The EU Commission has published its latest proposals for tackling perceived issues with the taxation of the digital economy. The proposals include the introduction of a new tax for certain businesses in the short term and, ultimately, the redefinition of the concepts of taxable presence and profit attribution for digital activities.
What is driving this?
The EU Commission considers that tax should be levied where value is created. However, it is of the view that there is currently a mismatch between the location of value creation and taxation for certain digital activities. A particular concern is that value creation arising from the participation of users in platforms cannot be taxed at the location of the users under the existing internationally accepted frameworks. It argues that swift action is needed because:
- Digital businesses are of growing importance (now compromising 9 of the top 20 global companies by market capitalisation)
- Digital businesses have a lower tax burden than traditional ‘brick and mortar’ businesses (the publications suggests typically half the effective tax rate)
- There is a high degree of political pressure for Member States to take action
- Challenges would arise through a proliferation of unilateral measures taken by individual member states and therefore the single market needs a common model as soon as possible.
The EU Commission recognises that the ideal solution would be a globally agreed approach that takes account of user generated value in the attribution of taxing rights and profits through the concept of a digital presence / virtual permanent establishment (PE). However, it acknowledges that this will take time. It would be necessary to change the OECD Model Tax Convention and, in turn, renegotiate existing tax treaties to give such measures effect – even if this could be implemented by a multilateral instrument like the BEPS changes.
Therefore, the EU Commission proposes a harmonised interim tax to mitigate the risk of unilateral action being taken by the Member States and preserve the single market.
The interim tax is intended to focus on scenarios where revenues are escaping the current tax framework altogether. It is characterised as a basic indirect levy on gross revenues (with no deduction of costs) where users play a major role in value creation that leads to those revenues. This will cover services where the main value is created by user data, either through advertising or by the sale of the data collected by companies such as social media platforms or search engines, and services of supplying digital platforms that facilitate interaction between users, who can then exchange goods and services via the platform (such as peer-to-peer sales platforms).
The proposed scope is, therefore, on revenues created from:
- Selling online advertising space
- Digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them
- The sale of data generated from user-provided information (assuming this remains legally possible in future)
The interim tax would not appear to affect businesses where users are mere ‘consumers’ of a good or service – including services such as the supply of digital content or solutions for users. This would mean that, for example, electronically supplied media, streaming, online gaming, IT solutions, cloud computing services and fintech activities would not be affected by the interim tax. However, it is important to remember that the scope of activities that fall within the interim tax could evolve as discussions at the level of the OECD progress.
The interim tax is intended to apply to large businesses so it is proposed that it would only apply where a business carrying out a supply of relevant digital services satisfies each of two thresholds:
- Annual worldwide total revenue above EUR 750m at the level of the multinational group, and
- Minimum annual revenue from the provision of digital services in the EU of EUR 50m.
The tax would apply equally in a cross border context between Member States, between a third country and an EU Member State and in a purely domestic scenario. It would be an annual tax on relevant gross revenues and would be collected by the territory in which the users are located. There is limited detail on how the location of users would be identified in practice.
The rate is yet to be confirmed, but the proposals appear to suggest that a rate of 3% is contemplated. Measures would be built in to mitigate cases of double taxation, however the precise form of these measures is not specified.
The EU Commission is clearly seeking to lead the global debate on the taxation of digital businesses. Its preferred long-term solution would introduce the concept of a digital presence or virtual PE and profit attribution rules for all EU Member States through a standalone Directive. The Directive would require implementation of these concepts within the domestic law of EU Member States.
It is proposed that a digital platform would trigger a digital presence / virtual PE in a member state if it meets any of the following criteria:
- The digital platform derives revenues from the provision of digital services in an EU member state exceeding EUR 7,000,000 in a tax year
- The number of users of the digital platform in a member state in a tax year exceeds 100,000
- The number of online contracts for digital services concluded between the company and business users in a tax year exceeds 3,000.
How ‘digital services’ would be defined is not explicitly set out. It may take inspiration from the EU definition of electronically supplied services currently used for VAT purposes. If this were the case, this would cover a broader range of services than proposed for the interim tax.
The proposed approach to attribution of profits to a digital presence / virtual PE would be expected to respect the fundamental principle that taxation takes place in the jurisdiction where value is created. The proposals would, however, introduce new concepts for determining the attribution of profits in the context of digital businesses. Examples of the factors that would be taken into account in determining attribution are:
- Profits from user data
- Services connecting users (eg online marketplace, platforms for the ‘sharing economy’)
- Other digital services (eg subscriptions to streaming services).
Where a business in a third country with whom a Member State has a tax treaty is involved, it would be necessary to incorporate the concept of a digital presence / virtual PE and profit attribution approach into the tax treaty as well as the OECD model tax convention. The EU Commission intends to issue a ‘Recommendation to Member States’ regarding changes to Article 5 (PE) and Article 7 (Business Profits) of the OECD Model Tax Convention to give these measures effect. In practice, there may be a different timeline for achieving the necessary changes between EU member states, versus treaties between EU members and third countries.
The proposals note that the measure could eventually be integrated into the scope of the Common Consolidated Corporate Tax Base (CCCTB),which is being separately discussed.
Demand for the reform of the taxation of digital business is growing rapidly and action in the near term at a UK, EU and broader international level is increasingly likely.
There is broad coalescence amongst HMRC, the EU Commission and the OECD around a concept that the existing international tax framework does not adequately allocate taxing rights in respect of certain digital activities. It is also common ground that remote exploitation of intangible property in a market is an area of particular concern.
The problem is seen to be especially acute where there is an active user base in a market which is seen to add value to the business’s platform – there is a view that this value creation should be taxed in that territory. This represents a paradigm shift from the traditional view that it is the development of platform technology and a powerful user experience which drives value for a business.
While the overall direction of travel is clear, there are still many questions that will need to be answered in order to understand the practical impact on companies. It will be important for all businesses to monitor developments as the impact on some business models could be significant.