A growing number of policymakers argue that tax needs to be updated to keep pace with the digital economy.
Efforts by governments all over the world to change where and how digital companies pay taxes are evolving into a broader effort, with the potential to affect even brick-and-mortar businesses that serve global markets.
Options on the table include expanding the scope of existing indirect tax regimes by adopting or adapting traditional tax concepts or introducing a Digital Services Tax (DST) that redefines how income taxes are determined and paid in jurisdictions where businesses operate and sell, even if they don’t have a physical presence.
But while early attention and news headlines focused on the potential impact of these proposals on the world’s digital mega-giants, the scope has steadily and quietly expanded to have implications for virtually all sectors operating in this transformative age.
“The changes under debate are more sweeping than the digital label suggests,” says Washington-based Barbara Angus, EY Global Tax Policy Leader. “All businesses that operate across borders should be following these developments and modelling how these evolving proposals might affect them.”
In March 2018, the European Commission (EC) issued two proposals that would have delivered new ways to tax a closely targeted set of digitalized business activities. They proposed an interim measure focused on a 3% gross revenues tax that would be followed by a longer-term approach addressing the taxation of profits even when a company has no physical presence in a country.
A year of intense debate later, however, and the EC has not been able to get the necessary unanimous agreement from the member states, and on 12 March 2019, the effort stalled.
But a number of individual European countries, including Austria, Belgium, France, Italy, Spain and the UK, have already moved forward with their own DSTs. “No country is just sitting by and watching what’s happening,” says Channing Flynn, EY Global Tax Technology Sector Leader, who is based in California's Silicon Valley. “In fact, many countries are involved in this very deeply and pushing their own agendas forward.”
The UK, for example, plans to target social media platforms, search engines and online marketplaces, as these business models are considered to derive significant value from participation by UK users. The measure is not intended to apply to regulated financial and payment services, the provision of online content, sales of software/hardware and television/broadcasting services. This is narrower than the stalled draft EU directive, which would include broader application to online advertising and data collection.
Non-EU countries are also seeking ways to tax the digital economy. “Turkey and Uruguay both recently enacted what looks like a DST, although each is framed slightly differently,” says Amsterdam-based Gijsbert Bulk, EY Global Director of Indirect Tax. “That’s where problems increase exponentially, when companies have to deal with a ‘patchwork quilt’ effect of similar, but ultimately, different, measures.”
In an October 2018 discussion paper, Australia explored a new corporate tax system for its digital economy, a move followed by New Zealand in February 2019. However, the Australian government in early March 2019 determined that a DST may not be the best way to advance their interests, reflecting just how quickly this debate is evolving.
In the US, 2018’s Supreme Court decision in the Wayfair case echoes the targeting of businesses that can build what the EC calls “scale without mass.” Notably, an important distinction is that Wayfair focused on the obligation of such a business to collect existing state sales taxes imposed on consumers, as compared to the proposals for imposing tax on the revenues or profits of the business that are currently being debated globally.
In the current global debate, the US has cautioned that focusing on developing new taxation rules only for digital businesses would not be acceptable. “It is becoming clear that there is relatively little support for pursuing an approach that applies only to narrowly defined classes of challenges facing the international tax system” said a senior US Treasury official in January.
A global rethink
As debate continues around the world about the best way forward, the next 12 to 18 months will see a far wider rethink of how to tax global profits play out. According to Rotterdam-based Marlies de Ruiter, EY Global International Tax Policy Leader, the DST debate is paving the way for what, after the OECD’s Base Erosion and Profit Shifting (BEPS) project, may lead to a further significant, multi-year period of change for global tax rules.
“Initial proposals have been put forward that focus on a new global system that would essentially provide more reward for market jurisdictions in which customers reside,” de Ruiter says. “But there is a long way to go, and anything can happen with such a political issue.”
In January this year, the OECD/G20 BEPS Inclusive Framework group issued a policy note confirming they agreed to examine proposals involving two pillars that could form the basis for consensus. One pillar addresses the broader challenges of the digitalized economy and focuses on revising the allocation of taxing rights and redefining the nexus concept, while the second pillar addresses continuing BEPS concerns. The 129 countries making up the Inclusive Framework group renewed their commitment to reach a consensus on an approach for each of the pillars in 2020, with a work plan for achieving this objective to be developed and presented to the G20 during 2019.
At a day-and-a-half public consultation in March 2019, the OECD laid out a timeline through 2020 for advancing the work by developing specific proposals and reaching consensus on a coordinated global approach to such proposals. But dozens of stakeholders urged caution in making any major changes to long-standing rules for determining taxing jurisdiction over business profits and in pursuing broad new anti-base erosion rules that would go well beyond the 2015 BEPS project recommendations. At the same time, many stakeholders expressed the view that some changes to the international tax system may well be inevitable to better align the taxing rules with the new global economy.
London-based Mat Mealey, EY EMEIA International Tax Services Leader, agrees the OECD recognizes a broader overhaul of long-standing international tax norms may be unavoidable. “The perspective that we’re now seeing emerge from the OECD is that you can’t ring-fence a subset of the digital economy from the rest of the economy in a principled way,” he says. “If you’re concerned about the attribution of value to intellectual property (IP), for example, you need to look across the entire population of IP-rich businesses and think about a different profit attribution standard, and possibly a new nexus concept across the entire population of companies.”
That’s the new debate, Mealey adds: “This would make DST-targeted business models a subset of a much wider debate about renewed profit attribution standards in relation to intangibles.” Bulk elaborates: “There are many forms of digital activity. There are cross-border international companies that, by their very nature, are intangible and their activities take place remotely, with no physical nexus, or, in fact, any nexus at all.”
To be sure, purely digital companies must also pay attention, as does any business developing a digital business model. For example, companies need to understand and structure their tax profiles to align with digital models. They must also properly understand and plan all aspects of taxation related to digital monetization when it comes to strategic expansion, particularly around licensing and IP, and how to raise debt and equity in a digital investment scenario.
But because the “digital services tax” debate has evolved into a broader debate that could lead to significant changes to the overall international tax rules under which all multinational businesses operate, all industries should follow developments closely.
Implementation of major changes in the international tax architecture — whether through a global consensus reached in the OECD process or through unilateral measures adopted without coordination — is a current focus for many governments around the world. Angus says companies should take every opportunity to share their perspectives both through the OECD comment process and directly with tax policy officials in countries that are part of their global footprint.
“Everyone wants to get this right,” Angus says. “The more engagement from businesses that can provide practical input on operational considerations, whether relating to the physical world or the virtual world or both, the better.”
- Understand and communicate to C Suite that these pending changes affect far more enterprises than global technology companies.
- Gather all the relevant stakeholders from your business to assess the potential impacts.
- Engage with policymakers: at the country level, with the OECD, and with other business groups.
- Model the impact of proposals on current and future business models as they are being developed.