BEPS - challenges of the digital economy

On 5 October 2015, the Organisation for Economic Co-operation and Development (OECD) released its final report on the tax challenges of the digital economy (Action 1) under its Action Plan on Base Erosion and Profit Shifting (BEPS). This report was released in a package that included final reports on all 15 BEPS Actions.

The document, Addressing the Tax Challenges of the Digital Economy (the Digital Economy Report or Final Report), largely follows the initial Action 1 deliverable on the digital economy released by the OECD on 16 September 2014 (the 2014 Deliverable).1 At 290 pages, the Final Report exceeds the 2014 Deliverable by 88 pages.

The Final Report provides the OECD’s conclusions regarding the digital economy and recommended next steps to address the tax challenges presented by its evolution. The Final Report continues to acknowledge that special rules designed exclusively for the digital economy would prove unworkable, broadly stating that the digital economy cannot be ring-fenced because it “is increasingly becoming the economy itself.” The Final Report summarizes key features of evolving digital business models that the OECD considers relevant for the overall BEPS analysis; in addition, the Final Report considers the broader direct and indirect tax challenges raised by the digital economy and evaluates the options to address those challenges.

To address the direct tax challenges, the Digital Economy Report does not recommend creating special rules; rather, it states that those challenges will be effectively addressed by the work carried out under other BEPS Actions.

In that regard, the Digital Economy Report recommends:

(i) Modifying the list of exceptions to the definition of Permanent Establishment (PE) regarding preparatory or auxiliary activities as they relate to a digital environment and introducing new anti-fragmentation rules to deny benefits from these exceptions through the fragmentation of certain business activities

(ii) Modifying the definition of a PE to address artificial arrangements through certain “conclusion of contracts” arrangements2

(iii) A correlative update to the Transfer Pricing Guidelines3

(iv) Changes to the controlled foreign company (CFC) rules addressing identified challenges of the digital economy4

The Final Report also addresses the indirect tax treatment of certain digital transactions, recommending that countries apply the principles of the OECD’s International Value Added Tax and Goods and Services Tax (VAT/GST) Guidelines as well as consider the introduction of the collection mechanisms included therein. Each of the above recommendations is discussed in more detail in this Alert.

Future work in the area of Action 1 will be conducted in consultation with a broad range of stakeholders, and on the basis of a detailed mandate to be developed by the OECD during 2016 in the context of designing a globally inclusive post-BEPS monitoring process. A supplementary report reflecting the outcome of continued work on the overall taxation of the digital economy should be released by 2020. The OECD intends to develop implementation packages to enable countries to implement the OECD’s International VAT/GST Guidelines in a coordinated manner.

OECD issues final report on the tax challenges of the digital economy under Action 1