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EU proposes new rules to tax digital business

Corporate tax rules should be reformed so that profits are taxed where businesses have significant interaction with users through digital channels, the European Commission has proposed.21 Mar 2018

Until comprehensive changes can be made, the Commission says a 3% interim tax should be applied to revenues created from activities where users play a major role in value creation.

The EU's proposed changes are a response to the boom in digital businesses, such as social media companies, collaborative platforms and online content providers. Current tax rules were not designed to cater for digital companies that may be global, virtual or have little or no physical presence in the countries where their users are based.

The proposal to reform corporate tax rules would enable EU member states to tax profits that are generated in their territory, even if a company does not have a physical presence there. Under current rules a company must have a physical 'permanent establishment' in a territory to be taxed on the profits it makes there.

The Commission proposes that a digital platform should be deemed to have a taxable 'digital presence' or a virtual permanent establishment in a member state if it fulfils one of three conditions. The first two conditions are that the business exceeds a threshold of €7 million in annual revenues in a member state or has more than 100,000 users in a member state in a taxable year. The third alternative is that 3,000 business contracts for digital services are created between the company and business users in a taxable year.

The Commission also proposes to change how profits are allocated to member states in a way which better reflects how companies can create value online: for example, depending on where the user is based at the time of consumption. It also recommends that EU countries amend their double tax treaties with third countries so that the same rules apply to EU and non-EU companies.

The interim measure would apply tax, probably at the rate of 3%, to revenues created from activities where users play a major role in value creation such as revenues created from selling online advertising space or from platforms which allow users to interact with other users and which can facilitate the sale of goods and services between them.

Tax revenues would be collected by the member states where the users are located, and would only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million. The Commission said that this is designed to help to ensure that smaller start-ups and scale-up businesses are not affected by the new rules.

"The Commission's proposal for an interim tax on revenues from digital activities, looks similar to the UK's proposal to tax 'user generated' value," said Catherine Robins a tax expert at Pinsent Masons, the law firm behind Out-Law.com.

The UK Treasury recently released a paper making it clear that it supports reform of the international corporate tax framework to tax digital businesses but would be willing to act unilaterally on an interim basis in the absence of international agreement. The UK proposed that digital businesses could be taxed on the concept of 'user-generated value', being the value that users can create for digital businesses through their engagement and active contribution.

The Commission estimates that €5 billion in revenues a year could be generated for member states if its proposed interim tax is applied at a rate of 3%.

Its memo describes progress at international level on digital taxation as "challenging" saying the EU "cannot afford to delay any longer, given the growing number of problems related to digital taxation". However, the Commission says that it has been in close contact with the OECD and the G20 in order to keep the EU and global approach "as aligned as possible".

"Several EU countries are already taking unilateral action, creating inconsistencies and loopholes in the Single Market and making it a legal minefield for companies," it says.

Last week the Organisation for Economic Cooperation and Development (OECD) published an interim report on the tax challenges arising from digitalisation. This reported that OECD members had agreed to try to come up with an agreed approach to taxing the digital economy by 2020.

"Although it understandable that some EU countries are getting fed up with slow progress on this topic at OECD level, what is proposed is a fundamental change to the international tax system. International consensus is going to be difficult to reach but double taxation is likely to result if the system is not changed in a coordinated way," Catherine Robins said.

"The US firmly opposes proposals by any country to single out digital companies,” US Treasury secretary Steven Mnuchin said, in response to the OECD report.

The Commission's draft directives suggest that the proposed changes could apply from 1 January 2020. However, the measure will require the backing of all EU member states to become law and states such as Ireland will probably not support the measure as they could lose tax revenues if it is introduced.