Budget 2018: Taxing the Digital Economy | KPMG | IE

Budget 2018: Taxing the Digital Economy

Budget 2018: Taxing the Digital Economy

The ongoing expansion of the digital economy across all industries and markets presents new challenges for governments and tax authorities.

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Budget 2018: Taxing the Digital Economy

The ongoing expansion of the digital economy across all industries and markets presents new challenges for governments and tax authorities. Both the European Union (EU) and the Organisation for Economic Development (OECD) have recently sought to start a debate on these issues.

EU initiatives

On 21 September 2017, the European Commission released a communication on a “fair and efficient tax system” in the EU for a single digital market. The communication sets out the critical challenges that policymakers face in ensuring that businesses that provide services in the digital economy are taxed fairly. It noted two main challenges to be addressed so that profits are taxed where value is created:

  • Nexus - determining which state has taxing rights over services provided digitally and a commercial presence is only virtual, and
  • Value creation - allocating profits to such a virtual presence, when value is created through intangible assets, data, and knowledge.

The Commission says that EU Member States need to address these challenges in a coordinated manner to safeguard fair competition within the EU single market.

In the communication the Commission has proposed a number of possible short term measures which could be introduced:

  • An “equalization tax” on turnover, which would take the form of a tax on any untaxed or insufficiently taxed income from digital business activities, either creditable against a company’s corporate income tax liability or introduced as a separate tax;
  • A withholding tax on digital transactions, which would be levied on a gross value of certain payments to non-resident providers of goods and services online; or
  • A levy on revenues generated from the provision of digital services or advertising activity, which would apply on all transactions carried out remotely with local customers by businesses that have a significant commercial presence in that state.

The communication also proposes a long term objective of overhauling international tax rules to embed the taxation of the digital economy in the general international corporate tax framework and to update indicators of a significant economic presence in line with the new digitised business model (e.g., an updated definition of the permanent establishment (PE) to include a ‘virtual PE’).

One challenge that would need to be addressed in this context is the attribution of profits generated by digital businesses by identifying and valuing intangible assets and establishing their contribution to value creation. Alternative approaches to traditional transfer pricing methods would be required, together with specific anti-abuse rules, in order to prevent the shifting of profits outside the country where value is created. The European Commission also mentioned the possibility of amending the common consolidated corporate tax base (CCCTB) proposal to capture digital activities.

OECD initiatives

In parallel, the OECD is seeking public comments on the key issues identified in taxing the digitalised economy and the potential options to address these challenges. In this regard, on 22 September 2017, it published a ‘request for input’ on the tax challenges of digitalisation. This document outlines the work done as part of the Base Erosion and Profit Shifting (BEPS) Action 1 report. That report (published in October 2015) recognised that digitalisation and some of the resulting business models present challenges for international taxation. However, it also acknowledged that it would be difficult, if not impossible, to ‘ring-fence’ the digital economy from the rest of the economy for tax purposes because of the increasingly pervasive nature of digitalisation.

In its request for input, the OECD invites comments on: the impact of digitalisation on business models and value creation; challenges and opportunities for tax systems; the implementation of the measures outlined in the BEPS package; and potential options to address the direct tax challenges of digitalisation.

We welcome these efforts by the OECD to fully understand the practical and commercial challenges, and the apparent attempt to ensure any proposal is ‘future proofed’. This will provide companies with an opportunity to make their voices heard, especially in light of the EU discussions which seem to seek a short term solution, potentially involving one or more of these options. An interim OECD report on this new initiative is expected to be delivered to the G20 Finance Ministers in April 2018.

Wider economic and business impact

Recognising that digitalisation is an integral part of the wider economy, the proposals put forward by the EU and the OECD, if implemented, will introduce new taxation models that businesses in all sectors will have to consider. The three short term solutions set out in the European Commission’s communication were briefly described in the BEPS Action 1 report where it was acknowledged that “Adoption as domestic law measures would require further calibration of the options.”

Ireland’s government has made it clear  that any tax based solutions would require unanimity amongst Member States before EU-wide adoption. Further analysis of these options at an EU level will require close consideration of the following issues.

Equalisation levy:

  • A digital supply chain involving multiple intermediaries where there is an imposition of a levy upon each intermediary with no ‘input credit’ may result in multiple taxing points for the same supply. 
  • If an ‘input credit’ is available to eliminate the risk of multiple taxing points, this may mean that the levy operates much like VAT which means careful consideration is needed in relation to obligations under VAT Directives.
  • The difficulties experienced in implementing VAT on digital supplies such as identifying the type of supplies made by intermediaries and identification of the location of the end consumer, will likely also manifest themselves in a levy system. 
  • Additional costs will likely disproportionately impact on small and start-up businesses.

Virtual PE:

  • The introduction of a new ‘virtual PE’ concept will have implications for existing treaty obligations (within and outside the EU) which focus on a fixed place of business requiring a physical presence. Changes to treaties on this scale would likely take a long time to implement and may not be agreed to by other countries. 
  • The role of market access and customer data in ‘value creation’ will be important in determining how profits are attributed to a virtual PE. This will require new measures in order to apply consistent approaches to valuing market access and customer data.

Common Consolidated Corporate Tax Base (CCCTB):

  • The addition of a virtual PE concept to the existing formulary approach for attribution of profits potentially further favours large Member States over smaller Member States such as Ireland.

Macroeconomic and tax base implications for EU Member States to consider:

  • Will these measures help companies operating within the EU be more competitive in the digital economy or potentially prove a barrier to innovation?
  • Will the additional tax costs be passed onto consumers?
  • Will these measures slow the deployment of innovative business models in the EU? 
  • Will the adoption of measures without wider international consensus risk trade retaliation concerns from countries outside the EU?

Future implications for your business

Individual businesses will need to carefully consider the potential impact of these measures on their digitalised business channels and assess how the changes would affect their supplies to EU customers. Particular attention will need to be paid by those businesses whose supply chains include intermediaries and those businesses which make “remote supplies” (i.e. supplies without on-the-ground taxable presence).

If these proposals were to come to fruition, businesses will need to invest in new systems and process and may need to make changes to their supply chains and business models. This could be an expensive and disruptive process. Consequently, we believe it is important that Irish businesses actively contribute to this debate and make sure their voices are heard by policymakers both at home and abroad.

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