OECD interim digital report

Fri 23 Mar 2018

The OECD has released an interim report on the tax challenges arising from digitisation.   The report is a useful summary of the present state of play and the issues involved.  It covers the following main areas:

• A summary of how digital business models work (including examples based on Google/Facebook, Amazon and Uber).  It suggests that of three value creation models (value chain, value network and value shop) the ‘value network’ concept is generally likely to be more suited to identifying where value is created for these business models.  The value network concept involves three primary activities: network promotion and contract management; service provisioning; and network infrastructure operation.  There are additional traditional support services involved.
• The impact and stage of implementation of the BEPS package; indicating the various measures are already having an effect on reducing problems with the existing international tax system, but that it will be some time before the full impact can be assessed.
• An examination of how certain jurisdictions have already or are taking action to deal with perceived under-taxation of digital activity.  There are four main categories of tax policy action in this area:
  1. Alternative applications of the PE threshold – examples include Israel and India’s ‘significant economic presence’ test.  Israel’s test looks at a range of digital factors and has no turnover threshold.  India’s test applies to non-resident enterprises and applies thresholds based on local revenue and numbers of local users
  2. Withholding taxes – this seeks to assert taxing rights where there is no physical presence in the jurisdiction and can be in the form of: broadening the scope for royalty withholding, and withholding on fees for technical services.  An example could be the proposed UK extension to withholding on royalty payments made by non-UK residents.  Problems with these issues include the risk of re-characterisation and the fact that while these may have been brought in to domestic law in some jurisdictions, there have yet to be amendments to double tax treaties.  While these measures are easy to apply to ‘business to business’ transactions, they may be more difficult to apply to private consumers.
  3. Turnover taxes – these include examples like India’s equalisation levy on online advertising, Italy’s levy on digital transactions, Hungary’s advertising tax and France’s tax on online and physical distribution of audio-visual content.  They are not all targeted exclusively on digital activity.  Recognition is given to the fact that more countries are likely to implement such taxes (there is reference to the EU proposals) before a global consensus is reached.
  4. Specific regimes to deal with large MNEs – these include examples such as the UK and Australia’s diverted profits tax and the recently introduced US BEAT (base erosion and anti-abuse tax).  These are not specifically targeted at digital businesses, some situations at which they are targeted are relevant for digital business models.

There is a recognition that until a global consensus can be reached, these sorts of initiative are likely to result in increasing levels of distortion, double taxation, increased uncertainty and complexity and possible conflict with bilateral tax treaties.

• There is discussion of the fact that the current international tax system is based on intensive use of tangible assets and labour that were relatively immobile, and therefore strongly routed in physical presence requirements.  Digitalisation presents difficulties with applying nexus (due to reduced reliance on physical presence), such as what value to ascribe to data and how to characterise it for tax, and the proper characterisation of payments for digital products, particularly cloud computing.  There are three broad categories amongst jurisdictions on how to deal with these issues:
  1. Those who believe digital business models create specific issues that are not dealt with by the current tax system, leading to a need for targeted changes to existing tax rules and a reconsideration of profit allocation and nexus concepts.  They are broadly supportive of the existing tax system;
  2. Those who are concerned with the range of digital businesses able to involve them in a market jurisdiction without a physical presence with little tax being levied.  They suggest two areas need reform (a) profit allocation needs to be amended in view of non-physical and mobile value drivers and (b) a refinement to the nexus concept to place less reliance on physical presence.
  3. Those who believe the BEPS package needs to be given more time to settle down.

There are those in both the second and third categories on both sides of the view that data and user participation create value in the user’s jurisdiction (i.e. those that are of this view and those that are not).

This section of the report identifies further work for the OECD as involving further analysis of the value creation characteristics of digitalised business models with a view to understanding the impact on any revision to existing nexus and profit allocation rules. An update is to be provided in 2019, working towards a consensus based approach by 2020.

• A discussion of interim measures, and how these should ideally be designed to be compliant with international obligations;
• There is a discussion of how digitalisation is affecting the tax system beyond the international tax system such as driving growth and revenue, but also how tax authorities can take advantage of digitalisation to improve education on tax and improve tax collection methods

US reaction to the digital report

The US Treasury secretary’s reaction to proposals for interim taxes issued on the same day as the OECD interim digital report can be found at the following link.  He comments:

“The U.S. firmly opposes proposals by any country to single out digital companies. Some of these companies are among the greatest contributors to U.S. job creation and economic growth. Imposing new and redundant tax burdens would inhibit growth and ultimately harm workers and consumers.  I fully support international cooperation to address broader tax challenges arising from the modern economy and to put the international tax system on a more sustainable footing.”

To discuss tax developments affecting digital business operations, please get in touch with a member of the Mazars international tax team.