You and the Taxman, Issue 1, 2018

Rising to digital taxation

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A measured approach is necessary to regulate taxation of the digital economy, and manage uncertainties and risks. Chia Seng Chye and Lim Ting Ting elaborate.

In the 2015 Final Report on Base Erosion Profit Shifting (BEPS) Action 1 (addressing the tax challenges of the digital economy), the Organisation of Economic Co-operation and Development (OECD) made an observation that “the digital economy is increasingly becoming the economy itself” and cannot be ringfenced from the rest of the economy due to the pervasive nature of digitalisation.

It is easy to see why digital commerce is hailed as the new driver of the global economy.  The rapid advancement and widespread accessibility of digital technologies have influenced new consumer preferences and market trends across multiple industries and the world over.

For example, ride-hailing applications have redefined commute and customer interactions with traditional taxi providers, disrupting the automotive industry in manners not seen before.

In many ways, the effects of digitalisation have blurred industry boundaries, leading to the increasing convergence of sectors – and complications in taxation.

Challenges for the taxman

The burgeoning digital economy is raising alarm bells amongst governments and tax authorities worldwide, particularly on how it impacts their national coffers.

For instance, just two years after Malaysia introduced the goods and services tax (GST) in 2015, the Director-General (DG) of its Customs Department announced plans to amend the country’s GST system to tax foreign-supplied digital services. As pointed out by the DG, “taxes from the digital economy ... we can easily collect a couple of billions of ringgit. It runs into several billions. Nobody knows how big the ‘monster’ is out there. Once we amend the law and look into the details we would know for sure.”

A key feature of digital technologies is the ease with which barriers to entry and growth are broken down, enabling enterprises to instantly access and monetise global consumers, without the need for physical presence. This adds complexity to the taxman’s job of taming the “monster”. It has now become even more challenging than before to figure out who should pay taxes, where, how much, as well as how those taxes should be collected.  

What are some of the indirect and direct tax challenges posed by digitalisation and how can these be addressed?

South Korea, Japan, New Zealand and Australia are just some of the jurisdictions that have laid down rules requiring overseas online suppliers targeting their domestic markets to register for value-added tax (VAT) or GST. Singapore has also recently announced its decision to introduce an overseas vendor registration system. Overseas suppliers and electronic marketplace operators, which make significant supplies of digital services to Singapore consumers, will be required to register for GST with the Singapore tax authorities with effect from 1 January 2020.  

Besides overseas vender registration, the Singapore government has also decided to activate the reverse charge mechanism, which has been non-operative for many years. Certain groups of Singapore businesses (in particular, the partially exempt GST taxpayers) will have to account for GST to the Singapore tax authorities on the services that they import.   Arising from these recent changes are practical implications that need to be managed. For instance, compliance costs may escalate, which could hamper the smaller and medium-sized local businesses.

Other potential options drawn from the Action 1 Final Report include a tax nexus concept of “significant economic presence”, withholding tax on certain types of digital transactions and digital equalisation levy.

While the OECD stopped short of recommending these three options in its 2015 Final Report on BEPS Action 1, it has proposed that countries could introduce these options in domestic laws as additional safeguards against BEPS under certain circumstances.

Some of the said potential options have gained traction amongst certain governments. For example, India introduced an equalisation levy (or more popularly known as Google tax) on online advertising revenue by non-resident e-commerce companies earned in the country. The six percent levy is deducted from the total gross payment made to a non-resident who does not have a permanent establishment in India, for services such as online advertisement, any provision for digital advertising space, or any other facility or service for the purpose of online advertisement.

Italy proceeded with its own version of the web tax, which imposes a three percent levy on digital services such as advertising and sponsored links embedded in webpages. The greater European community or the EU is also in the midst of unravelling its digital tax proposals, which may potentially include an interim measure of a tax based on turnover for digital transactions while working towards a long-term objective of a digital taxable presence or permanent establishment framework.  

Complexities for businesses

As governments continue to find ways to protect their tax revenue base, there is a risk that established international tax principles, i.e., based on physical presence and sourcing, could be compromised. Imposition of the new taxes or levies could represent a shift in the taxing jurisdiction from the location where functions are performed, assets are used, and risks are undertaken, to the jurisdiction of consumption.

There are also arguments that a gross basis type of taxation will run contrary to the principles of fairness and neutrality, as enterprises with low profit margins or even losses (such as start-ups) could find themselves liable to tax nonetheless. Depending on the scope and rate of such turnover taxes, it could cause businesses to rethink their investments and potentially cease or exit certain markets and jurisdictions.

Further, the lack of a global consensus and consistency on digital taxation has presented challenges for businesses. They not only have to wrestle with different tax rules in different jurisdictions now but also how these rules should be interpreted and applied. This will increase compliance burden for businesses with global footprints and potentially result in more tax controversies and double (or even multiple) taxation risks.

The way forward for Singapore

Singapore’s taxation system has been built on the key principles of fairness and progressiveness, with policies that are pro-growth and competitive. It is important that our taxation system and rules remain relevant and are kept abreast of business and economic developments, so that businesses can continue to grow and thrive whilst paying their fair share of taxes.

The 2015 Final Report on BEPS Action 1 has focused on anti-abuse measures rather than proposals that will encourage and incentivise investments or support the evolution of new technologies and growth of the digital economy whilst accommodating the disruption brought about by such developments.

Even as more and more countries are considering or imposing a levy or tax on digital or e-commerce transactions, our view is that Singapore should be mindful about jumping on the bandwagon too readily. This is because it could prove to be more detrimental to the economy and business communities if we were to adopt unilateral anti-abuse measures rather than introduce tax policies that promote e-commerce and digital activities in Singapore.

On the other hand, the Singapore government may need to broaden the availability of our foreign tax credits to include the digital levies suffered overseas, so as to help local enterprises mitigate double taxation arising from the levies imposed by other jurisdictions. This could however translate into additional cost for the Singapore economy if such foreign tax credits are mainly unilateral and not reciprocated by other jurisdictions.

As the global community attempts to find and devise solutions to regulate the taxation of the digital economy, uncertainty results and double (or even multiple) taxation becomes a growing risk. Conventional wisdom tells us that this does not support long-term economic growth and stability. A measured, coordinated and consensual approach for a digital taxation framework endorsed by the global community at large would be the better way forward.

EY - Chia Seng Chye Chia Seng Chye
Tax Services
Ernst & Young Solutions LLP
EY - Lim Ting Tingy Lim Ting Ting  
Senior Manager
Tax Services
Ernst & Young Solutions LLP