Piecing together the digital tax puzzle

With the US back at the negotiating table, the OECD is pushing on with ambitious plans for a digital tax framework. But with so many competing voices, can an agreement be reached?

For the world’s digital giants, 2020 was a bumper year.

The seven most valuable technology companies added US$3.4 trillion to their market caps, all but unaffected by the COVID-19 pandemic sweeping the globe.

Amid one of the most punishing economic downturns in history, people and businesses became even more reliant on technology and the tech titans watched the cash roll in.

Apple and Amazon both raked in sales of US$100 billion in the final quarter of 2020 alone, while Google’s parent company Alphabet posted record revenue in two consecutive quarters.

The dominance of the digital giants continues to fuel interest in finding ways to shift profits into the hands of policymakers and allow nations who have a big user base but see little taxation revenue to benefit.

Find more statistics at Statista 

The OECD’s BEPS project has been developing a framework since 2019 to establish new rules to ensure digital giants would pay tax where they do business, even if they lacked a physical presence.

The issue came off the boil as the pandemic took hold but by October 2020, OECD member nations had reinforced an ambitious timetable to reach a consensus by mid-2021 about how to tax multinational digital companies.

Consensus among OECD member nations appeared remote while the United States remained firm in its push for a ‘safe harbour’ provision, which had been championed by the Trump administration since 2019, allowing any global tax agreement on digital companies to be voluntary.

But with a new administration came fresh direction and in February, the US Government’s insistence on the safe harbour clause was dropped, creating renewed hope of unlocking stalled negotiations and securing an agreement.

But getting nations to agree on policies is rarely straightforward.

The European Union was unable to get its own member nations to agree on a single EU digital tax framework in 2019 – and that was without a pandemic to complicate matters. That led member states including France, Spain, Italy and Austria pursuing their own tax, although the EU now has a fresh proposal on the table.

Federal governments have scrambled to fund stimulus measures in response to the virus crisis that had decimated economies.

Global economic decline estimates range between 3 and 4.5 per cent. But among developing nations, the World Bank considers the economic toll from COVID-19 to be more severe than anything endured over the past 60 years.

Can a deal be done?

Aggressive timeline for agreement

Jim Alajbegu, who leads the Baker Tilly US’s international tax services team from New York, says the Biden administration has made it clear that rebuilding infrastructure at home is the priority. But the decision to re-join discussions with the OECD on digital tax fits within the President’s broader agenda of strengthening US alliances and re-engaging on multinational endeavours.

“This will be a welcome change for the OECD, which was facing considerable resistance from the Trump administration on certain elements of the digital tax initiative,” he says.

“It is really opening the door for US buy-in on an OECD plan on digital taxation, and quicker implementation. Ultimately, there will be an agreement and I think that it will certainly transform the global approach to transfer pricing and to global expansion.”

However, noting the OECD’s mid-2021 deadline for a political agreement and implementation proposed for early 2022, he believes this timeframe may be too ambitious.

“Given the current circumstances with all countries dealing with the pandemic, and economic stimulus plans that we’ve implemented here in the US, and other countries having their own stimulus plans, I think political agreement in May 2021 is aggressive.

“An agreement perhaps in late 2021, or early 2022, is more likely and implementation in either late 2022, or 2023, may be more likely as well.”

Last year, the European Commission joined the ranks of jurisdictions proposing or implementing a digital levy. It plans to legislate its tariff by June 2021 and put it into effect by 1 January 2023 as a temporary measure until an OECD-endorsed policy is in place.

The EC’s proposal includes a rate of 3 per cent on revenues derived from online advertising services, receipts or income from digital intermediary activities, and sales of user-collected data. It would apply to businesses with annual worldwide revenues exceeding US$915 million (€750 million), and taxable revenues within the EU exceeding $61 million (€50 million).

But Jose Pedro Goncalves, a partner at Baker Tilly Portugal, says the issue of digital tax isn’t anywhere near the top of the current political agenda.

“In Portugal, we are not very concerned right now with those issues, we are more concerned with the COVID-19 problems that we have here,” he says.

Ines Paucksch, a tax partner with Baker Tilly Germany and head of the Global Corporate Tax Development Team, says any notion of increasing or raising taxes would not be welcome while waves of the pandemic continue to wash over EU nations.

“They will go back to this discussion, because all the money spent during the pandemic needs to be funded at a later stage.”
– Ines Paucksch

But given the vast sums that governments have borrowed to fund stimulus packages, it is inevitable that measures to raise additional tax revenue will be part of discussions when the threat eases.

“They will go back to this discussion, because all the money spent during the pandemic needs to be funded at a later stage,” she says.

“We will have to discuss VAT rate increases, additional corporate tax issues, and probably also this digital tax, because 3 per cent of a huge turnover is quite a nice sum to fund the costs of the pandemic.”

The US Government remains opposed to individual nations moving early on digital services taxes, including the EU’s proposal, and Mr Alajbegu says it was ultimately the consumer that would bear the costs.

“Both the Trump and the Biden administrations oppose countries going it alone and the companies affected, like Amazon, are going to be passing on that cost,” he says.

“At a time of global pandemic, and a time where countries and consumers are struggling to make ends meet, I don’t think an additional levy, whether it’s from the digital giants or from any other companies that are impacted by this digital service tax, is something that is appropriate at this time.

“A unified approach by the OECD and the EU, and the US, is much more powerful to a productive business environment, rather than this levy sort of being enforced unilaterally.”

Finding the investment sweet spot

The European Union’s proposed broad sweeping measures contrast with the UK’s more targeted tax policies that came into effect last year.

“The UK’s digital services tax was aimed at social media, internet search engines, and online marketplaces, it’s very specific in terms of the revenues that it’s trying to target,” says Chris Denning, Corporate and International Tax Partner at MHA Macintyre Hudson.

“We’ve also got a diverted profits tax, initially labelled the “Google tax”, that was introduced because companies such as Google are deriving billions of pounds worth of sales in the UK and paying very little tax because they sell in the UK through a non-UK based company.”

Nations that have introduced a digital services tax sought to target different sectors. Austria, for example, only looks at digital advertising, while Turkey’s levy covers digital content as well as advertising, intermediary activities, and sale of user data.

Therein lies one of the biggest issues with a global digital services tax – getting countries to agree on one model. Nations are making tax decisions based on politics and, says Ms Paucksch, the political atmosphere can easily change.

“In Germany, there is not yet an agreement about how to go forward, which is why Germany did not move as France and other nations did to implement its own tax,” she says.

“In February 2021, the Federal Government stated that they are of the opinion that the Inclusive Framework on BEPS is the best platform to develop a global solution. Different national solutions on the digital tax do lead to fragmentation, bureaucratic burdens and the risk of either double taxation or non-taxation. Therefore they prefer a globally agreed on solution that will be implemented in the EU subsequently on a joint basis.

“In addition we are facing the elections for the Federal Parliament and a new federal chancellor by the end of September 2021.”

Patrick Van Leeuwen, senior manager, tax advisory at Baker Tilly Netherlands, says achieving a balance between encouraging investment and generating revenue is challenging.

“The Dutch government is supportive of the OECD BEPS project. But at the same time, as we are a small and open economy. We must make sure that if it’s implemented, it’s implemented in such a way that it doesn’t hurt the economy too hard, and we can still attract business. And that’s quite a difficult balance to be found,” he says.

Portugal is another small economy that has spent considerable time and resources trying to attract investment from digital companies.

“We need more tax here, we are a little country, and we need the investment from international companies, we need that new business,” Mr Goncalves says.

Mr Van Leeuwen says the OECD’s policy does not create any new taxing rights, it simply relocates them.

“If it is incorporated into international tax systems, then there will be jurisdictions that will lose. If others win, there should be some losers as the overall pie isn’t increasing,” he says.

“But by not going for that situation, and everybody having its own digital protection implemented based on service taxes, on the percentage of sales or whatever, we’ll create more double taxation, which might harm economies further, and also your international competitiveness.

“If you consider that it only redistributes profits, the ones that are hit by it shouldn’t be hit that hard that they run away, because then the whole model loses its effectiveness.

“That’s one of the main take-aways, but that’s a political discussion. To get it up and running and keep everybody aligned, I think that’s one of the most important issues to be considered.”

Facing the new business world

The rise of the digital economy presents the most disruptive and difficult challenge currently faced by the international taxation framework. 

Mr Denning says the central tenet to any policy should be cultivating an environment that creates the economic activity from which to derive tax revenue.

“The conversation should move away from a pure rate discussion,” he says.

“Much of what we’re talking about here is driven by the politics behind it, but also by the media. The media get companies in their sights in terms of, ‘you don’t pay enough corporate tax’ and then we’re looking at brand reputation, corporate social responsibility policies and the like.

“At the moment, large multinationals are wrestling with all of the compliance obligations that they have across all the jurisdictions in which they operate.

“At the same time, they are concerned about whatever they do and how that might be perceived within the local media and how that could impact brand reputation. It’s moving away from the pure effective tax rate.

“Going back to my early days in tax, companies were driven by making sure they had a low effective tax rate to get the best return for shareholders.

“But the world’s moved on and corporates recognise that their shareholders are just one stakeholder. They recognise they have responsibilities for their communities, consumers, customers, suppliers, the environment and so on. We’ve moved away from aggressive tax planning.”

Ms Paucksch says it’s not only a discussion about fair taxation when it comes to digital services.

“It’s also a discussion about which industry might be more ’important’ and how competitive is this industry and how powerful this industry is allowed to be,” she says.

“And that makes it quite difficult to find a solution where several countries can agree on.

“The challenge that we are all facing is that the existing tax system is more or less related to the ‘old industries’, and the traditional way of doing business.

“We have now a situation that this tax system does not fit perfectly to the ‘new industry’, the digital industry. And the difficulty is to find a way to tax this new system without forgetting the ‘old system’.”

Despite the challenges, Mr Alajbegu believes an agreement can be reached.

“Ultimately, there will be an agreement and buy-in from the US and that will transform the global approach to transfer pricing and to global expansion,” he says.

“It may hurt lower developed countries or new markets and there will be less incentive for larger multinationals that operate in western countries to perhaps expand into local markets.

“However, there will be a baseline that is achieved and as a result, there will be support, not only from the US, but from all the OECD countries, and as well as emerging countries around the world, which will be a critical element to the ‘new business model’.

“I emphasise that term ‘new business model’, because we’re not only defining that in the tax world, but I think companies are also struggling to define that in the new age of digital, and how they fit into that new age of digital.”