The global economy is experiencing digital transformation at a blistering pace with the rise of e-commerce. The digital economy permeates all aspects of life including how we eat, sleep, breathe, and communicate.   It has immense impact on the world’s economic landscape touching all industries and sectors from aviation to wholesale trade. The digital economy is also shaping the way companies interact with customers and becoming the backbone of connecting customers to sellers worldwide.

The tax world, too, has also been impacted by these technological evolutions. Domestic tax legislation and international organisations such as the Organisation for Economic Co-operation and Development (“OECD”) have been challenged to keep up with rapid changes in the digital economy. This has, in turn, led to the erosion of the tax base of many jurisdictions as global businesses are able to maintain a profile and sell to customers without the creation of a traditional physical presence in a country. The consequences are:

• minimisation of tax in the source country by avoiding a permanent establishment (“PE”) or by maximising deductions where there is a presence;
• low or no withholding tax at source; and
• low or no tax at the parent level.

The taxation of the digital economy is at the forefront of the debate within the Base Erosion and Profit Shifting (“BEPS”) project. To counter such tax erosive planning, the OECD initiated “BEPS action 1 – tax challenges arising from digitalisation.” The OECD provided several options to help level the playing field with their report in 2015:

• amending the definition of a PE in treaties (possible introduction of a “virtual PE” category, or a “significant presence” test);
• changing the exemptions from PE status;
• application of a withholding tax to digital services; and
• more use of indirect taxes such as value added tax (“VAT”) / good sales tax (“GST”).

The final report emphasises that the digital economy cannot inherently be separated and dealt with independently from the rest of the economy. Also, the comments stated that work undertaken with regards to all the BEPS action points takes into account the problems associated with the key features of the digital economy. Hence the solutions proposed by such action points will also have an impact on action point 1. Specifically, the work and deliverables on the controlled foreign company (“CFC”) rules (action point 3), artificial avoidance of a PE (action point 7) and transfer pricing (action Points 8, 9 and 10) will be relevant.

Additionally, with respect to indirect tax matters, reference is made to the OECD’s international VAT/ GST guidelines which take into account digital issues, particularly with regards to matters including the remote supply of digital goods and services to VAT exempt businesses or to a centralised location for resupply within a multinational enterprise (not subject to VAT).

In direct tax matters, three  main policy concerns are noted:

• nexus (ability to have a presence without being liable to tax);
• data (how to attribute value to the generation of data through digital products and services and how to determine profit share on the basis of this value); and
• how to properly characterise the income within these new business models.

Five years later, countries are growing impatient waiting for a unified or harmonious approach to taxing the digital economy.  They are unilaterally taking matters into their own hands.  In Europe, we see Austria, France, Hungary, Italy, Poland, Spain, Turkey and the UK with their own versions of a digital services tax (“DST”). In Asia, Indonesia, Malaysia, Singapore, Thailand and Vietnam introduced tax on digital service providers. Rcently, Mauritius implemented a new tax in the form of VAT on digital services provided by non-residents in Mauritius, and has recently initiated an e-commerce scheme for the promotion and cater for the domiciliation of electronic platform and their auxiliary services in Mauritius. Digital taxation has strong support in Latin America too where already Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, Panama, Paraguay and Uruguay have DST in play.  Many African countries have introduced DST legislation including, Egypt, Kenya, Nigeria, South Africa, Tunisia, and Zimbabwe. Our friends in North America also have DST and, in the case of the US, a Supreme Court ruling that even permits state taxation on foreign sellers with no physical presence.

Do you think more countries will join the fight against base erosion by implementing tax legislation targeted at companies engaging in digital activities? Or is patience truly a virtue and will countries instead wait for a holistic best practice approach from the OECD?

Discover more