Taxing The Digital Economy

Introduction

As part of the OECD/G20 BEPS project, and in the context of Action 1, the Task Force on the Digital Economy considered the tax challenges raised by the digital economy. The 2015 Action 1 BEPS final report (the "2015 Report") and the 2018 Action 1 BEPS interim report (together, with the 2015 Report, the "Action 1 BEPS Reports") noted that highly digitalised business models are characterised by an unparalleled reliance on intangibles, along with the importance of data, user participation and their synergies with intangible assets.

Following the publication of the Action 1 BEPS reports, the potential tax challenges were debated - particularly in relation to the remaining BEPS risks and the question of how taxing rights on income generated from cross-border activities in the digital age should be allocated among jurisdictions. No consensus was reached regarding how to address these issues but there was a commitment to deliver a final report in 2020, aimed at providing a consensusbased, long-term solution.

Further to the analysis included in the Action 1 BEPS Reports, members of the OECD/G20 Inclusive Framework on BEPS (the "Inclusive Framework") suggested that a consensus-based solution to the taxation of the digital economy should be focused on the: (i) allocation of taxing rights by modifying the rules on profit allocation and nexus; and (ii) unresolved BEPS issues. On 31 May 2019, the OECD published a consensus document entitled "Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy" (the "Programme Report"). The Programme Report emphasises that the way multinational corporations are taxed will need to be reshaped in order to effectively deal with the tax challenges arising from digitalisation. The aim is still that a global, consensus-based solution will be agreed by the end of 2020. The proposals outlined in the Programme Report are summarised below.

Aside from the proposals in the Programme Report, the other BEPS Actions also have a significant impact on the taxation of a digitalised economy. The most relevant BEPS direct tax measures for digitalised businesses include amendments to the permanent establishment definition in Article 5 of the OECD Model Tax Convention (Action 7), revisions to the OECD Transfer Pricing Guidelines related to Article 9 of the OECD Model Tax Convention (Actions 8-10), and guidance based on best practices for jurisdictions intending to limit BEPS through controlled foreign company rules (Action 3). These topics are also explored in more detail below

The EU has also made efforts to find a solution to the tax challenges arising from digitalisation. In March 2018, the European Commission published two proposals to address such challenges. The first was based on a long-term solution that proposed to tax a digital permanent establishment, while the second was a short-term proposal that would apply to revenues created from specific digital activities. However, the EU Economic and Financial Affairs Council failed to reach consensus on a way forward on an EU digital services tax. It is unlikely that there will be an agreed approach in the EU until at least 2020, but the new European Commission President, Ursula von der Leyen, published a manifesto which stated that taxation of big technology companies is a priority, and that the EU should act alone if no global solution is reached by 2020.

Various jurisdictions have also been implementing unilateral national measures relating to the tax challenges arising from the digitalisation of the economy. As examples, French senators have recently approved a temporary digital services tax, and the UK digital services tax will take effect from April 2020. These measures are outlined below

The Programme Report - Digitalisation of the Economy, not the Digital Economy

One of the findings of the Action 1 BEPS Reports was that the whole economy was digitalising and, as a result, it would be difficult, if not impossible, to ring-fence the digital economy. The Programme Report may therefore impact multinational organisations which would not be immediately categorised as "digital businesses".

The Programme Report focuses on two pillars, namely:

Pillar One - Allocation of taxing rights: This pillar details the different technical issues that need to be resolved to undertake a coherent and concurrent revision of the profit allocation, and nexus rules are detailed. Pillar Two - Remaining BEPS issues: This pillar describes the work to be undertaken in the development of a global anti-base erosion ("GloBE") proposal that would, through changes to domestic law and tax treaties, provide jurisdictions with a right to "tax back" where other jurisdictions have not exercised their primary taxing rights or the payment is otherwise subject to low levels of effective taxation The Programme Report also discusses the work to be undertaken in connection with an impact assessment and economic analysis of the above proposals.

Pillar One - Allocation of Taxing Rights

The Programme Report considers the objective and scope of the reallocation of taxing rights across jurisdictions - i.e. the "new taxing right". The technical issues identified in relation to the new taxing right are as follows:

different approaches to determine the amount of profits subject to the new taxing right and the allocation of those profits among the relevant jurisdictions; the design of a new nexus rule that would capture a novel concept of business presence in a market jurisdiction reflecting the transformation of the economy, and not constrained by a physical presence requirement; and different instruments to ensure full implementation and efficient administration of the new taxing right, including the effective elimination of double taxation and resolution of tax disputes. Pillar Two - Remaining BEPS issues

The Programme Report recognises that the measures set out in the BEPS package (explored in further detail below) have sought to align taxation with value creation. However, it was also noted that certain members of the Inclusive...