Making sense of tax systems in a digitalised world

How do we develop a global tax system that takes into account business innovation and the digitalised economy, yet is fair to all stakeholders? It’s a debate world governments continue to grapple with as they consider radical reforms to adapt century-old tax rules to the 21st-century digital economy.

It’s also a question we put to Michael Lennard, Chief of International Tax Cooperation and Trade in the Financing for Development Office (FfDO) of the United Nations. His personal perspective includes taking a more holistic approach to defining and making sense of global tax system reform ideas.

Providing solid foundations to move the debate forward is vital. A good starting point is to agree on the very essence of a taxation system that applies whether you are a developing country; a developed super-power; a big tech giant or a family business. Consensus on this can create a set of standard ‘guiding principles’ to convey the spirit of what governments are looking to achieve from a modern tax system and the consequences for companies.

Take a fresh look at tax rules

Achieving global consistency on what now constitutes economic engagement in the light of technology-enabled business models can be more productive than assessing a company’s physical connection to a country as a test of economic engagement currently defined by permanent establishment (PE) rules. It’s about looking at what’s in our tax toolbox that can be applied or adapted to ensure that the digitalised economy’s beneficiaries pay a fair amount of tax that does not rely on having a physical presence.

Often when we discuss the digitalised economy, we refer to ‘new’ taxing rights. Yet international economic law already gives comprehensive taxing rights and the ability to tax companies based on their digital commercial presence in a country in various ways. One stumbling block is that tax treaties currently in place between states to prevent double taxation problems have also have the effect of limiting a country’s taxing rights. So it may be a question of looking at it as an allocation issue, rather than focusing on new taxing rights.

Tax uncertainty is a further issue. We currently have a plethora of unilateral, bilateral and multilateral tax agreements in place around the world. At their heart, they seek to address an approach to taxing international companies based on protocols and agreements that, in many cases, do not fully take account of new business models. Creating an improved level of tax certainty – either in parallel to, or by amending, existing treaties – recognises ‘digitalised’ and ‘bricks and mortar’ models in a fair way.  It should also treat the needs of taxpayers, governments of developed and developing economies and other stakeholders appropriately.

Consider balance, flexibility and simplicity

A key challenge as businesses increasingly adopt a more digitalised operating model, is getting the right balance of technical involvement to achieve political tax requirements and close loopholes. Achieving this balance is based on a shared language and understanding of tax rules that are fair to both digital and non-digital business models. At the same time, there’s the need for flexibility to cope with situations such as COVID-19. Ensuring countries have mechanisms to quickly implement temporary emergency tax measures that support all businesses and individuals in periods of high economic stress will be a key ongoing challenge in the future.

Achieve the right engagement

One of the fundamental changes brought about by digitalised business models is the instant removal of borders. Therefore, it is more important than ever that the international tax community places increased importance on how we communicate and engage in the complex tax issues involved in such a transformational period. Engaging with a broader range of experts including professionals and academics from additional disciplines such as sustainability and economic development can often give a different perspective and remove the inevitable industry bias that can build up when interests are too aligned.

As the digital economy transforms business models, having a continual multi-stakeholder and multi-disciplinary dialogue on new ideas can only help in creating a modern tax system that meets the needs of all and not just the few.

Read the full version of Michael Lennard’s A Tax Playbook for the Digitalised Economy (Part 1) and (Part 2).