Taxation of Digital Economy
The digital economy impacts all spheres of our life. We consume digital goods and services from the Internet without even thinking if the digital companies providing us with e-books, applications, social media pay taxes from their revenues. Obviously, online businesses pay relatively little tax on the services they offer. One of the reasons is that current international tax rules are not fit for the realities of the modern global economy and do not capture business models that can make profit from digital services in a country without being physically present. As a result, taxes are not paid in the country where the profit is earned.
The governments have already showed concern about payment of taxes not only by “real” companies but also by online businesses. The Organisation for Economic Co-operation and Development and the EU have addressed the challenges of the digital economy in their latest BEPS initiatives and Directives, with the goal of ensuring that multinational digital companies contribute to the tax revenues of the territories where they de facto carry out their business.
In particular, the OECD, under its BEPS Action Plan 1, addressed the tax challenges in a digital economy and discussed several options to tackle direct tax challenges arising in digital businesses. One such option is a new nexus based rule on “significant economic presence”. As per the Action Plan 1, a non-resident enterprise would create a taxable presence in a country if it has a significance economic presence in that country.
It further recommended that the revenue factor may be used to determine “significant economic presence”.
Digital Service Tax
In March 2018, the European Commission initiated two proposals to ensure fair taxation in a digital economy. In particular, the EU Commission issued the Digital Tax Package, in the form of two proposals for new Directives, focused on a two-phased approach, including: (i) an interim solution, referred to as the Digital Services Tax (The DST) and (ii) a longer term Council Directive laying down rules relating to the corporate taxation of a significant digital presence (SDP, or the Significant Digital Presence proposal).
Briefly, the DST proposal foresees a temporary 3% tax (in the sense that it will apply only until the SDP solution has been implemented) over gross revenues derived from the following digital activities:
— Selling online advertising space
— Digital intermediary activities which enable users to interact with other users and which can facilitate the sale of goods and services among them
— The sale of data generated from user-provided information
The DST, as proposed by the EU, would only apply to companies with total annual worldwide revenue of at least EUR 750 million and EU revenue of EUR 50 million or more.
If the proposal is finally approved such tech giants like Google and Facebook may soon face a new tax in the EU that could significantly impact the calculation of their tax liability.
According to the SDP proposal, ”digital services” means services which are delivered over the Internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology, including in particular:
(a) The supply of digitized products generally, including software and changes to, or upgrades of, software.
(b) Services providing or supporting a business or personal presence on an electronic network such as a website or a webpage.
(c) Services automatically generated from a computer via the Internet or an electronic network, in response to specific data input by a recipient.
(d) The transfer for consideration of the right to put goods or services up for sale on an Internet site operating as an online market on which potential buyers make their bids via an automated procedure and on which the parties are notified of a sale by electronic mail generated automatically from a computer.
(e) Internet Service Packages (ISP) of information in which the telecommunications component forms an ancillary and subordinate part, in other words packages going beyond mere Internet access and including other elements such as content pages giving access to news, weather or travel reports, playgrounds, website hosting, access to online debates or any other similar elements.
The DST will be based on a system of self-declaration by taxpayers. Member states will be able to carry out tax audits to check that taxpayers are fulfilling their obligations (as they do in the traditional economy). A digital portal, known as the One-Stop-Shop, will be set up to help companies to comply. As part of that system, one member state will be responsible for identifying the taxpayer, collecting the tax and allocating it to other member states as appropriate.
As regards the timing, by 31 December 2019 at the latest, the laws, regulations and administrative provisions necessary to comply with this Directive will be adopted and that they shall apply those provisions from 1 January 2020.
Virtual Permanent Establishment
The second part of the proposal relates to virtual PE. The traditional definitions of permanent establishment, which require both a physical presence and employee activity inside a country, are being changed in the digital age. New criteria are being applied to e-commerce companies based on a virtual presence that, nonetheless, generates revenue from a foreign country.
The main idea of that part of the proposal is to shift value creation as well as profit to the place where the digital services are provided.
These profits can then be taxed by the country where the digital presence is located.
A company will be considered to have a significant digital presence if it fills one of the following criteria:
— It exceeds a threshold of EUR 7 million in annual revenues from digital services in a member state;
— It has more than 100,000 users who access its digital services in a member state in a tax year;
— Over 3,000 business contracts for digital services are created between the company and business users in a tax year.
The introduction of this concept by the various member states of the European Union will, of course, also mean the abolition of the provisional “digital service tax”.
The concept of virtual permanent establishment raises lots of questions as to its practical implementation. The question is how to prove that the buyer used, for instance, social media and/or a certain application. Some consultants propose the relationship has happened if interactions through a website exceed more than 1,000 users a month, the interactions for more than six months via a website and the existence of a website.
This trend should also be of interest to all international businesses that believe they can avoid PE through limited time or exposure in a country, since their employees may still be communicating and transacting business over virtual mediums sufficient to meet new PE standards. This may be the wave of the future, as the business “nexus” tests are expanded to create permanent establishment based solely on revenue, rather than physical offices or in-country staff.
The OECD uses examples of foreign companies with a “significant digital presence” to recommend establishing PE in the following areas:
— The use and sale of data, such as news media through aggregators such as Google News. Aggregators affect readership of local publications, take away market share from news sources, and could be taxed on that basis even though the aggregator service is free to readers.
— Online sales of goods and services into a foreign market, including tangible products, media or other digital products. Since these e-commerce sales are paid for from a foreign source, this would meet the accepted criteria for PE of “concluding contracts” inside a country of business, as a virtual PE agency.
— Housing servers, hosting websites and other minimal facilities that still generate revenue in the country. Depending on bandwidth and market share, digital exchanges could be enough to establish a ‘physical presence’ in the country.
Introducing digital tax in Europe
By the end of 2018 a EU countries had to determine if the digital tax should be imposed. Some EU members like Ireland, Finland, Sweden and the Czech Republic have taken a stance against the plans. Some countries like Spain and Italy have already included the digital taxes as additional sources of income to their budgets.
In particular, Spain announced its intention to introduce a Spanish DST by the end of 2018 (potentially applicable in 2018), with the objective of taxing digitalized companies in the jurisdiction where their added value is generated. Even though no draft of this proposed new tax has been released yet, the announcement states that Spanish DST will follow the features of the EU proposal.
As to Italy it has already introduced a so called “Web Tax” which was included in the 2018 Budget Law. The Web Tax is levied at a 3% rate on the value of each digital transaction and due for payment by residents and nonresidents enterprises rendering more than 3,000 digital business to business transactions in a calendar year and will not be credited from Italian income tax.
The Web Tax should be applicable starting from 1 January 2019.
France is going to introduce its own digital tax on large multinational technology companies from 1 January 2019. A new so-called "GAFA tax" — named after Google, Apple, Facebook and Amazon — will be imposed to ensure the global giants pay a fair share of taxes on their business operations in Europe.
Latin America leading the path to ñhange
In the Latin American region businesses are often not allowed to register only for VAT purposes. The business is usually required to set up a form of local establishment in a country — either a branch or a legally incorporated entity. This rule completely corresponds to the OECD recommendation that digital services should be taxed at the place of their consumption and a non-resident business should be accounted for the taxes due in the country of consumption.
VAT on digital services
Another important issue to consider when talking about digital sales is VAT on digital services or goods. Every company selling digital goods to a customer in the EU needs to charge VAT during the sale, collect it from the customer, and then later file and pay it to the government. But before charging VAT it is crucial to understand whether the customer is a business or individual because this status determines whether or not the company supplier should charge VAT.
In particular, in B2B there is no need to charge VAT; there is a reverse-charge method wherein the buyer pays VAT to its own government. The company seller just needs to receive a valid VAT number from the buyer and validate it with the special service from the European Commission. In B2C the company should charge VAT and apply the local rate of the customer’s country. For non-European businesses, similar rules apply.
In B2B the seller does not need to charge VAT, while in B2C transactions there is an obligation to charge VAT in the customer’s country.
The digital world is adding numerous changes to the rules on corporate taxation. And it is not only about tackling aggressive tax schemes. It is also about moving to new concepts of taxation principles to capture new forms of adding value, which can no longer be linked back to a physical presence, or even, in some cases, a monetary transaction. As a result of this, a watching eye is needed in respect of adoption of new laws all over the world to follow the taxation rules for digital business.
is an international tax advisor, attorney at law