As the scandals keep multiplying with Lux Leaks, Swiss Leaks and Panama Leaks, public cries increase calling governments to stop tax avoidance, as a result of which EUR 50-70 billion of tax revenue is being annually lost by the Member States of the European Union (EU).
The increasing number of EU and Member State investigations against digital companies such as Google, Amazon, Apple and Facebook show that the digital sector is highly involved in aggressive tax planning practices, which permits the biggest companies of the world to get away with the payment of close to zero taxes.
Although the European Commission shall be commended for its proactiveness, the investigations are seen as a temporary solution to tax avoidance and are being constrained by the EU case law, the four fundamental freedoms as well as lengthy investigation processes.
While the digital economy does not create Base Erosion and Profit Shifting (BEPS) issues, it ‘exacerbates the existing ones’.
Digital goods are highly mobile or intangible, physical presence of a company in the market country is often not needed in the digital sector, rendering it substantially different from traditional brick-and mortar businesses. New digital business models (subscription, access or advertisement models) and new technologies such as robotics or 3D printing are not confined by national boundaries and can easily escape their tax liabilities by chanelling their royalty payments towards a tax haven, for instance.
Taxation of e-commerce is problematic due to anonymity, difficulty to determine the amount of tax, lack of paper trail, tax havens, companies incurring liability in multiple countries, tax administration’s lack of capacity to identify companies and to manage VAT. These factors render it difficult for tax administrations to collect Value-Added Tax (VAT), especially due to BEPS risks stemming from exemptions for imports of low valued goods and remote digital supplies to consumers.
Tax challenges arise from nexus, data and characterisation in the digital sector.
These concepts relate to the difficulty to define tax jurisdiction, the problem of attributing value to data created by users free of charge and the dilemma on whether or not e-commerce transactions fall under the category of royalties.
To give a few examples, MNEs usually often rely on the exceptions under the Organisation for Co-operation and Development’s (OECD) Model Tax Convention to circumvent Permanent Establishment (PE) status, use tax incentives such as patent boxes for tax purposes rather than for their intended purpose of promoting Research and Development (R&D) activities, engage in treaty shopping to shift taxable revenue to tax havens or negotiate sweetheart deals with governments willing to attract Foreign Direct Investment (FDI).
Thin capitalisation, transfer pricing, hybrid mismatches, circumvention of Controlled Foreign Capital (CFC) rules, preferential tax regimes and artificial contractual agreements are commonly used methods to eliminate tax base by Multinational Enterprises (MNEs) in the digital sector.
Especially, the OECD / G20 BEPS measures related to Permanent Establishment, CFC rules and transfer pricing are designed to address the BEPS issues in the digital economy.
These include addressing the exceptions included in the definition of the Permanent Establishment status, eliminating artificial arrangements or contracts, regulating transfer pricing of intangibles and modifying the definition of CFC rules.
Although the OECD / G20 recommendations in 15 different action fields constitute a step in the right direction, their adoption is left at its Member States’ discretion, as OECD is a soft-law Organisation and often comes up with minimalist and multiple-option solutions to facilitate consensus building among its Members.
BEPS Action 1 on the digital sector fails to come up with short-term solutions, as it fiercely defends the idea that ring-fencing the digital economy would not be feasible as ‘the digital economy is increasingly becoming the economy itself’. Moreover, concerns about productivity losses and deviation from the OECD’s neutrality principle and breach of the EU’s four fundamental freedoms, such as the movement of services, also justify that isolation of the digital sector would not be an optimum solution.
Notwithstanding this, some EU Member States and some third countries experimenting with or flirting with the idea of the introduction of specific taxes on the digital economy. The European Commission raised doubts about these specific measures because of their impractical, irrational or temporary nature while highlighting the need for some out-of-the box thinking within the boundaries of the existing system.
In this framework, it is worthwhile to keep a vigilant eye on the reform process within the US tax system, as the Obama administration proposed a minimum tax of 19 % on global earnings of US companies, ‘regardless of whether the income is repatriated to the US and imposed ‘limits on deferral of overseas income and use of corporate structures that leave some income untaxed by any country.’
The overall analysis on the OECD/ G20 BEPS measures relevant to the digital sector reveals that some measures fail to address the core of the problem. This may stem from the OECD’s being a soft-law organisation and its efforts to reach consensus by offering de minimis solutions and multiple options.
Yet, the OECD does not exclude the future possibility of engaging in far-reaching reforms relevant to the digital sector, referred to as ‘Beyond BEPS strategy’, such as the conception of a single firm, modification of source and residence and deemed PE, while providing several possibilities, including fractional apportionment, deemed profit methods, withholding tax on digital transactions and equalisation levy.
The unitary approach is seen by many as the ultimate solution to the tax problems in the digital sector, especially those related to transfer pricing, suggesting that the OECD’s arm’s length principle is untenable.
Going beyond the recommendations of the OECD, the EU has recently proposed an Anti-Tax Avoidance Directive (ATAD), which goes further than the OECD recommendations.
The Directive suggests the following three actions, which were also recommended by the OECD / G20 BEPS project: Hybrid mismatches (Action 2), interest limitations (Action 4) and CFCs (Action 3). Moreover, the Commission proposes three additional actions, which were not covered by BEPS: General Anti-Avoidance Rule (GAAR), switch-over clauses and exit taxation.
Yet, the package including six legally binding anti-abuse measures is far from being inked as consensus could not be reached due to three controversial issues: the switch-over clause, CFC rules and provisions on hybrid mismatches.
For instance, usefulness of the switch-over clause is being questioned, as the 40 % relative threshold may lead to a race to the bottom and would not apply to low tax Member States. As for the nominal threshold proposed for the CFC rules, they may limit tax administrations to tax foreign based subsidiaries if the tax rate paid there is lower than 40 % of the home country tax rate.
Separately, the Commission announced the relaunch of the Common Consolidated Corporate Tax Base (CCCTB) based on two important changes: A compulsory CCCTB to combat BEPS risks, and a two-step approach to harmonise tax base across the EU and consolidation.
Furthermore, a Directive on the reporting rules by MNEs was adopted on May 25 May 2016 in the Council to implement the OECD’s BEPS Action 13 on Country-by- Country Reporting (CBCR).5 However, there is much criticism on both measures concerning the size of companies held accountable for reporting as a minimum threshold was set at USD 750 million.
The OECD findings show that this would exclude more than 85 % of MNEs while limiting tax administrations’ investigative powers.
The EU adopted regulations on money laundering (Anti-Money Laundering Directive) in 2015 to increase transparency and to address the problems posed by shell companies, foundations and trusts. Accordingly, companies in EU Member States are expected to declare the real owner of such entities but countries differ in their level of ambition when it comes to its implementation.
At the same time, only persons having a ‘legitimate interest’ are granted access to the registers of real owners and it is not clearly defined who these real owners are.
To tackle harmful tax practices, EU Member States endorsed the OECD’s Modified Nexus Approach, according to which a criterion of substantial activity with regards to IP Box regime was adopted. It is expected to will the scope of eligible IP to patents and comparable intangibles while rendering IP Box relevant to net instead of gross income.
Thanks to a grandfathering rule, companies having obtained advantages under the existing IP regimes until June 2016, will be able to fully benefit from them until the end of June 2021.
In order to address problems arising from the localisation of businesses and conceptualisation of taxable person, new rules regarding the destination principle and the Mini One Stop Shop (MOSS) entered into force in January 2015.
There is a shift in the EU to use more and more the principle of destination for VAT purposes. The VAT Action Plan Agenda, proposed under the Better Regulation Agenda by the Commission on 7 April 2016, is the first step towards a single EU VAT area, which is equipped to tackle fraud, to support business and to help the digital economy and e-commerce.
It is yet to be seen whether the EU will do away with an updated list of goods and products, which can be taxed at a minimum of 15 % rate or rather keep a regularly updated version of the list.