New tax nexus based on significant economic presence

This option would create a taxable presence in a country when a non-resident enterprise has a significant economic presence in a country on the basis of factors that evidence a purposeful and sustained interaction with the economy of that country via technology and other automated tools. These factors would be combined with a factor based on the revenue derived from remote transactions into the country, in order to ensure that only cases of significant economic presence are covered, limit compliance costs of the taxpayers, and provide certainty for cross-border activities. The following sections describe the details of such an option, together with potential approaches for attributing income to the new nexus.

1.  Revenue-based factor

As a general matter, revenue that is generated on a sustained basis from a country could be considered to be one of the clearest potential indicators of the existence of a significant economic presence. This is based on the assumption that even in multi-sided business models, and particularly those dependent on network effects, the two markets are likely to be strongly interrelated, and as a result are likely to besituated in the same country. To the extent that the country of the users and country of the paying customers are aligned, the value of an enterprise’s users and user data would generally be reflected in the enterprise’s revenue in a country. In other words, because user data serves to enhance the value of the services an enterprise offers, a strong user network (and the attendant user data) is likely to result in enterprises either selling more or enterprises charging more for its core products/services, or both. Under such circumstances, the revenues earned from customers in a country are a potential factor for establishing nexus in the form of a significant economic presence in the country concerned. Revenues will not be sufficient in isolation to establish nexus but they could be considered a basic factor that, when combined with other factors, could potentially be used to establish nexus in the form of a significant economic presence in the country concerned. In addition, the use of revenue as a basic factor could limit the compliance costs of taxpayers and provides a high degree of tax certainty for cross-border activities. In developing a revenue factor, consideration was given to the following technical issues:

(a) Transactions covered: One approach that could be considered in defining a basic revenue factor is to include only revenues generated from digital transactions concluded with in-country customers through an enterprise’s digital platform. Specifically, these transactions would involve the conclusion of a contract for the sale (or exchange) of goods and services between two or more parties effectuated through a digital platform where the contract conclusion primarily relies on automated systems. Such an approach could however create incentives for particular ways of doing business with remote customers. For example, such an approach would treat remote digital transactions differently from mail-order transactions (e.g. catalogue shopping) and telephone transactions (e.g. sale through call centres). Although in practice the latter transactions are less likely to enable a business to generate a significant amount of revenue, all three ways of transacting enable businesses to engage in sales transactions without physical presence in the country of the customer. In addition, businesses may leverage digital technology to reach a broader range of customers in another country without entering into digital transactions (e.g. website displaying the products but routing the customers to a call centre to perform the final purchase). Accordingly, to ensure that taxpayers in similar situations carrying out similar transactions will be subject to similar levels of taxation, it may be preferable to define the factor so as to include all revenue generated by transactions concluded by the non-resident enterprise remotely with in-country customers.

(b)  Level of the threshold: The core element of the revenue factor could be the gross revenues generated from remote transactions concluded with customers in the country concerned. This amount should be framed in absolute terms and in local currency, in order to minimise the risk of manipulation. A key objective in setting the level of threshold would be to set it at a high enough level to minimise the administrative burden for tax administrations as well as the compliance burden on and level of uncertainty for the taxpayer, while ensuring that nexus is less likely to be created in cases in which minimal tax revenue would be collected. The size of the country’s market might also be a relevant factor in setting the level of the revenue threshold. Given the relative mobility and flexibility in choosing the location of automated functions related to revenue-generating activities in the digital economy, the factor could be applied on a related-group basis rather than on a separate-entity basis to prevent any risk of artificial fragmentation of distance selling activities with customers of the same country among a variety of foreign affiliated entities. This aggregation rule could be introduced as a rebuttable presumption, with the taxpayer being able to demonstrate that it did not artificially fragment the distance selling activities in order to manipulate the revenue threshold.

(c) Administration of the threshold: An accurate application of the revenue threshold would depend on the ability of the country to identify and measure remote sales activities of the non-resident enterprise. One possible approach to address this challenge could be to introduce a mandatory registration system for enterprises that meet the factors giving rise to a significant economic presence. On the other hand, it could be difficult for tax authorities to know when activities are taking place and at what scale, to identify remote sellers, and ultimately to ensure compliance. Similarly, in the case of transactions concluded and fulfilled entirely online, it may be difficult for enterprises to identify with certainty the country of residence of clients. In this respect, regimes introduced to ensure compliance with VAT/GST rules by non-resident suppliers could prove extremely useful.

2.  Digital factors

In the case of “brick and mortar” businesses, the ability to reach significant numbers of customers in a country generally depends on a variety of factors, including a store’s location, local marketing and promotion, payment options, and sales and customer service employees. In the digital economy, the ability to establish and maintain a purposeful and sustained interaction with users or customers in a specific country via an online presence depends on analogous factors. A range of digital factors based on the current development of the digital economy could be used as part of a test for significant economic presence, including the following:

(a) A local domain name: A non-resident enterprise targeting customers or users in a country will generally obtain the digital equivalent of a local “address” where the nonresident enterprise establishes its store front, typically taking the form of a localised or specialised domain name. For example, while an enterprise’s “home” domain name might be “.com”, the enterprise’s site targeting one country would likely use a domain name reflecting that, in order to make it more likely that a local user would find the local site. This is reinforced by the need of enterprises to protect their trademarks by purchasing related domain names, including a local country domain name. In summary, while it is possible for an enterprise to do business in a country without a local domain name, the choice to do so carries reputational risk from potential domain “squatting” and trademark infringement from not protecting the enterprise’s business name, trademarks and trade names across various domains. Accordingly, MNEs doing substantial cross-border business would very likely operate in a country via a local domain name. Whether local domain names will remain the predominant method for accessing markets, however, is uncertain. In the near future, merchants selling camera equipment globally may, for example, use a generic “.camera” domain name, thus reducing the relevance of country specific domain name.

(b)  A local digital platform: Non-resident enterprises frequently establish “local” websites or other digital platforms in order to present the goods or services being offered in the light that most appeals to the local users or customers, taking into account language and cultural norms in particular. Local websites or digital platforms could include features intended to facilitate interaction by local users and customers with the site’s content, services and functions. Such features include language, local marketing such as targeted discounts and promotions, and local terms of service for users and customers that reflect the commercial and legal context of the local environment. Although some enterprises may elect to only operate only in one language and not attempt to undertake local marketing or promotional efforts, establishing a local platform is often critical to attracting meaningful numbers of local users and customers.

(c)  Local payment options: A non-resident enterprise that maintains a purposeful and sustained interaction with the economy of a country will frequently ensure that local customers have a seamless purchasing experience with prices reflected in local currency, taxes, duties and fees already calculated, with the option of using a local form of payment to complete the purchase. Integration of local forms of payment into a site’s commercial features is a complicated technical, commercial, and legal exercise requiring substantial resources, and an enterprise would normally not undertake such an investment unless it purposefully participates in the country’s economic life. While this factor may be less relevant in countries that share a common currency, it generally is a critical commercial requirement in countries that have stringent banking regulations, currency controls, or low penetration of international credit cards.

3.  User-based factors

Given the importance of network effects in the digital economy, the user base and the associated data input may also be important indicators of a purposeful and sustained interaction with the economy of that another country. A range of factors based on users could be used to reflect the level of participation in the economic life of a country, namely:

(a)  Monthly active users (MAU): One factor reflecting the level of penetration in a country’s economy is the number of “monthly active users” (MAU) on the digital platform that are habitually resident in a given country in a taxable year. The term MAU refers to registered user who logged in and visited a company’s digital platform in the 30-day period ending on the date of measurement. A factor based on MAU presents the advantage of measuring the customer/user base in a given country both in terms of size and level of engagement. Given that little material is publicly available on the process of defining and identifying MAU, more detailed metrics would need to be developed in consultation with businesses and IT experts for the purpose of using this factor, such as how to identify a unique “user” or what level of engagement is required for a user to be considered “active”. Reliability and veracity of the information would also need to be ensured, to address fraudulent accounts, multiple accounts, false information volunteered by users, and “bot”- produced data, to name a few.

(b)  Online contract conclusion: Another factor indicating the level of participation of an enterprise in the economic life of a country is the regular conclusion of contracts. This is the focus of the existing “dependent agent” PE test contained in Article 5 of the OECD Model which, in broad terms, requires that this contract conclusion be carried out in the country by a person acting on behalf of the nonresident enterprise. In the digital economy, contracts can frequently be concluded with customers via a digital platform without the need for the intervention of local personnel or dependent agents. For example, online platforms providing free services to their users often specify on their websites that by accessing or using the products and services of the company the user agrees to the “Terms of Service” and each use of the platform results in the conclusion of a legally binding agreement. The number of contracts concluded through a digital platform with customers or users that are habitually resident in the country in any taxable year could therefore be considered an important factor.

(c)  Data collected: Another factor which could be considered to reflect an enterprise’s level of participation in the economic life of a country is the volume of digital content collected through a digital platform from users and customers habitually resident in that country in a taxable year. The focus would be on the origin of the data collected, irrespective of where that data is subsequently stored and processed (e.g. data warehouse). The range of data captured by the threshold would not be confined to personal data, but would cover also, e.g. user created content, product reviews, and search histories. This core element could be coupled with proportionality tests, such as whether the volume of digital content collected exceeds a percentage of the enterprise’s overall stored digital content. Information on data collected is increasingly available, reliable and up-to-date, especially if the factor is focusing on data collected that is effectively stored by the non-resident enterprise on a server. At the same time, businesses may not necessarily maintain separate and comprehensive track records of the volume of data collected and stored on a country-by-country basis. In addition, the volume of data collected (and stored) from users in a country may not necessarily reflect an effective contribution to the profits generated by the non-resident enterprise, as the value of raw data is rather uncertain and particularly volatile.

4.  Possible combinations of the revenue factor with the other factors

For purposes of this potential option, total revenue in excess of the revenue threshold would be an indicator of the existence of a significant economic presence.

Total revenue, however, may not by itself suffice to evidence a non-resident enterprise’s regular and sustained participation in the economic life of a country. To be an appropriate measure of participation in the economic life of a country, the revenue factor could be combined with other factors, such as the digital and/or user-based factors that indicate a purposeful and sustained interaction with the economy of the country concerned. In other words, a link would have to be created between the revenue-generating activity of the non-resident enterprise and its significant economic presence in the country. The choice of which factors should be combined with the revenue factor to ascertain whether a significant economic presence should be deemed to exist is likely to be driven by the unique features and economic attributes of each market (e.g. size, local language, currency restrictions, banking system).

This concept may be illustrated by an example. If a non-resident enterprise generates gross revenues above the threshold from transactions with in-country customers concluded electronically through a localised digital platform where the customer is required to create a personalised account and utilise the local payment options offered on the site to execute the purchase, it could be considered that there is a link between the revenue generated from that country and the digital and/or user-based factors evidencing a significant economic presence in that country. In contrast, it would be more difficult to find such a link where a non-resident enterprise generates gross revenues above the threshold from transactions with in-country customers through in-person negotiation taking place outside of the market jurisdiction, if the enterprise only maintains a passive website that provides product information with no functionalities permitting transactions or intensive interaction with users (including data collection).