The increasing digitalisation of the economy poses considerable challenges for the international tax system and the Organisation for Economic Cooperation and Development (OECD) is trying to get international consensus on how the tax system could be reformed. Meanwhile individual countries are pressing ahead with their own measures to tax a bigger slice of the profits of multinational technology companies.
Tax experts from Pinsent Masons, the law firm behind Out-Law.com, argued at a recent Pinsent Masons event that the effect of the reforms would not be restricted to digital companies.
The OECD published a public consultation document in February setting out its plans for helping international tax rules to fairly allocate technology companies' taxing rights, recognising that current rules were not designed to cope with the increasing digitalisation of the global economy.
The OECD is looking at three proposals for changing the profit allocation and nexus rules. These alternative proposals would allocate taxing rights on the basis of user participation, marketing intangibles or significant economic presence. It is also discussing two proposals to address the shifting of profits to low tax jurisdictions by ensuring that businesses operating internationally pay a minimum level of tax.
In the meantime, individual countries, including the UK, Italy, Spain, Austria, New Zealand and France are all proposing interim measures to tax revenues from digital activity.
The UK's proposed digital services tax (DST) coming into force in April 2020 will tax search engines, social media platforms and online market places, subjecting them to a 2% tax on revenues linked to UK 'user participation'.
Judith Freedman, Pinsent Masons Professor of Taxation Law at Oxford University said that, as the current international tax system is based on concepts which are not sustainable in an increasingly digitalised world, changes are inevitable and they will affect all companies eventually as it is not possible to ring fence the digital economy.
She criticised the current approach of countries like the UK which claim they are taking a principled approach in trying to tax 'user created value' whilst in reality their proposals are a "sticking plaster" to tax the businesses that governments want to tax, essentially the tech giants. Freedman said the UK's proposals make no real attempt to value 'user generated value' because that is an impossible thing to do, a fact which can be illustrated by the proposed use of proxies, such as the number of users in a particular state.
Freedman pointed out that the pace of technological change means that designing a system now, as the UK is doing, to target current types of business, such as social media platforms, may well be out of date by 2020. In addition, systems based solely on the interaction of humans will not reflect user generated value created by machines, such as driverless cars sharing information about traffic holdups.
Pinsent Masons corporate tax expert Eloise Walker said that the UK's DST is simply a continuation of an existing trend in the UK to seek to tax overseas businesses which have UK end users. Diverted Profits Tax seeks to tax businesses as if they had a UK PE, even if that is not the case on established international concepts, she said, operating on the basis that if a business has a warehouse full of products sold to UK customers it "must" have a UK branch even if international law says not.
A case involving Hastings Insurance Services concerning the concept of a fixed establishment for VAT purposes is a "worrying development", Walker said, as it "suggests that the mentality of HMRC is that if there are UK end users, there should be UK tax". In that case HMRC tried to claim that a UK insurance broker was the fixed establishment of a Gibraltar insurance underwriter; and therefore that the supply of services was from itself as broker in the UK to itself in the UK as fixed establishment of the offshore underwriter.
Walker warned that the approach of western governments in trying to tax by reference to users could amount to "shooting themselves in the foot" if new economies such as China and India adopt this approach. India's population of 1.3 billion and China's of 1.4bn dwarf the UK's 67m people and the US's 327m, she said.
Georg Geberth, director of global tax policy at Siemens AG and Vice-Chair of the OECD's Business and Industry Advisory Committee pointed out that the OECD's activity in relation to digitalisation stems from Action 1 of BEPS. However, he said that BEPS was meant to be all about closing loopholes and not about reallocating taxing rights.
Geberth pointed out that some of the approaches currently being considered by the OECD such as the minimum tax or marketing intangibles have little to do with the digital economy and would affect all companies. He said that none of these solutions would make the system simpler and would inevitably lead to disputes. He stressed that it is important for businesses to engage as they are "not going to be able to stop the train".
Glyn Fullelove, deputy president of the Chartered Institute of Taxation, looked at the various proposals from the point of view of businesses trying to work out what they will need to do to be able to file a tax return. He said the measures could mean a move from the concept of self assessment to self audit. Most businesses would find that some activities were within the scope of new taxes like DST and some were not and a difficult allocation would have to be performed.
While companies may hold information about their users, as distinct from their customers, this would most likely be contained in marketing or sales databases, Fullelove said. There would be difficulties in matching this data up with the accounting system, he said.
He questioned whether trying to "stretch corporate taxes to fill a perception gap around digital activities" was the right approach. Fullelove wondered if a better approach would be to simply charge businesses a licence fee for collecting data from the population, in a similar way to countries charging a mineral extraction fee.
Sir Edward Troup, former executive chair of HMRC, approached the issue from the angle of a tax authority. He stressed the importance of recognising that we are not just talking about the digital economy; these changes could affect all businesses operating across borders. He gave as an example the introduction of the VAT mini one stop shop for digital supplies, where, unexpectedly, some of the biggest problems arose for individuals selling knitting patterns on the internet.
Sir Edward said that the proposals for taxing the digital economy had arisen from political concerns that multinationals were not paying their 'fair share' of tax and the problem should be recognised as a political issue. Multinationals are not perceived to pay the same level of tax on their income as individuals do, he said. Even though individuals effectively end up paying the taxes imposed on corporates, through pricing or lower returns to shareholders, any solution will only be politically acceptable if the public can see that companies are contributing, he said.
All tax administrations should be trying to make the tax regime as certain as possible, Sir Edward said, but this is problematic in relation to the measures proposed in relation to digitalisation. Whatever is decided upon must be deliverable and must not trigger behavioural change – and that certainty should be prioritised over the amount the system collects when looking at design principles. He added that there is also no point in creating regimes that just shift tax revenues from one jurisdiction to another as this inevitably leads to disputes over allocation. He said the focus should be on reallocating receipts between zero tax regimes and other regimes and bringing offshore receipts onshore.
There was some discussion of the fact that changes to the EU VAT place of supply rules mean that businesses operating in EU countries without significant infrastructure in those countries are already paying a turnover tax there, in the form of VAT. Joanne Clarke, a Middle East VAT expert at Pinsent Masons, said that ecommerce and technology companies had already been through a major exercise to comply with the changes in the EU VAT place of supply rules for services and therefore had the infrastructure in place to identify where their customers belonged. Such rules are already scheduled to be extended in 2019 and 2021 to capture supply chains for goods and to remove some competitive advantages for non-EU vendors.
Pinsent Masons tax expert Jason Collins asked whether the panel thought that it was inevitable that the world would move more towards a market-based system of taxation and the general consensus, albeit not universal, was that it would.
There was consensus that there are no easy solutions and that the OECD's current direction of travel makes it likely that all companies operating cross border, and not just technology companies, will have to deal with further changes to the tax system.
This analysis is based on a summary by Catherine Robins, a tax expert at Pinsent Masons, which was published in Taxation on 7 March.