OECD Seeks Stability in Taxing the Digital Economy

The current pace of technological change is unprecedented and shows no signs of slowing down. To put it into perspective: In 2013, the Apple Watch was still in production, Alexa was number 60 on the list of most popular baby girl names, and Uber had just launched the first drive-for-hire service using nonprofessional drivers and their personal vehicles. By 2023, 2013 will feel like a different lifetime.

This latest era of technological disruption has given rise to the digital economy. In March 2018, the U.S. Bureau of Economic Analysis released its first-ever report exploring the size and growth of the digital economy, which, per bureau estimates, has grown at a rate of 5.6% per year from 2006 to 2016, compared to 1.5% growth in the overall economy. To quote the U.S. government, “There is little doubt as to the importance of digital technology in American business and its role in fostering national economic growth and competitiveness.”

But as is often the case with such advances in technology, a system for regulating them usually lags behind. Herein lies one of the challenges the Organization for Economic Cooperation and Development (OECD) endeavors to meet in a relatively short amount of time: To create a global framework for taxing digital services.

“Because the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes,” the OECD has said.

On October 9, about a week in advance of the G20 meeting in Washington, D.C., the OECD released the discussion draft of a proposal to create the framework for an international digital services tax and is looking to get a consensus on the “outlines of a unified approach” within just a few months, by January 2020.

Among the proposed rules is a requirement that multinational enterprises pay taxes in countries in which their customers buy and use their products and services.

After January 2020, when the OECD seeks consensus on the “outlines” of a unified approach, the OECD will pursue an actual consensus solution among the G20 countries, for which it has given a deadline of end of 2020.

 

What’s the Matter with the Status Quo?

The current global tax regime dates to the 1920s and ties taxation to physical presence, making it more than ripe for an overhaul. In the absence of an international tax regime that addresses modern business transactions—which notably do not require a physical presence in order to sell a product or service—tax authorities contend that some multinational enterprises are taking advantage of what the OECD calls “gaps in the interaction of different tax systems” to “artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed.”

An international digital tax would decouple physical presence from sales, among other things. Some countries, like France and the United Kingdom, have proactively created their own digital tax rules. But for a multinational, the burden of complying with dozens, if not hundreds of discrete digital tax systems would be a significant logistical challenge.

So, the OECD is endeavoring to catch up; some multinationals, such as Amazon and Google, have said they support the OECD’s efforts; and the UK and France have indicated they will abandon their individual solutions in favor of a collective one as soon as consensus is reached.

 

Digital Tax Disparity

The disparity between individual countries’ tax rules has created confusion around what constitutes a fair apportionment of profit allocation for multinational entities with digital offerings, such as video streaming or online media. Under existing rules (e.g., the physical presence standard), taxpayers with digital business models are able to isolate sales from operations, precluding countries from collecting tax on income earned by entities domiciled elsewhere. As a simplistic example, if a company, Streaming Inc., is incorporated in a country like Ireland, which is a relatively low tax jurisdiction, but makes sales into another country, that other country is unable, under existing rules, to levy taxes on Streaming Inc. for those sales. Estimates of revenue losses resulting from the inability to tax digital income range from $100 billion (OECD) to $600 billion (International Monetary Fund) per year.

At the same time, several tech giants have come under scrutiny for using transfer pricing strategies to shift their profits from higher tax jurisdictions to low- or zero-tax countries. (As currently drafted, the OECD’s proposal would apply not only to technology multinationals but to consumer product companies.)

To rectify the “gaps” in the tax system—and to capture that lost revenue—the G20 in 2013 commissioned the OECD to spearhead a comprehensive solution that would eliminate the so-called base erosion and profit sharing (BEPS) strategies by multinationals. The OECD’s October 9 proposal comprises the first of a two-pillar approach to global digital taxation and focuses on the allocation of taxing rights and a review of profit allocation and nexus rules. Pillar two will address the remaining BEPS issues.

Within the OECD’s overarching proposal are three proposals under consideration and open for comment. Commonalities between them all include reallocating taxing rights in favor of the user/market jurisdiction and a new nexus rule that would not depend on physical presence of the user/market jurisdiction.

They also seek greater simplicity and stability of the tax system, the OECD said in the document. Rather than link taxing authority to countries in which companies are incorporated or where they site intellectual property, the OECD’s proposal would give more taxing authority to countries in which consumers are located.

Furthermore, the OECD said it would consider applying the €750 million ($823 million) revenue thresholds that some countries, such as France, have implemented. Businesses that manufacture goods that are used by other businesses, rather than sold to consumers, would be excluded, as would those that mine raw materials.

While the OECD is targeting the end of next year to agree upon a framework, many details remain to be hammered out. The OECD is holding an open comment period until November 12, and a public consultation meeting on November 21–22 in Paris.

 

What to Expect: Wayfair as Analogue

We have seen an analogue of digital tax implementation play out in the United States. In the Wayfair v. South Dakota case, the Supreme Court handed down a decision that essentially decouples sales from physical presence and allows states to implement their own remote sales tax laws. In other words, companies that were making digital sales into states in which they didn’t have a physical presence are now responsible for collecting and remitting sales tax in those states, depending on whether they meet a state’s threshold for doing so. From tangible goods to services, and state income/franchise tax to financial reporting, Wayfair has unleashed a formidable amount of change to the most basic tax operations of a business.

While international rules governing digital taxation are far from concrete at this point, we can anticipate the extent of their impact. Multinational entities already face significant challenges complying with discordant digital tax regimes. Companies may find themselves suddenly being responsible for paying taxes in ten or twenty countries, which, in lieu of a global tax framework, may all have different thresholds. Companies that are in the business of making cross-border sales should be analyzing how a digital tax will affect their total tax liability—the sum of all taxes owed at any given point in time.

Visit BDO’s Taxation of the Digital Economy for the most current news and tools to help you assess how your business may be affected by the implementation of digital taxes around the world.