The Silicon Valley Tax Directors Group (SVTDG) submitted its response in October 2017, as part of the request for comments to the Final Report on BEPS Action 1, Addressing the Tax Challenges of the Digital Economy published by the OECD’s Task Force on the Digital Economy (TFDE) in 2015.
The 2015 Action 1 Report acknowledged that it was not desirable or possible to “ring fence” the digital economy from the rest of the economy for tax purposes because of the increasingly pervasive nature of digitalisation. The SVTDG accepted and applauded this view of the TFDE.
To address the broader tax direct issues raised by digitalisation, the TFDE had explored three options in their Report:
(1) A new nexus rule in the form of a “significant economic presence” (SEP) test;
(2) A withholding tax that would be applied to certain types of digital transactions; and
(3) An equalisation levy , intended to address the disparity between foreign and domestic businesses where the foreign business had a sufficient economic presence in the jurisdiction.
Although none of these options were recommended in the 2015 Action 1 Report, it was left to individual countries to introduce any of these options in their domestic laws or bilateral tax treaties. Indeed this has manifested in the form of similar options in the European Commission’s Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence as well as an EC interim tax on digital revenues derived from user-participation on digital platforms above certain thresholds.
The SVTDG main comments on the three OECD options raised above would be as below.
(1) The Significant Economic Presence (SEP) test
The SVTDG does not believe there is sufficient policy justification to support the allocation of more taxable income to a jurisdiction on remote sales than would be recognised through a limited risk distribution channel. The SVTDG believes “meaningful income” cannot easily to attributed to a SEP permanent establishment under the arm’s length principle for a PE without physical presence. Therefore, any profit attribution would have to be based on formulaic apportionment principles which have previously been rejected at both OECD/G20 as well as UN levels. Also, any profit attribution approach would have to acknowledge that losses too will be attributed to the SEP PE in cases where transactions were not profitable. Indeed this is quite common in the early years of a digital business. Given the general reluctance of many tax administrations to allow PEs to realise losses, it is uncertain how fair equivalence in attribution of both profits and losses would be achieved. Finally, the compliance obligations for a SEP PE would be extremely burdensome given these businesses are non-resident; and its in the very nature of such businesses to be non “bricks and mortar” and without presence such as offices or local staff to handle compliance.
(2) Withholding tax
Tax imposed on gross income without due regard to net income is generally regarded as an unfair basis of taxation, does not foster smooth cross-border trade and runs contrary to policy adopted within the EU (e.g. the EC Parent-Subsidiary or Interest & Royalty Directives) and also OECD member countries to eliminate or reduce withholding tax. Imposition of new gross basis taxes would presumably exceed DTA rate limitations or be inconsistent with treaty obligations given these are normal business profits that should be taxed only on a net basis to the extent attributable to a PE. Also SMEs would be disproportionately be affected and WHT levels could easily wipe out their slim margins. This would adversely impact the entire eco-system of start-up businesses including in the local economies. Finally, a gross-basis tax would operate like a “tariff” and would adversely impact cross-border trade.
(3) Equalisation levy
An “equalisation levy” would effectively operate in the same manner as a gross WHT and apply regardless of profitability. Therefore such a levy would give rise to the same concerns as the imposition of a gross WHT. If the levy were to operate as a de-facto “excise” tax it would fall outside the scope of DTAs and would be seen as yet another “tariff” suffering from the same shortcomings in terms of hampering international trade.
The SVTDG urges the OECD to evaluate the results of the first post-BEPS tax returns and allow systems changes within organisations made necessary by BEPS to bed down before conclusions are drawn in the OECD Interim Report (already published in March 2018 – see our linked articles). Therefore it is advisable to wait until 2020 for a proper evaluation as agreed in the Action 1 Report.
Regarding VAT/GST the SVTDG welcomes the publication by the OECD of the International VAT/GST Guidelines in April 2017. The key concerns are that VAT/GST regimes should be uniform and not overtly complex and therefore expensive to comply with. Digital invoicing and record keeping should be encouraged to assist compliance. Penalties for misreporting VAT registration numbers to document B2B sale transactions should be imposed on the reporting entity (the VAT-registered local business) rather than the non-resident company.