New technologies fuel the trend of digitization and change the economy by:
- Decoupling it from the physical presence of service providers or producers
- Reducing the use of tangible assets in favor of intangible ones (e.g. software, apps etc.)
Because of the lack of physicality both in terms of residence and the nature of the products or services, digital players can pick and choose between the legislations of different countries in order to optimize their tax situation. Google, Amazon and Facebook are famous companies that actively use tax planning in order to save taxes.
International Tax Solutions for the Digital Economy
In order to stay on top of such tax saving strategies, source states (the states where the actual consumers are located) are looking for ways to levy their taxes in spite of a lack of physical residence. Such measures have been summarized in the OECD`s report “Tax Challenges Arising from Digitalization – Interim Report 2018”.
Examples for measures against tax evasion by Big Business are the application of:
- alternative limits for permanent establishment
- withholding taxes
- turnover taxes
- special tax regimes for large multinational companies
Alternative Limits for Permanent Establishment
Such alternatives could for example be the number of contracts signed with customers in the country, a significant number of users or customers of that service in the country, specific features for the country’s customers (e.g. targeted advertising, program language, discounts for people of that country, adoption of currency and means of local payments) or the revenue obtained from the local market.
Withholding tax should be made on remittances to foreign residents due to certain digital products and services (as is the case in Brazil).
Turnover taxes are being implemented in India, Hungary, Italy and France. These taxes tend to affect the revenue of the operation, and are not considered as Income Tax itself. Here, a distinction is made between the source of payment and the actual locality of the recipient of the service.
In France and Hungary, the recipient of the content independently from the paying source was chosen when it comes to audiovisual content and advertising services. This demonstrates the intention to use the consumer market as an element of connection for establishing tax jurisdiction.
In the case of India and Italy, on the other hand, the tax will be due at the place of the paying source.
This approach could lead potential multiple taxation situations one transaction, for example if an operation involves a paying source in Italy, with a provider in the US and the destination of advertising in Hungary .
Special Tax Regime for MNE
This approach has been chosen in the United Kingdom and Australia with the aim to avoid the leakage of revenues generated domestically, but artificially directed to another country. Here, the volume of operations that are artificially diverted is estimated and taxed with a 25% rate.
Result of different Strategies
Looking at the different strategies, it becomes apparent that the only general consensus in terms of taxing the digital economy seems to be that tax evasion or certain types of tax planning need to be hindered. However, the chosen methods differ from country to country which poses a big risk of double or multiple taxation. This in turn not only hinders the development of the digital economy but also encourages the respective companies to look for other ways of avoiding taxation or possible cease their operations in certain countries altogether. Consequently, finding a common ground in terms of taxing the digital economy internationally will be one of the big challenges of the coming years.