusses how the development of the other measures outlined in the BEPS Action Plan, and the OECD work on indirect taxation, are also expected to address such strategies. The Discussion Draft states that the comprehensiveness of the BEPS Action Plan should ensure that taxation is more aligned with where economic activity giving rise to the income takes place. The Discussion Draft goes on to state that this should restore taxing rights at the level of both the market (source) jurisdiction and the residence jurisdiction of an ultimate parent company.

Identification of the broader tax challenges raised by the digital economy

The Discussion Draft lists four broad categories of policy challenges that it considers to be raised by the digital economy:

  • Nexus
  • Attributing value to data
  • Characterization
  • VAT Collection

The Discussion Draft describes the continued increases to the potential of ICT and digital technologies as impacting nexus and the ability to have significant presence without being liable to tax. For example, the reduced need for extensive physical presence in order to carry on business allows for movement of business functions to a new location that may be removed both from the market jurisdiction and the jurisdictions where related functions are taking place. The Discussion Draft states that these considerations raise questions as to whether the current rules are appropriate.

With respect to data, the Discussion Draft focuses on the questions of how to attribute value created from the generation of data through digital products and services and how to determine the share of profit attributable to these value drivers as raising cross border tax challenges. Additionally, the Discussion Draft notes that the issue of how to characterize a person or entity's supply of data in a transaction for tax purposes (e.g., as a free supply of a good, as a barter transaction, or some other way) also raises tax challenges.

Income characterization in the context of new business models similarly creates challenges when products and services are provided to customers in new ways. According to the Discussion Draft, income characterization difficulties raise questions with regard to the rationale behind existing income categories and consistent treatment among similar types of transactions.

The Discussion Draft notes that cross-border trade in both goods and services creates challenges for VAT systems. The Discussion Draft identifies two primary tax challenges related to VAT in the digital economy. First, the capability of private consumers to receive from online suppliers low value parcels treated as VAT-exempt in many jurisdictions. Second, the growth in the trade of services, particularly to private consumers, on which no, or a low amount of VAT is levied due to the complexity of VAT enforcement with respect to such services.

Summary of the potential options to address the broader tax challenges raised by the digital economy

The Discussion Draft provides an overview of four potential options proposed to the Task Force to address the challenges of taxing the digital economy. The Discussion Draft specifically notes that while the Task Force has had initial discussions on several options, the options are still in the process of being developed and it is important to receive input on them.

The first potential option presented to the Task Force and listed in the Discussion Draft would modify the exemptions to permanent establishment (PE) status under paragraph 4 of Article 5 of the OECD Model Tax Convention (relating to preparatory and auxiliary activities). The Discussion Draft states that several variations of this option are possible. One approach would eliminate paragraph 4 of Article 5 entirely. Another variation would eliminate just the enumerated exceptions of paragraphs (a) – (d) of Article 5(4) or make them subject to the overall condition that the character of the activity conducted be preparatory or auxiliary in nature, rather than a core activity, thus making such exceptions unavailable to businesses if such activities constitute one of their core activities or functions.

The second option, a variation on alternative PE thresholds, would establish an alternative nexus based on significant digital presence to address situations in which business are conducted “wholly digitally.” In such case, an enterprise engaged in certain “fully de-materialized digital activities” would have a PE if it maintained a “significant digital presence” in another country's economy. Potential elements of a test for when a fully de-materialized digital activity would be conducted and for when a fully de-materialized business would have a significant digital presence are provided are provided in the Discussion Draft.

The third option is another variation on alternative PE thresholds and includes three broad alternatives: a “virtual fixed place of business PE” (creation of a PE when the enterprise maintains a website on a server of another enterprise located in a jurisdiction and carries on business through that website), a “virtual agency PE” (extension of dependent agent PE concept to contracts habitually concluded with persons located in the jurisdiction through technological means, rather than through a person), and an “on-site business presence PE” (creation of PE through economic presence within a jurisdiction where the foreign enterprise provides on-site services or other business interface at a customer's location).

The fourth option provided in the Discussion Draft would impose a final withholding tax on certain payments for digital goods or services. The Discussion Draft notes that these types of options are intended to address the possibility of maintaining substantial economic activity in a market without being taxable in that market under current PE rules due to lack of physical presence.

Action 1 identifies the need to also address indirect taxation and the effective collection of consumption taxes (e.g., VAT, GST) with respect to the cross-border supply of digital goods and services. In this respect, the Discussion Draft identifies exemptions for imports of low value goods and remote digital supplies to customers as two areas where jurisdictions should focus their efforts.

In considering how best to evaluate the potential options, the Discussion Draft highlights the necessity of developing a framework that ensures the analysis can be done consistently and objectively. The Discussion Draft recommends the Ottawa framework principles, from the 1998 committee on Fiscal Affairs Report “Electronic Commerce: Taxation Framework Conditions,”1 of neutrality, efficiency, certainty and simplicity, effectiveness and fairness, and flexibility as a good starting point to establish such a framework. Specifically:

  • Neutrality: Taxation should seek to be neutral and equitable between forms of electronic commerce and between conventional and electronic forms of commerce. Business decisions should be motivated by economic rather than tax considerations. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation.
  • Efficiency: Compliance costs for taxpayers and administrative costs for the tax authorities should be minimized as far as possible.
  • Certainty and Simplicity: The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction, including knowing when, where and how the tax is to be accounted.
  • Effectiveness and Fairness: Taxation should produce the right amount of tax at the right time. The potential for tax evasion and avoidance should be minimized while keeping counteracting measures proportionate to the risks involved.
  • Flexibility: The systems for taxation should be flexible and dynamic to ensure that they keep pace with technological and commercial developments.

The Task Force considers that these principles are still relevant today and that supplemented as necessary, can constitute a basis to evaluate the potential options to address the tax challenges of the digital economy.


The Discussion Draft reflects the ongoing work of the OECD with respect to the tax challenges of the digital economy. This work is at its early stages, but the OECD considered it important to get input from stakeholders. Companies should evaluate how the issues and options discussed in the Draft may affect them, stay informed about developments in the OECD and in the countries where they operate or invest, and consider participating in the dialogue regarding the OECD BEPS project and the underlying international tax policy issues.


1. The Report was one of the outcomes of the 1998 Ministerial Conference on Electronic Commerce in Ottawa, Canada (Ottawa Conference).

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax services, Washington, DC
  • Barbara Angus
    +1 202 327 5824
  • Lisa Findlay
    +1 202 327 7180
Ernst & Young LLP, International Tax services, San Jose
  • Channing Flynn
    +1 408 947 5435
  • Jon Cisler
    +1 408 947 5786
Ernst & Young LLP, International Tax services, San Francisco
  • Zachary Perryman
    +1 415 894 4911

EYG no. CM4337