The clash between internet freedom and the need to tax
As legislators still struggle over taxation at the crossroads of brick and virtual economy, all eyes are on the Organisation for Economic Co-operation and Development (OECD) and its work on “Base Erosion and Profit Shifting (BEPS)”. The OECD Digital Economy Task Force has taken up the first of all together 15 of the BEPS action items, in order to “address the tax challenges of the digital economy”. The final recommendations that could include proposals to update the OECD Model Tax Convention will be published in September 2014, in time for the meeting of G20 finance ministers in Cairns, Australia.
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How to deal with growing cross-border business-to-consumer (B2C) internet sales and services, or with tax revenues from cloud or hosting services? These are the questions governments feel increasingly compelled to address. Not to mention issues like how to tackle reinventions of payment and whole money systems, for example Bitcoin.
Tax optimisation through the iTax model
The “tax optimisation” strategies of large multinationals, including the digital giants Amazon, Apple and Google have resulted in investigations at the national and EU levels. Schemes like Apple's “iTax”, as Australian economist Antony Ting described it, has allowed the company to shelter 44 billion US dollars between 2009 and 2012 from taxation anywhere in the world.
The Irish Financial Portal Finfacts in its contribution to the BEPS digital economy consultation warned:
In the period since, services exports surged and by 2013 we estimate that at least € 45bn ($57bn) or 48% of Ireland’s reported services exports of € 94bn in 2013 are tax-related - arising from diversions of global revenues to Ireland that are unrelated to economic activity in Ireland.
Proceedings over tax exemptions helping iTax-models have been started against three EU countries, Ireland (Apple), The Netherlands (Starbucks) and Luxemburg (Amazon and Fiat Financial Services).
“Others will follow”, said the designated EU Commission President, Jean-Claude Juncker, when he introduced himself on 9 July to the Green Party Group in the EU Parliament. Juncker said he intended to leave the proposal on a common tax base for corporations in all of Europe on the table and continue the work on a financial transaction tax.
"We would try to put some morality and ethics into the European tax landscape so that the governments do not become the victims of tax competition which is sometimes unfair,” the former President of Luxembourg promised. He would, he said, “like to see profits taxed where they are made."
One way to evade tax is for example to sell intangible property, like patents, to a subsidiary in a low tax country and make the mother company pay high licensing fees to the subsidary - which reduce the taxable income there.
BEPS, first steps and warnings
The EU finance ministers in fact made a first move by passing in their first session of the new legislature an amendment to the EU parent-subsidiary directive. The amendment according to the statement by the Italian presidency would “prevent cross-border companies from planning their intra-group payments so as to result in double-non-taxation”. The member state in which the parent company is registered will in the future only exempt profits from taxation when these profits will not have been made by a subsidiary who by transferring them is eligible for tax reduction for the very same profits. The move was a first along the line of the BEPS action items, a Council of Ministers spokesperson explained.
Four options for potential direct taxation have been put on the table by the Digital Economy Task Force:
modifications to the exemption from permanent establishment status, obliging companies to get that permanent establishment status,
a new tax nexus based on significant digital presence, to link taxation to profits made by digital companies in a market where they do not have a permanent establishment,
the creation of the status of a virtual permanent establishment, a new form of permanent establishment for digital activities, and/or
the creation of a withholding tax on digital transactions.
The introduction of the status of a virtual permanent establishment or classification of a significant digital presence and the special withholding tax for digital transactions were especially criticised. They were, German software service and cloud vendor SAP sais, “not appropriate to distinguish traditional activities from digital activities, lack legal certainty, would significantly increase the administrative burden and also lead to significant double taxation.”
Much sharper criticism of the potential special treatment for the digital economy were filed by Baker & McKenzie on behalf of the digital giants (calling themselves the “Digital Economy Group”): not only, they wrote, the BEPS Digital Task Force had mis-characterized the digital economy – by underestimating its operation costs compared to traditional industry, and overestimating for example the problem of mobility of intangibles – the measures were contradictory to the broadly shared admission that the digital economy could not be ring-fenced from tax rules and violated several older E-commerce principles, passed by the OECD member states in Ottawa 1998, namely neutrality, flexibility, simplicity and effectiveness.
The fight for data
The Digital Economy Group further threw shells at one particular idea: that of value, in other words, the taxable asset nature of data. Data collections were nothing new, the group’s lawyers underlined, pointing to data collection by customer-facing enterprises in other industries or by adverstisers using data to establish target audiences.
The statements about data in the consultation point to a much broader, and somewhat more hidden point, which Amcham, the American Chamber of Commerce, presents nicely in its consultation contribution. The Amcham experts warn that using location of data or intellectual property as a key criterion for taxation “could have the unintended consequence of generating a wave of forced data localisation.”
For Amcham, potential ring-fencing of data flows - “which have been discussed as potential means to implement a data tax”, “would create barriers to crossborder commerce”. Free flow of data is in fact very high on the agenda of all ongoing trade talks of the US.
The clash between internet freedom and the need to tax, visible in most countries, according to Pierre Sauvé, Director at the World Trade Institute in Bern, is finally approaching the day of reckoning. “We have to tax”, Sauvé is convinced, but he also considers it highly possible that countries would come to the conclusion that “the only way to tax is, if the server is in my territory.” Certainly it is more complicated that that, the academic said, but in the political debate, that complexity is sometimes lost.