Digital Economy and Taxation

There has recently been a resurgence of the debate on the consequences of the digital economy on taxation, or perhaps better expressed as, on the form of adapting international taxation to the digitalization of the economy. Commissioner Moscovici has said that the European Commission will present its new proposals in March, in line with similar declarations from the French government.

This concern over the consequences of digitalization on the economy is nothing new. Leaving aside earlier precedents, such as the OECD works on the digital permanent establishment and the later French 2013 Collin & Colin report, the key milestones in this debate are:

1. Firstly, the OECD’s BEPS report devoted action 1 to these challenges of the digital economy. The final report in October 2015 was not particularly precise when it came to offering solutions, but it introduced the framework for the debate by determining this need to respond to the consequences of digitalization either in connection with the concept of permanent establishment, by accepting the idea of “significant economic presence”, or by creating new tax concepts, in the form of new “withholding tax” scenarios or of taxes on certain types of transactions to fill the gap left by the lower taxation of companies focused particularly on the digital economy.

In 2017, the OECD launched a new phase in this analysis with the document published on September 22 which should give rise to a specific report appearing soon.

1. Later, on September 21, 2017, the European Commission published its Communication on a fair and efficient tax system in the European Union for the Digital Single Market.

This Communication is connected with the VAT package launched in 2017 which included the announcement in December 2017 of a new VAT system for online cross-border sales.

1. Lastly, various EU countries have approved measures or published important documents. The reform of Italian legislation, which took effect on January 1, 2018, broadened the definition of permanent establishment, to take in economic presences without the backing of a physical presence, and taxed certain digitally supplied services. And in November 2017, the Treasury of the United Kingdom published a detailed “position paper” that is of particular interest.

But what does this movement towards adapting taxation to the digital economy broadly mean? According to the reasons given by the European Commission, the current rules no longer fit the modern context and are resulting in a number of technology giants not paying the taxes they should be paying. As a result, international taxation should allow income to be taxed where it is generated. This standpoint has focused the debate on direct taxation, although it has always been thought that the treatment of the digital economy requires a global view that considers both direct taxes on the income of companies and indirect taxes and, in particular, VAT on the supply of digital goods or services, or digitally supplied goods or services. From another angle, that approach has concealed the greater complexity that the problem encloses.

When the European Commission accepts in its Communication that digitalization affects all companies, but in varying degrees, it is admitting that in actual fact its proposals will be directed at particular business models, which are listed in the Communication itself: basically, online retail platforms, social media models, audiovisual digital services and the so-called collaborative economy. In relation to these sectors, it is sought to alter the rules determining the taxing powers of each state by introducing the concept of a significant commercial presence, even where there is no physical presence, and especially to alter the rules on calculating the tax relating to each state. Beyond taking the opportunity to offer the Common Consolidated Tax Base as a global solution, the Commission accepts the difficulties associated with the task, the setbacks associated with unilateral solutions, and the need to offer alternative solutions to the broadening of the definition of permanent establishment, solutions such as a tax on insufficiently taxed income, a withholding tax on income from certain types of transactions, or a specific tax.

Indeed, as the UK government’s position paper recognizes, the current debate is questioning the validity of the rules developed a century ago, but only to a certain extent or to the extent that those rules are now having effects that are rejected by being unfair for certain countries. As opposed to what we sometimes hear, it is not a question of companies paying taxes where they sell, because now, like then, most states argue that a company must pay taxes where it designs, produces and sells its products regardless of where its customers or consumers are located. What happens is that this principle, which continues to be at the core of consensus, is seen as unfair or inadequate in relation to the taxation of certain activities based (and here countries’ views vary) on the use of their users’ data, on digital advertising services targeted at those users from another country, or on certain digital intermediary platforms. And besides, these issues must be seen in light of other problems arising from the age-old transfer pricing principles, when trying to determine what portion of the income relates to certain intangibles, above all when they are in low-tax jurisdictions.

All in all, the difficulty now lies in how to justify this differentiation in the taxation of certain activities, and how do so without treading on the toes of any of the states with differing positions.