Tax and Technology – the state of play
In recent years, the tax sphere has been blighted by a number of controversies, which have brought the tax strategies adopted by multinational enterprises under the spotlight. Events such as the Luxembourg leaks, as well as the European Commission investigations into state aid granted by member states to multinational enterprises, have resulted in a period of the biggest changes to international corporate tax rules.
This has led to the OECD (Organisation for economic corporation and development) to pursue the base erosion and profit shifting (BEPS) project. The latter being an ambitious task of reviewing existing international tax rules and principles, to set out recommendations, as well as establish minimum standards in order to ensure a fairer system of taxation, with the aim of taxing profits where economic activities leading to value creation are conducted. As a result of the work carried out by the OECD as part of the BEPS project, one theme emerged where present tax rules, when applied within the context of a global economy with increased mobility of capital and resources, which was adopting increased digitalised processes, were not up to the task of successfully bringing to tax income where value was created.
The sourcing rules laid out within the OECD Model Tax Convention, on which most double tax treaties are based including the majority of those entered into by Malta, contracting states typically have the right to tax income sourced within their jurisdiction by a foreign enterprise through a fixed place of business, which carries out the business activity. However, an exception to this rule found application towards certain specific activities conducted by an enterprise in a jurisdiction, such as warehousing, which were considered to constitute preparatory and auxiliary services and therefore outside of the source jurisdiction to tax the profits from such activities, if any. Such loopholes have been exploited and further enforced the need, to truly understand the digital changes happening within the economy and establishing a way to tax profits where value is truly created.
On the 16 March of this year, following work previously carried out in the area of the digital economy as part of BEPS Action 1, the OECD published the highly anticipated interim report on tax challenges arising from the digital economy (the ‘Interim Report’). The Interim Report considers certain digital business models and how and where value is created within the global digitalised economy, as well as the views of the different members of the Inclusive Framework on BEPS (a group of around 100 countries which collaborate on the implementation of BEPS measures), on whether and to what extent changes to international tax rules should be made in order to cater for a digitalised economy. The salient takeaways from the Interim Report include a lack of consensus by the Inclusive Framework, with a commitment to deliver a final report by 2020 on a proposed solution, as well as short-term solutions being perceived as the wrong approach to the issue at hand.
The challenge posed by digital business activities, has also been of interest to the European Commission. Shortly after the publication of the Interim Report by the OECD, on 21 March 2018, the European Commission published two proposed directives with the intention to address the need for a fair and effective taxation of the digital transformation within the economy.
The first proposed council directive intends to lay down rules relating to the corporate taxation of a significant digital presence (COM/2018/147/FINAL). This proposed directive aims at establishing a taxable nexus for businesses with a digital presence in jurisdictions, without any physical commercial presence, i.e. a significant digital presence. Further to the formation of what is being labelled as a ‘digital permanent establishment’, this proposal further sets out principles for the attribution of profits to qualifying significant digital presence. In terms of the proposal, the threshold for a significant digital presence in a member state to subsist would require for a digital service to be provided through a digital interface, which generates revenues in a Member State during a taxable period in excess of €7million, to users in excess of 100,000 and through the conclusion of 3000 business contracts for the supply of a digital service in a member state during a taxable period. This threshold led to numerous comments on the proposal, where it has been considered to be low, considering the size of the European market. Furthermore, the proposed attribution of profits to a significant digital presence is akin to a physical permanent establishment, with modifications to reflect the virtual nature of the significant digital presence, taking into consideration the economically significant activities performed.
The second proposed directive (COM/2018/148/FINAL), seeks to establish tax on revenues from certain digital services and is labelled as a quick fix, to the problem of having international corporate tax rules designed prior to today’s digital era. Set to be an interim solution, the European Commission is proposing a digital sales tax (DST) of 3% on revenues from the provision of certain digital services by qualifying multinationals, with a total worldwide revenue in excess of €750m and revenue from within the EU in excess of €50million. The proposed DST, should it be adopted, would be levied on gross revenues (net of VAT) from certain online advertising, transmission of collected user data, as well as from digital platforms which facilitate user interaction. The aim of the European Commission, through the DST, is to hit digital firms that rely heavily on user participation as a means to generate revenue, a move which some have labelled as specifically targeting digital giant multinationals headquartered within the United States, at a time when the United States has pushed through the biggest federal tax reform in a generation. Whilst the DST is only expected to find application until a long-term solution can be found, many fear that such an interim measure could potentially become a permanent fix, along with the perceived issues which have been identified so far.
The developments broadly discussed above ought to be carefully considered from a Malta perspective, given the importance which digitalised business continue to play within the economy. As the EU proposed directives go through the different consultations and discussions, along with the OECD’s report set to land in 2020, the impact which these will have on Malta’s competitiveness should be fully understood. This is essential, especially with the increased importance that the iGaming and IT sectors play within the economy and considering further Malta’s recent commitment in developing a regulatory framework for the blockchain industry to flourish.