Taxing the Digital Economy

There have been a number of significant recent developments in international corporate tax relating to the taxation of the digital economy.  In March 2018 the UK’s HMRC published a position paper update recognising that the participation and engagement of users (e.g. social media users such as those on Facebook, Twitter or Instagram) is an important aspect of value creation for certain digital business models.  Such participation can result in value creation through various channels, e.g. contribution to content or enhancement of IP or brands and therefore a legitimate basis for taxation.

On 21 March 2018, the European Commission proposed new rules to ensure that digital business activities are taxed in a fair and growth-friendly way in the EU.  The EC set out a Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence.

The EC maintains that today’s international corporate tax rules are not fit for the realities of the modern global economy and do not capture business models that can make profit from digital services in a country without being physically present.  Current tax rules also fail to recognise the new ways in which profits are created in the digital world, in particular the role that users play in generating value for digital companies.  As a result, there is a disconnect – or ‘mismatch’ – between where value is created and where taxes are paid.

In the digital economy, value is often created from a combination of algorithms, user data, sales functions and knowledge. For example, a user contributes to value creation by sharing his/her preferences (e.g. liking a page) on a social media forum. This data will later be used and monetised for targeted advertising. The profits are not necessarily taxed in the country of the user (and viewer of the advert), but rather in the country where the advertising algorithms has been developed, for example. This means that the user contribution to the profits is not taken into account when the company is taxed.

The European Commission has made two legislative proposals:

  • The first initiative aims to reform corporate tax rules so that profits are registered and taxed where businesses have significant interaction with users through digital channels. This forms the Commission’s preferred long-term solution.
  • The second proposal responds to calls from several Member States for an interim tax which covers the main digital activities that currently escape tax altogether in the EU.

The legislative proposals will be submitted to the Council for adoption and to the European Parliament for consultation. The EU will also continue to actively contribute to the global discussions on digital taxation within the G20/OECD, and push for ambitious international solutions.

There have been recent developments at the OECD also.  On 16 March 2018 the OECD released “Tax Challenges arising from Digitalisation – interim report 2018” which was presented to the G20 meeting.  This interim report of the OECD/G20 Inclusive Framework on BEPS is a follow-up to the work delivered in 2015 under Action 1 of the BEPS Project on addressing the tax challenges of the digital economy. It sets out the Inclusive Framework’s agreed direction of work on digitalisation and the international tax rules through to 2020. It describes how digitalisation is also affecting other areas of the tax system, providing tax authorities with new tools that are translating into improvements in taxpayer services, improving the efficiency of tax collection and detecting tax evasion.

The linked articles in this section paint an interesting picture of how tax rulemakers are chasing events in the digital economy which keeps moving at break-neck speed.