Taxation of digital activity – reactions in various jurisdictions

Tue 10 Jul 2018

There has been a lot of discussion and consultation, both nationally and internationally, on how digital activity should be taxed. This article is the second of three, providing a brief summary of the position as at June 2018 and links to those within Mazars able to help businesses prepare for coming changes.  This article provides information on how different jurisdictions are reacting to the issues.

How different jurisdictions have reacted to the proposals

Some jurisdictions have already implemented defensive measures to protect their tax base from perceived erosion from business being conducted digitally.

• Israel introduced a significant economic presence test in April 2016 which considers tests such as whether there are: a significant amount of contracts with Israeli customers for internet activity; a significant amount of Israeli customers using the digital service; whether the online service is adapted for use by Israeli customers (for example by using Hebrew language and currency); the level of internet activity by Israeli customers and correlation between use by Israelis and payments to foreign entities.
• The Slovak republic has an expanded definition of a fixed place of business for foreign businesses, where their online platform offers transport or accommodation services in Slovakia.
• From April 2019 India will apply a significant economic presence test to determine whether an online service provided by a non-resident in India, means the non-resident has a permanent establishment (PE) in India.  It will apply where either transactions in respect of goods/services/data in India exceed a threshold for the previous year, or where there is a systematic or continuous soliciting of business activity or users in India by digital means.  A foreign entity meeting either of these tests will have a PE in India, regardless of whether they have any physical presence in India.

This digital PE rule will not be effective in cases where the foreign entity is located in a country with which India has a tax treaty. The definition of PE in each tax treaty would require amendment for rule to be applicable.

The EU digital revenue tax of 3% of turnover is proposed to apply from 1 April 2020.

• It would apply for businesses with worldwide revenues > €750m and EU revenues exceeding €50m.
• The tax would be due in the member state where ‘value is created’ (where the users are located)
• There would be a formulary apportionment of tax between members states based on: the number of times advertising has appeared on users’ devices; the number of users who conclude transactions on an online platform; and the number of users from whom data is collected.
• There would be relief from corporate income tax by deduction of the revenue tax against profits.

For a business making a profit before tax of 15% of turnover without the revenue tax, the introduction of a revenue tax of 3% of turnover would reduce that profit from 15% to 12%. At this level this in effect represents a further tax on profits of 20%, so that if the tax rate was 20%, the total tax on what was profit of 15% of turnover would be 36%. Businesses within scope which are loss making would have to pay the revenue tax unless some relief, or an exemption was applied.  One aspect of a revenue tax is that it does not take account of costs required to generate the revenue.

The EU also discussed in March 2018 proposals for a digital PE, with the aim of taxing profits generated by businesses providing certain digital services and those having a “significant digital presence” within each Member state. This proposed approach builds on the existing PE concept and covers any digital platform (i.e. website or mobile app) that meets on of the following criteria: revenue >€7m; annual users >100,000 or has online contracts concluded with users in a member state >3,000.

The digital PE definition would apply to EU residents and to residents in non-EU jurisdictions without a double tax treaty (DTT). It would not apply to non-EU residents in a jurisdiction where there is a DTT in place with the relevant EU member state. The proposed rules on profit allocation appear to be based on the current OECD framework applicable to PEs, with profit split listed as the preferred method.

The US is opposed to any revenue tax and wishes to wait for an international consensus. More recently the US Supreme Court has overturned a long standing precedent concerning US State sales taxes applicable to businesses without a physical presence in the State in a case concerning South Dakota and Wayfair.  Whereas previously there could be no collection of this tax from those businesses making sales in a State unless they had a physical presence there, following the Supreme Court decision States can now require businesses without a physical presence to register and pay the State sales taxes on their in-State sales.

The State Sales tax may be considered in a similar way to VAT in the UK. In Dakota there is a $100,000 turnover threshold before which the tax applies.  In the UK and the EU he turnover threshold for VAT is currently under review but for UK purposes, there is a zero threshold for non-resident businesses selling to UK retail customers.

The US Supreme Court decision makes some interesting comments on whether there is a need for physical presence to generate a liability to the sales tax, concluding that in the 21^st century, basing liability to tax on a requirement for physical presence is inappropriate.  How far this approach will be applied to other taxes, whether in the US or elsewhere we will need to wait and see.  However it seems very likely that there will be some refinements to the requirement for physical presence tests applicable to other tax areas.

Reactions of EU member states other than the UK to the proposed EU digital revenue tax

Normally on tax measures, all member states would need to agree. It may be feasible (though a longer process) for the EU to get approval for a digital revenue tax via qualified majority voting. This requires a majority of the member states (more than 50%), and the votes of member states representing 74% of the voting rights, and the votes of member states representing 62% of the population.  Another alternative is for those states wishing to proceed on a measure, to invoke enhanced cooperation using ordinary legislation – which requires unanimity from those proposing the measure and consultation of the European Parliament.

If the EU delays in concluding or going ahead with its digital proposals, some countries have already indicated how they will react.

• Italy, Hungary, Austria, Spain already have legislation ready to apply if the EU does not approve a Directive.
• France and Portugal have indicated they will act if the EU does not.

France and Germany in their 19 June Meseberg declaration have indicated that they intend to “..reach an EU agreement on a fair digital taxation by the end of 2018…”. This is in addition to their declaration to converge their position on corporation tax and specifically the application of the common corporate tax base on which they have issued a position paper.

Member States which are opposed to a revenue tax include Denmark, Finland, Sweden, Ireland, Luxembourg and Malta.

The other articles in this series cover the background and the UK reaction and business considerations.  For further discussion of the issues and how Mazars can assist, please get in touch with a member of the Mazars international tax team.