As we reported in our most recent “digital economy” update in December 2017, digital taxation has raised everlasting debates at the international level and become part of the OECD Base Erosion and Profit Shifting (“BEPS”) package discussions. The OECD calls for a growth-friendly reform stemming from a global consensus and scheduled an interim report to the G20 for April 2018. Whereas an internationally agreed-upon solution remains preferable, the European Union (EU) is tempted to implement temporary measures while waiting for a global consensus. The EU Commission was expected to move forward with legislative proposals by early 2018.
As planned, the OECD and the EU have now published their positions—the OECD, earlier than expected, in the form of an interim report published on March 16 and the EU with two draft directives published on March 21.
The OECD Position
The interim report from the OECD highlights the current lack of consensus among the OECD Inclusive Framework members. According to the OECD, members agree to undertake a coherent review of the “nexus” and “profit allocation” rules, which are the basis for determining an enterprise’s profit subject to taxation in a given jurisdiction. However, divergent views among the members necessitate further work toward a long-term consensus-based solution. The final report is planned to be delivered by 2020, with an interim report to the G20 in 2019. It is worth noting that there is also no consensus among the members on the need for, or the merits of, interim measures.
The EU Position
The EU Commission proposals aim to address a perceived fiscal distortion between the “traditional” business and digital companies “such as social media companies, collaborative platforms and online content providers.” The draft directives suggest both a long-term solution and a quick fix (in the form of interim measures).
The long-term measure, the “Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence” aims to define a "significant presence" in an EU member state. This virtual Permanent Establishment (PE) would allow a member state to tax the allocable profit when the enterprise meets at least one of the following criteria:
- It exceeds a threshold of €7 million in annual revenues in a member state.
- It has more than 100,000 users in a member state in a taxable year.
- Over 3,000 business contracts for digital services are created between the company and business users in a taxable year.
This long-term solution is raising questions such as how to allocate profit to the virtual PE. If adopted, this directive would supersede the tax treaties concluded among the EU member states. It would, however, have no impact on tax treaties between an EU member state and a third country (at least as long as the tax treaty is not re-negotiated).
The short-term measure, the “Proposal for a Council Directive on the common system of a digital services tax (Digital Tax) on revenues resulting from the provision of certain digital services” works as a kind of excise charge, outside of the scope of tax treaties. The tentative rate is set at 3%.
The EU Digital Tax would, if adopted, apply to revenues created from activities where users play a major role in value creation, which are the hardest to capture with current tax rules. This is the case, for example, with revenues created from:
- Selling online advertising space
- Digital intermediary activities, which allow users to interact with other users and which can facilitate the sale of goods and services between them
- Selling data generated from user-provided information
Tax revenues would be collected by the member states where the users are located and only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million.
The thresholds are designed to keep smaller start-ups and scale-up businesses out of scope.
The interim measure also intends to prevent unilateral measures to tax digital activities in certain member states, which would be damaging to the EU Single Market. Italy's 2018 Finance Bill already includes a new 3% Web Tax, effective January 1, 2019, and the UK published a position paper in November 2017 targeting the value attributable to user participation through a deemed PE.
The lack of consensus at both the OECD and the EU levels is a major obstacle for implementing interim measures. Indeed, based on the EU rules, harmonization in the field of tax law requires a unanimous decision by all member states, which is unlikely to happen given the current state of play.
The most impatient EU member states may nevertheless attempt to invoke the enhanced cooperation procedure, according to which nine member states could introduce a tax measure limited to their jurisdictions. As of today, there has only been one attempt to initiate this procedure in the field of tax law, which was in relation to the introduction of the so-called "financial transactions tax."