An effective solution for taxation of businesses in the digitalised economy should be found at the global level, to prevent further unilateral action and to ensure sustainable growth, investment, tax certainty and fairness, international tax experts and civil society representatives stated at a hearing held by the European Economic and Social Committee (EESC) on 29 January.
The hearing "Taxation in the digitalised economy – Which way forward?" was organised as part of the preparation of an own-initiative opinion on the subject and to initiate a dialogue with international experts and civil society representatives. Discussions focused on major tax challenges and possible solutions.
A global solution is preferable to unilateral measures
Opening the hearing, Stefano Palmieri, President of the EESC ECO section, said that only a solution at the global level could be effective, both in terms of regulation and governance.
But international consensus is lagging behind. Although significant progress has been made on tax avoidance especially in the framework of the 2015 OECD action plan on Base Erosion and Profit Shifting (BEPS), the international tax system is still not adjusted to the new business reality. It allows for under-taxation or very low tax levels and raises uncertainty about tax revenue. International discussions on a solution are ongoing, but in the absence of consensus governments are tempted to adopt unilateral measures.
"Unilateral actions involve much more than administrative complexity. We are talking about enacting harmful tax rules that discriminate against non-residents and that create a risk of retaliation from much larger markets. These policies will harm growth and negatively affect foreign direct investment and the competitiveness for exporters," said William Sample from the United States Council for International Business.
Participants were not of the opinion that ring fencing of the digitalised economy could be a possible solution. In an on-going evolution Robert Stack, former U.S. deputy assistant secretary for international affairs at the U.S. Treasury Department and chairperson of the OECD Digital Tax work under the Base Erosion Profit Shifting (BEPS) work, currently with Deloitte LLP saw a risk for new tailor-made principles to soon become obsolete. The application of the underlying architecture of international taxation to all taxpayers who operate in an across border environment would be preferable.
EESC hearing welcomes that discussions at OECD level are advancing
David Bradbury from the OECD said that the inclusive framework on BEPS made a commitment to reach a global consensus by 2020. Further work by 127 jurisdictions would focus on two pillars to concretise possible solutions. The first pillar would examine possible approaches for the allocation of taxation rights, by dealing with both nexus and profit allocation questions concurrently and simultaneously. The second pillar related to countries' ability to exercise taxing rights in circumstances of base erosion and profit shifting.
At the hearing, speakers discussed the three options under pillar one. The approach based on user participation, advocated by the United Kingdom, assumes that targeted user-related activities could involve contributions that allow for amending the rules in favour of market countries. The broader approach on marketing intangibles, advocated by the U.S., assumes that some investments or assets made by companies can be market-focused and that their contribution to profits may require a partial recognition in the market country. The notion of a significant economic presence would concern defining the scoping of the taxable nexus.
The second pillar involved two connected and interrelated rules, the income inclusion rule and a rule on taxation of base erosion payments. France and Germany have been advocating this type of approach with a proposal on a minimum tax, that could, in the view of Prof. Wolfgang Schön from the Max Planck Institute, be a way to address tax avoidance to a certain degree. He also advocated that the possibility to address the tax issue within the Value Added Tax (VAT) system should be fully explored.
In the view of the Commission, a solution could lie between the U.S. and the UK approach. The common ground of these proposals and a scope for simplification should be further explored.
Income tax solution vs. consumption tax solution
The dilemma of allocating international taxation rights, the question of a possible split of corporate profit tax revenue between market countries, where consumption takes place, and production countries, where innovation and strategic decision-making take place, must be clarified said Krister Andersson, rapporteur for the EESC opinion under preparation.
Speakers lamented that the aim of international discussions was not clear. It must be further examined whether an income tax solution focusing on tax allocation of revenues would be preferable to a consumption tax solution. Participants had different views about the focus of current discussions and the better approach.
A possible solution would be to reassess where value is created and to allocate further taxation rights to market countries, but this would be against existing applied tax principles. Applying new rules to the concept of value creation is the challenge at hand, in the ongoing OECD work.
"The old political consensus has been that both the market and the production country can tax an event, the production country gets the corporate income tax and the market country gets VAT", said Prof. Schön, but this would work firstly for countries which had a VAT system. The scholar proposed to amend the VAT directives so that apparently gratuitous services would also be subject to VAT, which would have a value of consumption.
Another question for debate was whether, because of a customer base, market countries would have a justification to tax profits made by digitalised services companies, in addition to VAT. Some countries and stakeholders view user participation and contribution as being a key driver of values and others look more broadly to intangibles associated with the market jurisdiction but are broader than user participation and contribution.
It was viewed that companies would not create a value but invest in markets by offering services. Overall taxation of the digital economy could thus be defined in coherence with the old system. Without looking at user participation, corporate tax would still be a tax on the return on capital, taking place in the place of permanent establishment.
Prof. Schön explained that the US proposal on marketing intangibles would allow going further, but that the taxation of investment in marketing would affect businesses way beyond the digital economy. In 2018 he had put forward a proposal to "look at the digital side of investment and try to identify the capital a company has invested in its digital presence in another country."
Shifting the tax base and profits to market jurisdiction, combined with worldwide network connectivity, could give all countries the right to tag the same pool of multinational income. Companies with customers and affiliates in many countries would suddenly be taxed in all countries where they have revenue. "Inconsistent tax policies and unilateral actions would result in chaos and that would harm the smaller markets first", said William Sample. A solution based on traditional allocation methodologies would thus be preferable.
Helen Pahapill, Adviser of the Ministry of Finance of Estonia, saw the possibility of achieving an agreement within the current corporate income tax system. This would likely be complex and possibly result in higher implementation costs, but could be perceived as the fairest solution. Given the recent agreement on the UN tax convention model, international consensus in this area would be almost at hand. Nevertheless, a solution outside the corporate income tax system would have more room for creativity and could be easier to apply.
A single definition of value creation must be agreed
The concept of value creation is interpreted in different ways. A common definition was urgently needed. It would be necessary to clarify whether countries where products have been produced and invented or countries where they are used and sold were the place of value creation.
Bert Zuijdendorp from the European Commission mentioned user participation as an issue for further examination: "The consumer is much more than just a consumer. He actually contributes to the products for instance through his data or by providing content in certain cases, and we will need to analyse and define what exactly is the contribution of users to the value creation of the product or the intangibles."
Reforms must pursue some general objectives
Speakers urged adhering to certain principles like the avoidance of double taxation, simplicity, certainty and equality for the design of possible new rules, which also have been agreed at the OECD level. A simplified methodology would be critical for both tax administrations and business.
Fair and efficient dispute resolution mechanisms must be developed and implemented in connection with any new rules. An update might include binding mandatory arbitration as part of a minimum standard.
Businesses, tax professionals, academics, civil society organisations and others must be involved in ongoing debates.
In the context of evaluating the proposed approaches David Bradbury said: "There is a need for a further economic analysis, not just of the impact of the BEPS project but indeed of the potential impact of any measures that might be implemented in the future. One of the serious limitations that always impede that work is a lack of currently available high-quality data."
The findings of the hearing will feed into the EESC opinion on taxation in the digitalised economy, which is under preparation and is expected to be adopted in July 2019.
Previous EESC opinions on the issue