• Taxation of the digital economy – are Banks ready?

Taxation of the digital economy – are Banks ready?

05 September 2019

In the UK, the Government has committed to pressing on with the introduction of its Digital Services Tax (DST) by publishing its draft DST legislation and guidance on 11 July 2019. The UK DST, which will be effective for fiscal years beginning on or after 1 April 2020, will apply a new 2% tax on the revenues of large businesses providing internet search engines, social media platforms and online marketplaces to UK users.

Banks and payment service providers will have welcomed clarification in the DST draft legislation that businesses engaged in financial or payment services will be outside the scope of the UK DST. However, the DST exemption for financial and payment services providers should not stop these business from closely monitoring developments in the OECD/G20’s inclusive programme of work on the taxation of the digital economy, which are sector and business model agnostic.

Recently, members of the OECD/G20 Inclusive Framework on BEPS agreed on a roadmap to develop a solution to the tax challenges arising from the digitisation of the economy and whilst tech giants are the obvious challenge, there is a growing consensus that there needs to be sweeping reform of the international tax rules more generally to acknowledge, across all sectors, the digitisation of the economy at large.

What is included in the proposed work plan?

The OECD/G20’s Inclusive Framework on BEPS published its programme of work in late May 2019. The work plan has two “pillars” that will focus on (a) a review of taxable nexus and profit allocation rules (Pillar One) and (b) a global anti-base erosion/minimum tax proposal (Pillar Two). The expectation is that agreement on a solution will be reached by the end of 2020 and it is increasingly unlikely that the rules will be limited to any particular sector.

This trend was already fairly clear as the 2015 OECD/G20 BEPS Action 1 Report stated that it would be difficult, if not impossible to ring-fence the digital economy. It is therefore likely that banks will be in scope of the forthcoming changes proposed by the OECD/G20’s Inclusive Framework’s Program of Work on Digitalisation, which has the potential be the biggest shake up of international tax in modern times.

New Nexus Rules

The consequence of the revised tax nexus rules will allow countries to impose corporation tax on remote seller’s profits allocated to the country, regardless of physical presence. The work plan outlined that it will develop a concept of remote taxable presence (i.e. not requiring a physical presence) by modifying the existing OECD model treaty articles 5 (determining whether a permanent establishments exists) and 7 (Business profits and the conditions that give a State entitlement to tax those profits). However, since its publication, the language regarding the new nexus test appears to have shifted towards a focus on sales as the primary (or perhaps even sole) metric, with less reliance on other indicators of sustained economic activity in a jurisdiction.

How will the new nexus rules impact banks?

For the past number of years, we have steadily seen banks move away from a branch network model and steer customers towards digital channels (mobile phones, tablets and online). Consequently, customers may ‘consume’ banking services in any jurisdiction by simply logging onto their mobile banking or by carrying out a card transaction abroad. A fee charge for carrying out these type of transactions, either directly or via margins, could dramatically increase the possibility of the bank having a taxable presence in a territory without any physical presence of a business in that territory - whether that is a pure compliance burden, or something that results in a different cash tax position, will be a function of how profit attribution to the taxable nexus is defined.

New profit allocation rules

The work on new or modified profit allocation rules will consider methods of allocating profits (and losses) to jurisdictions in which a business operates without a physical presence. The methods considered in the programme of work are: modified residual profit split; fractional apportionment; distribution based approaches (such as determining a baseline profit allocation to a jurisdiction); and determination of profits using business line and regional segmentation. That said, the focus on sales on the revised tax nexus rules may also flow through into the profit attribution leg as the primary factor for profit attribution, though that seems to be less clear at this stage.

How will the new profit allocation rules impact banks?

If sales become the primary factor of profit attribution then we will effectively shift towards a destination based tax system - this would be a very significant change for banks who consider where the Key Entrepreneurial Risk-Taking Functions (KERTs) are performed when attributing value.

Adoption of technology in the banking sector also needs to be considered when attributing value in transfer pricing analyses. Technology tools and solutions are increasingly being utilised as part of the banking business with developments in artificial intelligence allowing an increasing number of decisions to be passed from human to machine. For example, credit decisions are often now determined on the data of users’ behaviours, interests and consumption habits through direct information that the users provide and the monitoring of their engagement with a platform.

Where people previously made decisions is was relatively straight forward to identify where they were present and attribute value to that. However, with artificial intelligence replacing human decisions, the question arises as to where the value and risk truly reside? Furthermore, IT costs associated with this technology will often form part of a banking group’s global cost recharge. Does that mean that the credit decision should also be allocated? Or do banks now re-evaluate their business model and conclude that these risks decisions are all made centrally where the technology is based?

Automated trading and algorithmic trading has been around for many years but have become increasingly prevalent and sophisticated. Simply applying a global trading split to all locations, where they apply an algorithmic trading model, risks ignoring the true value associated with people who wrote the underlying code and macros that make up the algorithm. If trading locations have no ability to access or change the underlying code is it reasonable to allocate them risk on the same basis as the location that controls the underlying code?

The above points raise various system issues i.e. how do you ensure that you have the systems in place that will enable you to track the data required to allocate profit in the manner the rules will require? For example, do systems enable regional or business plan segmentation? Exactly what that looks like, and therefore the systems impact, is not yet known but will be something to reflect on carefully for any planned systems changes.


Whilst banks have experienced changes to the way that they operate as a result of the Digital Economy they perhaps don’t see themselves as “pure digital companies” and may overlook the OECD/G20 Inclusive Framework’s work plan on the basis that it will not/does not apply to them in the same way that it will to large companies providing internet search engines or social media platforms.

Indeed, there is an argument that the OECD/G20 Inclusive Framework on BEPS’ “Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy” should be rebranded – perhaps to “Tax Globalisation”.

Globalisation, in combination with digitalisation, has put established tax rules under great strain and the proposed work plan to bring sweeping reform of international tax rules has the potential to be the biggest shake up of international tax in modern times. It could fundamentally change a country’s respective share of global tax revenues and the “arm’s length principle” may largely be consigned to history along with analogue technology. One thing is clear, the international consensus of governments is that tax principles applied in the digital age need to fundamentally change to reflect the value of business conducted in a country.