Tax challenges arising from digitalisation

Rwanda Revenue Authority personnel at work at their headquarters in Kimihurura. / Photo: File.

By

Nicky Gouder

As the world becomes more digital, international tax principles have some catching up to do to remain relevant in today’s world. Tax concepts which were agreed to 30 – 40 years ago, are no longer relevant

today, as most business transactions are now deemed to be digital in nature.

For developing economies which are drawing up new tax policies, taxation of the digital economy will be a key component of the overall tax system. New fiscal policies will be implemented for the next 30 – 40 years, during which it is expected that even more businesses will become digital. For a country like Rwanda, which has embraced digitalisation during the last years, taxation of the digital economy will be a key ingredient of its fiscal policies, in order to ensure that that it not only raises fair revenues from such transactions, but that it continues to attract digital players to the country.

But what is the current status of taxation from digitalisation?

In March 2018, The European Commission (EC) proposed two rules to tax digital activities in ‘a fair and growth friendly manner’. The first proposal related to the creation of a new permanent establishment where companies have a significant digital presence. This proposal would result in companies having to pay tax in each Member State (MS) where they have a significant digital presence.

The Commission also proposed an interim digital services tax of 3% on revenues, which would be applicable to companies with total annual worldwide revenues of €750m and EU revenues of €50m

In parallel, the OECD has been working to achieve a global solution on how to tax the digital economy. The OECD has always stated that it didn’t want a fragmented approach, but that it would like to achieve global consensus to change the current international tax principles to be relevant in today’s digital world.

In March 2020, in order to avoid different systems at EC and OECD level, the EC stated that it is committed to support the work of the OECD, but if no solution is found by the end of 2020, it will again make a proposal for its own digital tax.

Whilst the EC and the OECD have been working on their proposals, a number of countries have taken unilateral action, and have introduced domestic tax laws specifically to target companies within the digital economy. A number of countries have introduced a Digital Services Tax (DST);  Austria introduced a 5% tax on online advertising as from January 2020; Italy introduced a 3% tax on a number of digital services, also applicable as from January 2020; France has also introduced a similar 3% tax, which was implemented as of January 2019, but agreed to suspend the collection of the DST until December 2020. A number of other countries have also introduced similar DSTs.

In October 2020, the OECD issued a Cover Statement to explain what the current status of the 2020 consensus-based solution is. In its statement, the OECD announced that the members of the OECD/ G20 Inclusive Framework on BEPS (Inclusive Framework) have made substantial progress towards building consensus. The IF released a package consisting of the Reports on the Blueprints of Two Pillars.

Although no agreement has yet been reached, these pillars are meant to provide a solid foundation for future agreements. Pillar One tackles the issue that digital businesses are able to generate profits in a number of jurisdictions with or without having a physical presence. The solution, which is being presented in this pillar, would be to allocate a portion of residual profit to the market/user jurisdiction. A new multilateral convention would need to be developed to implement this solution.

The Report on Pillar Two Blueprint is presented as a solution that would address remaining BEPS challenges and provides a right to jurisdictions to ‘tax back’ where other jurisdictions have not exercised their primary taxing right, or payment is otherwise subject to low level of taxation. One of the aims of this proposal is to ensure that all large internationally operating businesses pay at least a minimum level of tax.

The United Nations (UN) has also proposed changes to taxing the digital economy, and during its 21st session, the UN Committee of Experts on International Cooperation in Tax Matters has agreed to add a new, optional article (Article 12B) to the UN Model tax treaty, which would grant taxing rights to jurisdictions where the customers of automated digital services (ADS) are located.

The taxing rights at customer jurisdiction could take the form of a withholding tax agreed to in bilateral tax treaties. The commentary on Article 12B suggest a modest tax rate of 3% or 4%. There would also be the option for the beneficial owner of the income to be taxed on a net profit basis.

In contrast with OECD’s, the UN’s proposal is simpler to understand and easier to administer and could be the right proposal to start off with particularly, but not just, for developing economies. Although the UN’s proposal does not cover the full range of the issue, the complexities of the OECD proposal, particularly in terms of profit allocation, could result in large administrative burdens and costs for digital companies, not to mention double taxation issues.