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OECD and EU reports on the tax challenges of digitalisation

OECD and EU reports on the tax challenges of

The OECD’s interim report sets out their progress so far and proposed next steps, and the EC’s paper describes what steps will be taken within the EU.

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On 16 March, the OECD published its interim report on the tax challenges arising from digitalisation. The report analyses changes to business models and value creation stemming from digitalisation, as well as identifying the different positions held by the member countries and how this will affect their approach to various solutions. The interim report also sets out the next steps that will be taken before the final report is released in 2020, as the 110 member countries of the Inclusive Framework work together to agree and implement long-term solutions. In addition, on 21 March the EC published a package of documents set around a theme of ‘Fair Taxation of the Digital Economy’. These documents set out the action the EC intends to take within the EU.

OECD report – Tax Challenges of Digitalisation

The report was released at the end of last week, and as KPMG’s Matthew Herrington writes, it emphasises the need for coordinated and multilateral action, which is a welcome stance from the perspective of business. It identifies three key characteristics of digitalised businesses:

  • Cross-jurisdictional scale without mass – digitalisation allows businesses to produce and sell across many different countries. Businesses may also be heavily involved economically in a jurisdiction without significant physical presence;
  • Reliance on intangible assets, including IP – digitalised businesses are more likely to invest in intangible assets, especially IP; and
  • Data, user participation and their synergies with IP – data and user generated content are more likely to provide benefits to these businesses, such as in social networks.

There is currently no consensus among members of the Inclusive Framework on the impact of these three factors on value creation, and it is acknowledged that these factors are not necessarily exclusive or unique to digitalised businesses. There are also differences of opinion on the extent to which data and user participation create value for these businesses, so the report considers at length all of the ways in which digital businesses can create value.

With no consensus on the need for interim measures, the report does not recommend any, but does note that where countries feel they are necessary, they should take steps to make sure that interim measures are designed to be compliant with international taxation obligations, temporary, and targeted. They should also be designed so they do not stifle start up innovation.

The report considers the impact of the BEPS measures released in 2015 on the behaviour of digitalised businesses, including those focusing on permanent establishment, transfer pricing, CFCs and treaty abuse, and the new VAT guidelines. It also covers how digitalisation affects other areas of the tax system, including opportunities to enhance tax services and compliance, and risks associated with new technologies such as blockchain.

For the next steps, the members of the Inclusive Framework will undertake a review of the ‘nexus’ and ‘profit allocation’ rules which allocate the taxing rights between jurisdictions and the determination of the relevant share of the multinational enterprise’s profits that will be subject to taxation in a given jurisdiction. In exploring potential changes, members will consider the impacts of digitalisation on the economy, relating to the principles of aligning profits with underlying economic activities and value creation. The final report is expected to be delivered in 2020, with a further update due in 2019.

EC Report – Fair Taxation of the Digital Economy

In their package of documents published on 21 March, the EC sets out two main legislative proposals to tackle the issue of taxing the digital economy. Our initial response to these proposals can be accessed here.

In summary, the EC is proposing both an interim measure and a framework for a longer term solution:

  • The interim measure would consist of a tax on revenues (levied at a rate of 3 percent), applying to digital businesses whose revenues are significantly driven by user participation. These will include revenues derived from selling online advertising space, digital intermediary activities, and revenues generated from selling user-derived data. The tax will only apply to groups with annual worldwide revenues of at least EUR 750 million, and annual EU revenues of at least EUR 50 million; and
  • The longer term proposal considers reform for the taxation of the digital economy more broadly. The Commission recommends the introduction of a common system for taxing digital activities in the EU, which would be based on profits (rather than revenues). It would be based around a framework to recognise a taxable digital presence in the EU when (very broadly) a business has more than €7 million of annual revenues in a member state, more than 100,000 users in a member state, or over 3000 annual business contracts for digital services.

Affected businesses should be familiarising themselves with these proposals as a matter of urgency, and watching the developments in this space closely – the next step is for the legislative proposals to be submitted to the European Council for adoption. For more details, see KPMG’s EU Tax Centre’s European Tax Flash here.

For further information please contact:

Matthew Herrington

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