The European Commission in a paper released on 21 September 2017 outlined different options for taxing profits of digital businesses, to ensure tax is paid where ‘value is created’ (access the press release here).
Currently, taxes are chargeable on an entity’s business profits in the jurisdiction(s) where it is resident or has a taxable presence (a permanent establishment, “PE”). OECD work to date has looked at possibilities for amending the existing international tax framework and PE rules, so that profits of a digital business operating remotely may be taxed where its customers are located.
In parallel to this ongoing OECD work, and noting the uncertainty of its success, the European Commission is proposing a number of alternatives for EU Member States. These include: (i) an ‘equalisation tax’ chargeable on revenues of digital companies from EU customers, (ii) a final withholding tax on gross income paid to overseas suppliers of goods and services ordered online, and (iii) a levy on revenues generated from the provision of digital services or advertising activity. Most of the proposals target both B2B and B2C transactions, and raise significant questions around ability to enforce. These levies are proposed to be turnover (not net profit) based and are aimed at digital businesses (for example Apple, Google, Amazon or Facebook) who suffer less EU tax on their profits than conventional businesses.
An important question remains as to what is meant by ‘where value is created’: location of customers, entrepreneurs, staff, valuable intangibles, etc. The European Commission clearly appears to equate location of value with that of customers.
The pressure to tax profits of the digital economy where ‘value is created’ has been gradually mounting. The OECD BEPS Action 1 Report of October 2015 delivered no solutions to achieve this objective, bar concluding that the digital economy “is increasingly becoming the economy itself”. This Report also noted other BEPS recommendations including suggestions that tax treaties and PEs should help further the tax policy objectives for the digital economy. The OECD work to find new ways to tax digital economy profits is ongoing and the G20 has agreed that the OECD will publish a report on this topic in 2018.
In the interim various countries have put in place unilateral measures, for example India introduced a levy at a rate of 6% on gross consideration for B2B digital advertising services. Italy introduced a voluntary ruling procedure for digital businesses. The objective is to provide means for digital businesses to agree in advance with the Italian tax authorities a “fair share of profit” allocated to their Italian activities. If a business does not avail itself of the opportunity to agree such a ruling, the risk of an Italian tax audit becomes significantly higher.
Given the growing political pressure, it is likely that some changes will be announced at the EU and/or OECD level regarding the taxation of profits from digital business.
A summary of other important BEPS outcomes and immediate action items for your business are discussed in Business Implications of BEPS (here) and Current BEPS Action Items (here).