Tax jurisdictions around the world are feeling the pressure to update their rules to keep pace with the disruptions brought about by the digitization of the economy. Defining where value is created has become much more complex than when most countries’ corporate tax rules were written.
Traditional corporate tax rules largely do not account for the realities of the modern global economy, for two reasons: 1) they do not capture business models that profit from providing goods and services online to customers within a jurisdiction without being physically present under traditional permanent establishment (PE) rules; and 2) they fail to recognize the evolving role that users play in generating value under these newer business models.
With such disparity between value creation and where taxes are paid, many countries are taking unilateral action to reform their corporate tax rules so profits are registered and taxed where businesses have significant interaction with users through digital channels—and it is time that multinational enterprises (MNEs) take notice. Notable tax legislation changes are occurring globally that will have a considerable impact on businesses.
The European Commission (EC) recently proposed new rules to ensure that digital business activities are taxed fairly in the European Union (EU). The first proposal includes a long-term initiative aimed at reforming corporate tax rules so profits are registered and taxed where businesses interact significantly with users through digital channels. The second proposal responds to calls from several EU member states for an interim tax, which covers the main digital activities that currently escape tax altogether in the EU. Under this proposal, the interim tax would apply to companies with total annual worldwide revenues exceeding €750 million and EU taxable revenues exceeding €50 million.
The proposals will be submitted to the Council of the EU for adoption and to the European Parliament for consultation. The EU will continue to contribute actively to global discussions on digital taxation and will push for international solutions. Although several EU member states (e.g., the Netherlands) oppose the EC proposals, a clear majority do not, so they will likely be enacted.
Due to the push for EU-level measures, the Organisation for Economic Co-operation and Development (OECD) announced that it may accelerate the release of its own final report on digital taxes from 2020 to 2019, depending on how quickly participating countries reach a consensus.
In the OECD’s 2018 interim report, Tax Challenges Arising from Digitalisation, a glimpse of what’s to come is highlighted by the identification of two key concepts of the international tax system—the “nexus” and “profit allocation” rules—that relate to how taxing rights are allocated between jurisdictions and how profits are allocated to the different activities carried out by MNEs.
This report, once complete, will signal countries around the world to enact legislation in accordance with the OECD’s guidance.
In June 2018, the G7 leaders held a summit in Canada, announcing in the resulting communiqué their commitment to working toward fair and efficient tax systems, including taxation of the digital economy.
In March 2018, India published the Finance Act 2018, becoming one of the first countries to expand its PE rules to include the activities of nonresidents that do not give rise to a physical presence in India.
The Finance Act 2018 amends Section 9(1)(i) of India’s Income Tax Act, 1961 (ITA) to specify that “significant economic presence” in India constitutes a business connection. “Significant economic presence” will mean either:
- any transaction in respect of any goods, services, or property carried out by a nonresident in India, including downloading data or software in India, if the aggregate payments arising from such transaction(s) during the previous year exceed a specific threshold; or
- systematic and continuous soliciting of its business activities or engaging with a certain number of users in India through digital means.
The measures will apply starting April 1, 2019.
In the United States, the recently passed Tax Cuts and Jobs Act (TCJA) introduced global intangible low-taxed income (GILTI), a new anti-deferral provision that requires certain U.S. persons who are “U.S. shareholders” of controlled foreign corporations (CFCs) to include in income their pro rata share of GILTI for the taxable year.
In general, this provision was enacted to address the situation where CFCs generate high returns, primarily through foreign intellectual property, with little or no tangible business assets. The U.S. shareholder (e.g., corporation) can deduct up to fifty percent and take an eighty percent deemed paid foreign tax credit (FTC) for GILTI. A U.S. company can also deduct up to 37.5 percent of its foreign-derived intangible income (FDII) for the taxable year. The FDII rules encourage the development of intangibles in the United States, with a reduced tax on a U.S. corporation’s intangible income derived from foreign use. It remains to be seen whether the World Trade Organization will classify FDII as a prohibitive export subsidy.
While the EC favors short-term measures to tax the digital economy, the U.S. Treasury Secretary, Steven Mnuchin, issued the following statement regarding the OECD’s 2018 interim report in March 2018:
“The U.S. firmly opposes proposals by any country to single out digital companies. Some of these companies are among the greatest contributors to U.S. job creation and economic growth. Imposing new and redundant tax burdens would inhibit growth and ultimately harm workers and consumers. I fully support international cooperation to address broader tax challenges arising from the modern economy and to put the international tax system on a more sustainable footing.”
Another monumental U.S. tax change affecting domestic and foreign businesses is the U.S. Supreme Court’s five-to-four decision in South Dakota v. Wayfair on June 21, 2018, which overturned the physical presence nexus requirement adopted in Quill v. North Dakota and National Bellas Hess v. Department of Revenue of Ill. The Court held that the physical presence standard is “unsound and incorrect.”
South Dakota’s legislature had enacted a law requiring out-of-state sellers to collect and remit sales tax “as if the seller had a physical presence in the State.” The law covers only sellers that deliver yearly more than $100,000 of goods or services into the state or engage in 200 or more separate transactions to deliver goods or services into the state. Respondents in Wayfair, top online retailers with no employees or real estate in South Dakota, each met the law’s minimum sales or transactions requirement, but do not collect the state’s sales tax. The main dispute in Wayfair was whether South Dakota could require remote sellers to collect and remit sales tax without a physical presence in that state.
Several senior U.S. government officials said recently that the Wayfair decision would impact their multilateral discussions at the OECD on measures needed to address the digitization of the economy.
Preparing for Business Impact
Tax professionals should prepare for the ongoing disruption by taking proactive action. The numerous implications of the digital economy require proactive planning—and the time to start is now. Companies should map global operations, as they have for country-by-country reporting, to better understand where their business activities may create digital tax “nexus.”
It’s important for tax professionals to take advantage of research tools to keep up-to-date with ever-evolving tax legislation. Companies should look for a trusted provider that specializes in expert research, guidance, technology, tools, learning, and news. Timely updates and authoritative insights on key tax developments that impact businesses are key to maintaining compliance in a complex digital landscape.
Using integrated compliance software is also imperative. With complicated regulations and nuances in country-specific rules, MNEs must understand new laws and make forecasts based on this legislation. Using multiple sources or multiple jurisdictional sites for rate changes or legislative information is cumbersome, so they should make sure the latest changes to tax legislation are in a centralized location and linked to compliance platforms. The value of an integrated tax compliance and research offering becomes more appealing since each change has a downstream impact on other tax processes.
With the perspective that proactive planning allows, and the agility and foresight that technology brings, businesses can turn the challenges of the digital economy into an opportunity to showcase the strength and importance of their tax departments in executing company strategy.
Jessica Silbering-Meyer is a managing editor and Robert Sledz is an editor, both specializing in international tax, within the tax and accounting business of Thomson Reuters.