By: Diane Ring
Complaints regarding the international tax system’s ability to handle the digital economy (think Google, Amazon, and a myriad of online service providers) are now ubiquitous. The heart of the problem is two-fold: (1) technology allows these corporations to effectively conduct business in a country without a physical presence there, and (2) much of these businesses’ value derives from intangibles whose value can be difficult to document.
The first reality limits a host country’s ability, under current law, to assert jurisdiction to tax the businesses. The second means that for core transactions by these businesses, such as licensing intangibles to related parties, it can be very difficult for the tax authorities to guarantee that the transactions are at arm’s length prices (and not shifting profit into low tax jurisdictions). The topic is pervasive enough to have merited its own Action Item in the ongoing OECD BEPS Project (Base Erosion and Profit Shifting).
However, a real, coordinated global response has been much harder to secure. This week, the European Commission (EC) made its most recent foray into the debate with a Communication from the Commission to the European Parliament and the Council. But the EC was not just talking to European Union (EU) bodies; it was directly speaking to the OECD and EU member states. What exactly is the EC’s goal with this Communication?
Bottom line the EC seems to have several intersecting objectives: (1) clarify the problem, (2) identify and prod global actors, (3) delineate proper approaches, and (4) warn about the implications of nonaction.
First, the Communication emphasizes the seriousness of the international tax problems posed by the digital economy and the need for a response.
Second, the EC explicitly urges the OECD to take meaningful steps in addressing the digital economy, with specific pressure on the OECD to demonstrate this forward progress in its interim report to the G20 expected in early 2018. Relatedly, the EC advises the EU to work contemporaneously on the digital economy, but argues against individual country action. Plainly, in the view of the EC, a coordinated global response to the digital economy is the first best option.
Third, in addition to the expectation that coordinated global action is preferred, the Communication outlines a strategy for the EU, noting the potential benefits of the Common Consolidated Corporate Tax Base proposal (which I’ve previously blogged) as a tool in the efforts to tax the digital economy appropriately.
Finally, the EC notes that failed efforts on a global level should not deter or delay EU-based plans. Moreover, if the EU struggles to achieve more comprehensive reform, a variety of short-term measures (for example, an equalization tax on turnover of digital companies, withholding taxes on digital transactions, or a separate levy on revenues from transactions with customers based in the jurisdiction) are possible that could ensure some taxation of digital economy, even if that taxation is imperfect.
Clearly, the EC wants action, wants action globally, and wants the EU to be ready to step in should that global action not materialize. Lurking in the background is the reality that individual countries will otherwise take unilateral action on the digital economy, creating conflicts and potentially delaying more united action.
What will happen? Unclear. Some benchmark moments lie ahead (such as the OECD report to the G20) that will further illuminate our short-term prospects. Ultimately, much turns on the degree to which countries can be persuaded to see a common interest in a shared resolution, and to believe that such a resolution is indeed preferable to a patchwork of individual action. Does the leadership exist to corral vastly different countries and economies into a single vision of reform on taxation of the digital economy? Does it help or hurt that the challenges posed by digital businesses (those driven by technology and intangibles) are not wholly unique to purely digital businesses in today’s economy, but now reach into more traditional sectors?
One potentially positive sign: a widespread appreciation for the impact of business practices typified by the digital economy on international taxation. This stands in contrast to a few years back when some major international tax players continued to argue that talk of tax reform for the digital economy was like “law of the horse” – an unnecessary attempt to view a new activity as a separate area of law. Experience suggests that while we may be able to cram the digital economy into our existing rules on jurisdiction-to-tax and pricing, the results may prove deeply unsatisfying and ultimately drive jurisdictions to adopt ad hoc responses that complicate international taxation.