9 minute read 23 Apr 2021
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How the OECD can head off unilateralism in taxing the digital economy

By EY Global

Multidisciplinary professional services organization

9 minute read 23 Apr 2021
Related topics Tax Tax planning

The OECD is leading efforts to alter the global tax architecture for a digital economy. Will it halt the rise of unilateral digital taxes?

In brief
  • The OECD continues to lead the charge on changing international tax rules in light of the digitalization of the economy – with a target date of mid-2021 for consensus.
  • This is taking place against a backdrop of countries introducing their own unilateral digital services taxes (DSTs), creating complexity for multinationals.
  • Organizations need to get up-to-speed on numerous potential outcomes in order to understand their potential tax exposure.

The rapid digitalization of the global economy has created exciting new opportunities for businesses to sell goods and services to anyone, anywhere in the world who has an internet connection.

One result has been the development of a vibrant, global digital services economy that has unlocked huge value. Digitalization has also created significant challenges, however, both for governments, which fear their existing tax laws don’t capture revenues related to doing business online, and for businesses, which must deal with new and uncoordinated approaches for taxing digital activity around the world.

One of the biggest challenges involves the ongoing viability of traditional tax approaches. Increasingly, governments are rethinking the idea that a physical footprint should determine tax rights in a world where digital companies can generate significant revenue in countries where they have virtually no employees, no real estate and no physical presence.

“Just look at search engines, social networks and digital platforms which can locate their servers and software overseas,” says Chris Sanger, EY Global Government and Risk Tax Leader. “The perceived problem at the moment is that the taxing rights go to wherever the intellectual property is based rather than the customer.”

The Organisation for Economic Co-operation and Development (OECD) is now at the forefront of global efforts to remedy this situation and reimagine the rules for taxing the digital economy. It has embarked on one of the biggest shake-ups of global tax rules in a century, with 139 countries collaborating through what is called the Inclusive Framework on a new global tax architecture, in an effort to change how taxing rights over global business income are divided among countries.

The world is now watching the OECD to see whether global consensus can be reached on its proposals by mid-2021 and can head off a rising tide of uncoordinated unilateral taxes which would create unprecedented levels of complexity.

Redefining tax nexus

The effort to overhaul tax rules for the digital economy has its roots in the Base Erosion and Profit Shifting (BEPS) project initiated by the OECD nearly a decade ago. Aimed to address government concerns about the potential for multinational companies to exploiting mismatches in local country tax rules to reduce tax on cross border transactions.

This new project is divided into two distinct Pillars. Pillar One sets out to establish new nexus and income allocation rules. The objective is to ensure that companies pay taxes where they conduct sustained and significant business, even when they lack a physical presence. Pillar Two, meanwhile, focuses on agreeing a global minimum tax rate, to reduce tax competition between jurisdictions focused on lower tax rates and address any remaining opportunities for base erosion and profit shifting.

Any revision of nexus rules would require fundamental changes in every country's international taxation rules
Barbara Angus
EY Global Tax Policy Leader

Pillar One — which redefines the long-standing nexus and profit allocation rules that are the core of the international tax architecture — is arguably the most ambitious and the most contentious aspect of the OECD framework.

“Any revision of nexus rules would require fundamental changes in every country's international taxation rules,” says Barbara Angus, EY Global Tax Policy Leader. “In addition, the only way an alternative framework could succeed is if every country agrees to exactly the same allocation rules and applies them in the same way, so that income is taxed only once.”

Achieving this would require unprecedented levels of coordination and consensus between the 139 countries involved.

Revising international transfer pricing rules

“Pillar One would require a revision of international transfer pricing rules,” says Angus. “These rules regulate how profits are allocated to companies within a multinational group to determine how much of the total profits are taxed in each country.”

Angus points out that increasing the taxing rights of the country where a digital business’s customers are based would mean assigning less income to countries where other value drivers are based, such as development of intellectual property, which require significant investment. The result would be real winners and losers in terms of tax revenues, making it even harder for countries to reach agreement.

The complexity of these issues and the challenges in developing, agreeing, and implementing new income tax rules on a coordinated basis have driven interest in the approach of a unilateral gross-basis tax on revenue, such as a DST. A major issue with that approach is the obvious difference between revenue and income and a company’s fundamental ability to pay.

Jeff Michalak, EY Global International Tax and Transaction Services Leader, says he has serious reservations on this point. “It’s important to bear in mind that not every digital company with significant revenue generates significant profit,” he says. “In fact, some companies make no profit at all. A gross-basis tax, which focuses on revenue rather than income, may be easy for countries to collect, but it ignores the simple fact that a loss-making company may be unable to pay its tax bill.”

The COVID-19 effect

While the OECD has pushed ahead with its project on digital services taxes, it hasn’t been immune to the impact of the global COVID-19 pandemic. Indeed, it has had to push back its initial target date by six months, saying it now wants to reach an agreement by mid-2021 rather than December 2020.

COVID-19 has also increased governments’ appetite for additional revenue to finance the costs of the current period of spending on support and stimulus.

For example, European Union (EU) member states recently agreed to borrow €750 billion to finance a COVID-19 recovery package1. The EU has said it will repay this debt by introducing a digital levy, which must be in place by 2023. The EU has pledged to continue to work within the Inclusive Framework, but it says it is exploring other policy options as well lest agreement not be reached on the OECD project. These include:

  • A corporate income tax top-up to be applied to all companies conducting specific digital activities in the EU
  • A tax on revenues created by specific digital activities conducted in the EU
  • A tax on digital transactions conducted business-to-business in the EU.

The European Commission first attempted to introduce a DST in 2018, when its Fair Taxation of the Digital Economy package failed to win European Council support. However, the DST in that package would have been temporary with the intention of being replaced by a coordinated income-tax based approach such as the one currently being developed by the OECD.

The introduction of unilateral DSTs

While the EU and the OECD have been setting deadlines and attempting to reach consensus, more than 20 countries have acted unilaterally by introducing their own DSTs.

This proliferation of local DSTs has given rise to a confusing global tax landscape featuring a mix of VAT, customs duties, levies, withholding taxes, extra-terrestrial taxes and hybrid digital transaction taxes, each with their own taxable rate, global revenue and local revenue thresholds.
Gijsbert Bulk
EY Global Director of Indirect Tax

Nine countries have already enacted DST legislation — UK, France, Italy, Austria, Spain, Czech Republic, Poland, Turkey and India — while the remainder have DST legislation pending or on hold. Many of these tax laws feature “sunset clauses”, which mean they will expire if an agreement is reached at either the OECD or EU level — but there is no guarantee that countries will allow these taxes to lapse or withdraw them as part of an OECD or EU agreement. Additionally, some DSTs are being developed at the subnational level. For example, the US state of Maryland approved the country’s first tax on digital advertising, which is being challenged in court.

As Gijsbert Bulk, EY Global Director of Indirect Tax, says, “This proliferation of local DSTs has given rise to a confusing global tax landscape featuring a mix of VAT, customs duties, levies, withholding taxes, extra-terrestrial taxes and hybrid digital transaction taxes, each with their own taxable rate, global revenue and local revenue thresholds.”

With each country designing its own digital services tax, the cost and complexity of achieving compliance can rapidly become prohibitive.

Nicoletta Mazzitelli, Tax Partner at Studio Legale Tributario EY, based in Rome, has had first-hand experience of dealing with Italy’s new digital services tax and provides useful insight into its scope. “The Italian DST has a rate of 3% and was applicable from the 1 January 2020,” she explains. “Tax is due from any single entity or group which exceeds the following thresholds: worldwide revenues over €750 million and digital services revenues sourced in Italy of over €5.5 million.”

The Italian DST covers digital advertising, social media and goods and services platforms — it also covers the sale of data collected from users.

Channing Flynn, EY Global International Tax and Transactions Services Partner, Tax Technology Sector Leader and Digital Tax Leader, outlines the real-life impact of such unilateralism: “If a company operates in 80 or 90 countries, the danger is that they will have to run 80 or 90 different tax calculations in order to remain compliant,” he says.

Flynn also notes that these companies will then have to consider how this complexity funnels through to the economics of their organization — how they price and what’s the cost of doing business in certain jurisdictions. “As you can see, this all becomes incredibly complicated very quickly,” he says.

Faced with this labyrinthine level of complexity, it’s clear why many countries and businesses hope the OECD can achieve a consensus-based coordinated approach to applying income tax principles to digital activity. Key countries such as the US must be a part of the agreement in order for any new global tax regime to be viable.

In the US, the Trump administration found the French DST discriminatory against US companies and proposed 100% tariffs on select French-origin goods totaling $2.4 billion; DSTs in Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey and the UK also were found to be discriminatory2.  No further action has been taken on these findings and the Biden administration has not yet weighed in on these trade matters.

Plotting the way forward

Faced with uncertainty and increasing levels of complexity and cost, what steps can digital services companies take to ensure they remain compliant? Michalak says, “Unilateral digital services taxes are real and they’re happening right now. Organizations need to keep a close eye on how and where these taxes are being enacted, and what this means for their levels of tax exposure.”

The increasing complexity of the global DST landscape means many organizations will need the help of a trusted third-party advisor with resources to track developments in real time.
Jeff Michalak
EY Global International Tax and Transaction Services Leader

Without adequate support, some companies may find it difficult to make critical tax decisions and plan appropriately. Companies need a certain level of clarity and predictability to ensure they can make the right commercial decisions and be compliant.

“The increasing complexity of the global DST landscape means many organizations will need the help of a trusted third-party advisor with resources to track developments in real time,” says Michalak.

And what of the OECD’s Inclusive Framework? What practical steps can companies take to protect themselves?

Rob Weber, EY Global Leader of Business Tax Services, encourages all global companies to speak up and ensure their voices are heard. “It’s in a company’s best interest to get involved while the policy is being developed, ensure they have fair representation and positively influence the development of the framework,” he says. 


As the target date for consensus on the OECD’s framework for global taxation approaches, there is much that needs to be ironed out before any agreement can be reached. There also is increasing pressure from the proliferation of unilateral digital services taxes (DSTs). This makes planning for any eventuality a particularly complex process. Organizations need to monitor DST activity on a country-by-country basis as well as following the OECD’s progress in order to reduce tax risk exposure.

About this article

By EY Global

Multidisciplinary professional services organization

Related topics Tax Tax planning