Taxing the digital economy
15 March 2018
The rise of the digital economy and the substantial profits generated by some digital businesses, together with the opportunity for tax base erosion and profit shifting afforded by digital business models, have resulted in a call to update the international tax system to address the digital economy. Tasked with formulating an international approach, the OECD has yet to propose a viable reform package. In the absence of multilateral consensus, many jurisdictions have begun to formulate unilateral rules to tax the digital economy. The inconsistency of these rules is likely to increase the tax burden of digitalised businesses operating internationally.
Concerns for tax authorities
Digitalisation has been observed to be the most significant development in the global economy since the industrial revolution. Recent technological advances have driven dynamic changes in how and where companies do business and this pace of change seems unlikely to slow.
This has created significant concerns for taxation authorities around the world, which can see huge profits being generated by businesses at the forefront of the digital economy revolution but struggle to tax such profits under the existing international tax framework. This issue has also crossed over into the mainstream in the form of political and media pressure to ensure that multinational business pays its fair share of tax in the countries where profits are generated, giving additional focus and impetus to finding a solution. Numerous international bodies are looking at this issue, but it is proving a complex problem with no easy solution. Frustrated by a lack of progress, or perhaps as a catalyst to further international progress, individual jurisdictions are increasingly adopting unilateral measures to tax the digital economy.
This article seeks to provide an overview of the different unilateral approaches being taken to the taxation of the digital economy around the globe and to put these into the wider context of the international efforts to determine a multinational approach to this issue.
The perceived problem with taxing the digital economy, and in particular some of the new business models that digitalisation has fostered, is that digitalisation has enabled businesses to generate large profits from consumers in a jurisdiction without a physical presence in that jurisdiction. Taxing such profits under the current international tax system is problematic, since this system operates predominately by reference to physical presence in a jurisdiction; i.e. a jurisdiction can only tax the profits of a business if such profits are associated with a form of presence in that jurisdiction.
Digitalisation allows more traditional business models (such as the sale of goods/services, i.e. e-commerce) to sell to consumers without the need for physical presence (or at least material physical presence) in the customer jurisdiction. It also paves the way for new business models, based upon user participation, to generate income without making any traditional sales to the user base in question; e.g. social media businesses that generate revenue through advertising sales. User participation business models are particularly problematic in the context of the existing tax system. While there may be no presence or transaction in a jurisdiction, the user base in that jurisdiction, that drives the ability for the business to generate revenue could be very large and key to the profitability of the business.
A further challenge for the international bodies looking at this issue is the sheer diversity of digital business models. There is no easy answer to what constitutes the digital
economy, making it very difficult to propose a single effective tax measure targeting the digital economy. Furthermore, the digital economy continues to evolve at a rapid pace and there are concerns that any measures introduced today may be quickly superseded by further digital evolution.
These issues have caused many to question whether it is in fact necessary or practical to radically reform the current international tax system to respond to the digital economy. However, this view does not appear to be shared by the international bodies looking at this issue or the increasing number of jurisdictions introducing unilateral tax measures targeting the digital economy.
This article was first published in Tax Journal and the full article can be accessed here.
For more information please contact Ben Jones, Susan Seabrook, Sebastiano Sciliberto or Georgina Jones.