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Digital dilemmas: building a new normal

Digital dilemmas: building a new normal

How do you solve a problem like digital taxation?

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Partner, Head of International Tax

KPMG in the UK

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How do you solve a problem like digital taxation?  

The only consensus we seem to have is that there is no consensus. The OECD and EU have issued substantial but inconsistent papers on the subject. The OECD is focused on dealing with the complexities of digitisation. In contrast, the EU seems to view it as a fair tax issue.  

Yet the pressure is on to find an international solution. Well-aimed kicks towards the long grass are not an option as many jurisdictions contemplate unilateral action to plug perceived gaps, raising very real concerns over maintaining coherence in the international tax system.  

I believe that all this represents a seminal moment for tax and today’s generation of tax professionals and policy makers. The outcome of these discussions will set the tax environment for decades and are likely to constitute our legacy. This is bigger than the BEPS project. That fixes historic issues. This will inform the future.  So we need to get it right, even if this takes some time.

A sandbox video game approach

One of my guilty pleasures is to spend time with my children in a sandbox, virtual reality, video game where players build their own world using a variety of cubes or blocks. This got me thinking: maybe we should take a similar approach to building our digital tax world. The Level I starting point is to identify foundational blocks, those of purpose and scope.

Level I – the foundations

Exploring purpose

Tax policies trigger reactions, both economic and political. This is why clarity of purpose is a fundamental building block of any digital taxation solution. What is the problem being addressed or the outcome being pursued?

The current muddle is due in part to a failure to articulate the problem. The messages from the OECD and EU suggest multiple or even competing objectives that will lead inevitably to different journeys with different outcomes. It is difficult to sell solutions when the core purpose of any change is not clear.

I am concerned that digital issues in the EU are being subsumed by the multinational tax avoidance debate. If this ends up being viewed as taking a swipe at US tech in pursuit of a short term political gain then it is highly unlikely to be achieved without negative consequences. Some stakeholders are beginning to wake up to this. There have already been media reports that Germany, in particular, is cooling on the prospect of taxing the digital economy as business concerns grow that this could worsen transatlantic tensions.  

I’m not advocating doing nothing on digital taxation, but let’s be clear on the objective of the proposals. That is the best way to build consensus and anticipate and allay concerns.

Exploring scope

Purpose drives scope and so an unclear purpose produces a confused scope.  

I am encountering many companies who view these proposals as targeting a US based tech problem and consequently fail to see the impact these proposals will have on them. Those of us that have read the proposals know the reality. We need to be careful what we wish for. Thinking that these proposals are only going to affect US tech giants is a sure way of wandering blindly into a dark room only to have the door slam shut behind you.

As digital activity infiltrates operating models and becomes systemic in the way business works, more groups will be affected by these proposals. As such I think we need to beware of viewing changes to digital taxation as targeting a US based tax problem. Over time the digital economy is becoming inseparable from the actual, real economy, so how it is taxed will affect more and more businesses. 

As tax experts, we have very little data on the practical and day to day impact on business, how disruptive it could be and whether there could be unintended consequences.  In part this is because many of those that are affected are not yet truly engaged. Those that are alert to the issue, however, are already concerned about the impact of some of the suggestions being put forward such as the EU’s 3% levy on digital services.

We need, in my view, to be more vocal about the far reaching consequences of these changes, so that those who will ultimately be affected can inform the solution.  

Level II: identifying the challenges

Understanding the Level I blocks of scope and purpose, and getting them right, will give us the springboard to go to Level II where we put the cornerstones in place. This is where we identify the specific challenges that digital business pose to the tax system.  

Some of this work has been done, particularly by the OECD report. Consensus is building around identifying the key points of difference, and whilst that may not seem very positive at face value, it actually is.  

We now have three common characteristic of digitalised business models: i) cross-border scale without mass, ii) the importance of intangible assets and iii) the importance of data and user participation.  

There does at least seem to be consensus on that.

Level III: stocking the toolbox

Value identification and measurement

Identifying the challenges is one thing but to move to Level III of the digital video game we need to be able to quantify them. This will need specific tools but this area, along with the actual purpose and scope, is where there is the most divergence.  

Differences still exist around how to value, in particular, data and user participation. As we have seen from the BEPS work, valuation is a core thread that runs throughout the principles of creating a new normal for taxing global business models.  

The OECD report accepts this and its next stage will be to refine the analysis of value contribution. But this will take time and the planned reporting deadline is to have an Inclusive Framework by 2020.  

This may seem a long way off but, in my view, we need to stick with it and resist the temptation of short term fixes. In our sandbox video game, we need to be in multiplayer creative mode and not in single player combat mode.

Unilateral action

Whilst the OECD and the EU cast around for an agreed way forward, short term unilateral action is increasing. In my view, this runs the risk of breaking consensus not building it and should not be part of the toolbox.   

One of the problems of increasing globalisation is that the number of interested parties in any tax change multiplies. This complicates developing a coherent solution as the needs and objectives of different parties become more disparate. Good tax policy is one thing but the ability to get it enacted across multiple borders is another.

As the world moves towards a more combative international trading environment unilateral action should be approached with real caution. Tax operates in a dynamic and changing environment where it is not possible to tax with impunity.  

My firm belief is that by implementing unilateral short term solutions governments are damaging the chances of a longer term global solution. The short term sub-optimal fixes will become long term reality. The resultant inequities will trickle through the system and become systemic. Tax will start to feed rather than fight the increasingly protectionist world we live in.

Solving the conundrum of the digital economy is already going to take sound and creative thinking. But it is beginning to look as much like an exercise in international relations as it is in tax policy. 

In our digital video game world-speak many countries seem to have decided to play in single player combat mode and I wonder how much of that was drift rather than clear sighted decision.  

A word about the UK

The irony of a UK tax adviser writing that unilateral action is far from ideal is not lost on me. The UK’s Diverted Profits Tax (DPT) regularly features on the list of unilateral action taken to fix the digital problem. One could almost call the UK a trendsetter in this regard. And of course further unilateral action is still on the agenda for the UK - albeit the government’s preferred option is long term international reforms.

DPT teaches us some of the dangers of playing Digital Video Games in single player mode. It certainly fixed a short term problem and, without doubt, has been a revenue raiser. But at what cost?

KPMG’s recent competitiveness survey showed that the UK is still an attractive place to do business and, whilst Brexit taints the picture, many businesses are able to see through the Brexit uncertainty to the positives that the UK has to offer. But the application and implementation of the DPT has caused concerns with international business. I am sensing an increasing caution with regard to the UK in recent months, and DPT is the common theme.  

There is another aspect of conversations on the digital economy that troubles me. Forbes recently published lists of the World’s 25 largest technology companies for 2017. Of the total 14 were US based (including 8 of the top 10), three were from South Korea and a couple in China. You get my drift. There were no UK technology businesses in the top 25.  

We are exploring how to tax every touchpoint that tech giants have with the UK but, to my mind, the more pressing question is why we don’t have any of the top 25 headquartered in the UK in the first place. What is it about the US environment that fosters this innovation and what can we do about it? Surely that is the real prize?

In our sandbox video game understanding this may well be the most fundamental building block of all.

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