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Commission pushes for 'fair taxation' of digital economy in EU

The European Commission will push for a fundamental reform of international tax rules including a redefinition of the concept of a permanent establishment (PE) to ensure internet-based companies are taxed in a "fair and growth friendly way", it has said.25 Sep 2017

The Commission wants to encourage a coherent EU approach to create a better link between how value is created and whether it is taxed, and to support moves towards a digital single market, it said.

"The current tax framework does not fit with modern realities. The tax rules in place today were designed for the traditional economy and cannot capture activities which are increasingly based on intangible assets and data. As a result, the effective tax rate of digital companies in the EU is estimated to be half that of traditional companies – and often much less," the Commission said.

It wants "appropriate and meaningful solutions" to taxing the digital economy to be agreed at international level by spring 2018. However, if no international solutions can be found, the Commission said it would present its own proposals.

The Commission's preferred approach is to use the Common Consolidated Corporate Tax Base (CCCTB) to revise PE rules and allocate the profit of large multinational groups by reference to assets, labour and sales. International PE rules are used to determine how much a company should be taxed based on its activity in a given country. At the moment, the concept is largely based on physical presence. However, digital businesses can have a significant economic presence in a country without necessarily having a substantial physical presence.

Tax expert Catherine Robins of Pinsent Masons, the law firm behind Out-Law.com said: "Redefining what constitutes a PE to include the concept of a virtual PE would be a very significant change. This would have ramifications for very many businesses trading across borders and not just the US tech giants."

"The whole point of a definition of PE is to set a threshold so that companies do not have to file multiple returns for relatively minor activities in other states. If the EU is to go ahead with these proposals, they should set a high ‘de minimis’ turnover limit for activities in each state – if they fail to do this, compliance burdens and cross-border tax disputes will increase significantly," Robins said.

The Commission first proposed the introduction of a CCCTB in 2011. It would create a single set of rules that cross-border companies could use to calculate their taxable profits in the EU instead of having to deal with different national tax systems. It has been opposed by the UK.

The Commission suggests also exploring shorter term solutions such as an 'equalisation tax' on the turnover of digitalised companies. This would be a tax on all untaxed or insufficiently taxed income generated from internet-based business activities, creditable against corporate income tax or as a separate tax. An equalisation tax is backed by a group of EU states including France and Germany.

Other short term solutions mentioned by the Commission include a withholding tax on digital transactions and a levy on revenues generated from the provision of digital services or advertising activity.

"It will be difficult to define ‘digital’ companies. For example will it catch a ‘bricks and mortar’ retailer established in one member state and paying full tax on its profits in that state which sells goods from its website to customers in other member states?" Robins said.

On average, domestic digitalised business models are subject to an effective tax rate of only 9%, less than half compared to traditional business models, the Commission said.

"This is mainly due to the characteristics of digitalised business models, which rely heavily on intangible assets and benefit from tax incentives. Cross-border digital businesses are able to further reduce their taxes as their intangible assets are highly mobile. By taking advantage of the most beneficial tax regimes, they can bring down their tax burden to effectively zero," it said.

"In addition, businesses can take full advantage of the networks, infrastructure and rule of law institutions available in EU member states, without paying any tax in that country."

EU countries should agree on their position, ready to push for changes to international tax rules in the Organisation for Economic Co-operation and Development (OECD) report to the G20 next spring, the Commission said.

"The EU seems to be trying to put pressure on the OECD to be more radical when it reports back on the digital economy," Robins said. "The OECD’s original Action 1 report did not recommend specific measures targeted at the digital economy."

"The current proposals contradict the 2014 recommendations of the EU’s own group of experts, which like the OECD recommended that there should be no specific regime for digital companies," she said.

The OECD has today launched a public consultation into its work on the tax challenges of digitisation.

"The EU is proposing an ambitious timescale if it is to have agreed proposals in this complex are by spring 2018. Businesses operating internationally will be concerned that measures could be rushed through which will increase uncertainty of tax treatment and are likely to lead to more international tax disputes," Robins said.

"In view of Brexit, UK businesses may think that it does not matter what the EU proposes, but these proposals are likely to put pressure on the OECD to come up with a global solution, which will affect the UK whether it is in or out of the EU."

"It’s one thing to ensure that tax is being paid somewhere – but these proposals risk slicing the same pie in many different ways, rather than increasing the overall tax take for the EU," Robins said.