OECD Releases Digital Economy Taxation Interim Report

; posted on
March 19th, 2018

The OECD released the Tax Challenges Arising from Digitalisation –Interim Report 2018 of 8 chapters. This interim report is a follow-up to the work delivered in 2015 under Action 1 of the BEPS Project. The report sets out the Inclusive Framework’s agreed direction of work on digitalisation and the international tax rules through to 2020 and describes how digitalization is also affecting other areas of the tax system, providing tax authorities with new tools that are translating into improvements in taxpayer services, improving the efficiency of tax collection and detecting tax evasion.

National Measures on the Work in the Inclusive Framework and Unilateral Action

The report reviewed how relevant measures of the BEPS package are adopted on a global basis in Chapter 3 (Implementation and impact of the BEPS package), including amended PE definition (Action 7), revised transfer pricing guidelines (Action 8-10), strengthened CFC rules (Action 3), recommended solutions and available options for VAT collection in digital context (Action 1), minimum standards (Action 5 and Action 6), and transparency with Country-by-Country reporting (Action 13). The OECD recognised that implementation of such measures makes significant differences to BEPS issues (e.g., Conversion from remote sales models to local reseller models, on-shoring of assets), but could have limited impact on the broader direct tax challenges, that is, nexus, data and income characterisation.

In addition to efforts under inclusive framework, the report also identifies other relevant but uncoordinated country measures in Chapter 4 (Relevant tax policy developments). Four types of measures are categorised based on current unilateral actions to tax digital economy:

  • Alternative PE thresholds, including significant economic presence test (e.g. India, Israel), and virtual service PE (e.g. Saudi Arabia);
  • Withholding Taxes, including broader royalty definitions, technical service fees, and levy on online advertising;
  • Turnover Taxes, including sectoral taxes, such as for advertisements Hungary), levy on digital transactions (Italy), equalisation levy (e.g. India);
  • Specific regimes for large MNEs, such as the diverted profits tax in UK and Australia, and Base Erosion and Anti-Abuse Tax (BEAT) in the US.

Despite the measures varying from one to another, some common design features are observed by the OECD, namely, these measures all protect or expand the tax base, and involve elements linked to a market and discontent with outcomes produced by existing rules.

Technically Complex Questions on Taxing Rights and Profit Allocation

In a more technical area, the report starts with the process of value creation. Chapter 2 (digitalisation, business and value creation) points out the complex reality in digital economy value creation by identifying three key factors prevalent in highly digitalised businesses (HDBs):

  • Cross jurisdictional local scale without local mass, which refers to HDBs often being highly involved in economic life of a jurisdiction without any significant, physical presence;
  • Reliance on intangible assets, including Intellectual Property (IP) that provides crucial support of business models of HDBs;
  • Data, user participation and their synergies with IP. Indeed, it is generally agreed that user participation and data are common characteristics of highly digitalised businesses, but there is divergence on whether and the extent to which they represent contribution to value creation by enterprises.

The report subsequently analyses the factors above, under the income tax framework in Chapter 5 (Adapting the international tax system to the digitalisation of the economy). As regards direct tax, nexus rule and profit allocation rules constitute the cornerstone of international income tax system, but the three features of certain HDBs on the international tax rules indicates remarkable implications to taxing rights and profit allocation:

  • the feature “cross-jurisdiction scale without mass” could impact the distribution of taxing rights over time by reducing the number of jurisdictions where a taxing right can be asserted over the business profits of an MNE;
  • “reliance on intangible assets” is a significant progress under BEPS project, but this often makes it hard to determine how to allocate income from intangibles among different parts of an MNE group;
  • the employment of data and user participation complicates the source determination. If it is considered a source of value creation, challenges arise regarding matching tax and value creation, as the concept of value creation is currently not captured by the existing tax framework.

Diverse Positions: Three Broad Groups

The report consults 113 countries on long-term and short-term solutions to digital economy taxation. The view which can be generally described as three groups. The first group finds that user participation may lead to misalignments between where profits are taxed and where value is created. This does not undermine the principle of the existing international tax framework. Only targeted changes are needed.

The second group believes that digitalisation and globalization of the economy present challenges to the existing international tax framework, but these challenges are not exclusive or specific to highly digitalized business models. The third group advocates that the BEPS package has largely addressed double non-taxation, but still too early to fully assess the impact. Countries in the group are generally satisfied with the existing tax system and do not currently see the need for any significant reform.

Interim Measures

After identifying the issues in practice and positions of countries, the report concludes that there is no consensus on the need for, or merit of, interim measures in Chapter 6 (Interim measures to address the tax challenges arising from digitalisation), and no recommendation for introducing such measures is made. This is based on the lack of conceptual basis and potential for adverse consequences, including the impact of a tax on gross on investment, innovation and welfare, potential economic incidence of taxation on consumers and business, possibility of over-taxation, concern that interim measure may prove not be interim, and compliance and administration costs. The OECD is fully aware of the challenges but considers imperative to act pending global solution. Countries that favour the interim measures have agreed to have guidance for those needs to be taken into account in the design of such a measure:

  • compliance with a country’s international obligations, including tax treaties, WTO, EU and EEA membership;
  • the measure must be temporary;
  • the measure must be targeted, discussing both internet advertising and online intermediation services;
  • minimising over taxation;
  • minimising impact on start-ups, business creation and small business more generally;
  • minimising cost and complexity.

What’s Next: Beyond International Tax Rules and Delivery by 2020

The OECD holds comprehensive concerns in Chapter 7 (Special feature – beyond the international tax rules: the impact of digitalisation on other aspects of the tax system). First, more attention needs to be paid to gig and sharing economies, which indicate the rise of non-standard work and the role of online multi-sided platforms. In addition, tax rules should support innovation while ensuring a level playing field, instead of curbing new businesses. What’s more, digital tools should be properly used for providing the taxpayers with better service, and big data must be harnessed in an appropriate way for improved tax compliance. Finally, other technological risks need to be assessed and dealt, such as blockchain which underlies crypto-currencies.

As regards the future steps, the next meeting of TFDE will be held in July 2018. A final report is expected to be delivered by 2020, with an update in 2019. The technical options regarding profit attribution and nexus will be tested about their feasibility, and impact of BEPS implementation and other unilateral measures will continue to be monitored. The OECD is going to explore opportunities and risks for tax policy and administration as a result of new technologies.

Source: OECD

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