As traditional sales methods decline and business is increasingly transacted online, the way tax systems operate internationally will have to change – and that process has already started.
Digital services are just the start
While some governments are currently focussing on the difficult tax issues that are intrinsic to digitally provided services, the way that the OECD is responding to this debate recognises that digitalisation of the economy is pervasive – raising jurisdictional tax risks wherever transactions are completed or arranged online.
The OECD’s proposed options for taxing the digital economy are clearly aimed at developing common standards quickly to prevent the adoption of conflicting approaches being adopted by many jurisdictions. Whether the OECD will succeed in its goal of agreeing new standards by 2020 remains to be seen. However, the principles that are finally adopted as the global standard for digitally provided services are expected to be highly influential when new templates for all cross-border profit and tax apportionment are developed. Any framework that is ultimately agreed will apply irrespective of sector. It is no longer just an issue for “tech” businesses.
Difficulties with jurisdictional principles
Current transfer pricing principles and the arm’s length pricing test already create significant administrative burdens on international companies and local tax authorities in attributing profits.
Although the ‘user created value’ methodology suggested by the UK is highly specific to online services, it still resonates for sales of other goods and services. For example, purchaser reviews of physical goods can enhance or damage the seller’s brand or boost sales of specific models in just the same way as active participation in a digital platform that attracts advertisers.
Similarly, profit attribution based on the market intangibles in a jurisdiction (focussing on trademarks, customer lists, customer relationships, brand strength, market share etc. – as suggested by the US and China) could very easily apply to any service or product.
The third proposal under consideration of allocating profit based on broad formulae that link to the business’s significant economic presence (being promoted by India and other developing nations) would replace complex transfer pricing methodologies with simple allocation keys (sales, assets, employees) and apply a weighting to them so that profits can be apportioned using straightforward formulae. Again, this would be the case irrespective of sector or type of product or service.
For some nations (particularly France and Germany) the above proposals related to a change in profit allocation in themselves do not go far enough. They are still concerned that the international tax framework would offer opportunities for manipulation that could undermine the fair allocation of taxable profit between jurisdictions. So the supporting concept of a minimum taxation principle has obvious attractions. This would work by allowing residence and source countries a right to tax certain profits that are subject to no or low effective rates of tax. Clearly, tracing taxable profit could prove challenging for jurisdictions, and the residence and source countries would need to have reciprocal information sharing arrangements, otherwise there could be a risk of double (or worse) taxation.
All of these approaches have challenges for tax authorities and businesses, but the message is now clear. The international community is united behind a view that the international tax framework needs to change. The work of the coming year is to determine how.
The next stage of BEPS?
The OECD’s BEPS project has changed international taxation rapidly over the last four years and it seems clear that the early moves on digital tax services will spark even more change in the future.
I suspect that tax changes agreed over the next few years will affect the future design and structure of businesses for the rest of this century. All businesses selling across borders should take an interest in these developments now, as a new international tax order for our digital business world is starting to evolve.
If you would like some guidance in assessing how your business might be affected as the international tax landscape changes please do not hesitate to get in touch with your usual BDO contact or Ross Robertson.
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