by Iva Guterres, PhD student at the University of Leeds
In 1995 Don Tapscotts coined the term Digital Economy in his book, “The Digital Economy: Promise and Peril in the Age of Networked Intelligence”. At the time, he was far for imagining just how the future would be dictated by the internet and technological development (then still in its infancy). In the meantime, the internet has become a huge part of the global economy. Tapscotts’ book established the connection between the internet and the way economic models would change the way business was done and seen from there onwards.
At the beginning of the 1990s one major question rose on the legal landscape. What would the challenges be for global e-commerce and the tax rules or even global digital taxation? In 1996, David Tillinghast[i] wrote an article in which he questioned how traditional tax rules or policies would react to cross-border e-commerce.
Since then, history has witnessed radical changes in society and in the economy, which took Klaus Schwas, founder and chairman of the World Economic Forum, to write the book, “The fourth Industrial Revolution in 2016”.
In recent years, the EU and the OECD have been keeping an eye on business activities, especially since 2013, through the BEPS project (The Base Erosion and Profit Shifting). This was motivated by the behaviour of multinationals attempting to avoid paying tax in their home countries by taking their businesses abroad to low and no-tax jurisdictions. This generated practices and behaviors of schemes indicting aggressive fiscal planning.
The so-called aggressive tax planning has been prominent in the public discourse in several countries and has prompted action by the OECD and the UE, especially taking into account the big digital companies and their practices across the 28 Member States. As a result of this kind of behaviour, EU Member States have lost an estimated 50-70 Billion in tax revenues annually.
Therefore, while unpopular with electorates, it transpires that aggressive tax planning has been employed, if not with the connivance of governments, then often with their tacit knowledge. Often, companies have employed professional services from some of these economies, including the prominent financial services firms, in particular those in leading international accountancy firms.
Such intervention seems paradoxical when we observe the increasing pressure placed on national budgets to raise tax revenue, particularly in the wake of the 2008 global financial and economic crisis. In effect, this has meant that the burden of raising tax revenue has fallen disproportionally on corporations unable to avoid taxation. Since 2014, public disclosures have revealed the “true nature” of tax practices adopted by multinational enterprises (MNEs). Time and again, news stories have shown that MNEs have been involved in publicly embarrassing and (not surprisingly) conflicting situations, and even “games” with(in) (and between) European countries – which often serve as the incubator of MNEs tax planning structures.
To name just a few examples: (1) the “Cablegate/Wikileaks” case, which released classified cables, including American MNEs’ tax information, which had been sent to the U.S. State Department by 274 of its consulates, embassies, and diplomatic missions around the world (The Guardian, November 29th 2010); (2) Offshore “Leaks/International”, which disclosed details of 130,000 offshore accounts in April 2013 (International Consortium of Investigative Journalist – ICIJ); (3) the “LuxLeaks dossier” exposed tax rulings with hundreds of MNEs in Luxembourg (Financial Times, November 6th 2014); and (4) the “SwissLeaks” laid bare the financial information of more than 100,000 of HSBC’s banking customers in its Swiss subsidiary in Geneva (Financial Times, February 9th 2015), and most recently, the Panama Papers (Financial Times, April 6th 2016), which was covered widely in the media.
The ingenious tax planning structures revealed by these cases are not surprising. The structure and principles of the tax systems date back to the 1920’s League of Nations, and are therefore no longer adequate for dealing with the current digital economic structure of a MNE operating on a global basis, and are vulnerable to abuse. The existing tax systems of almost all countries are inherited from a system based on the notion of a locally organised business, typically in close proximity to their customers and having a strong physical presence, i.e., based on the principles of territoriality and physical presence. These rules are outdated. The world has changed, the economy has become digitalized and has therefore changed the lives of billions of European citizens in the Single Market.
The digital economy is increasingly becoming the economy itself. The digital economy and its business models present, however, some key features which are potentially relevant from a tax perspective.
The digital economy can be defined as the global network of economic and social activities that are enabled by platforms such as the internet, mobile and sensor networks. We can already say that the digital economy is the economy and that the rise of the digital economy is largely due to the information and the communication technology (ICT) and the widespread of ICT tools, such as laptops, smart phones, smart mobile phones.[ii]
The new economic paradigm emerging from the digital economy brings with it further difficulties for the traditional fiscal rules. These difficulties are uniquely complex for the European single market and the 28 Member States along with their 500 million consumers. The EU is faced with two problems: the What of Tax, which means how to determine the value of the transaction for taxation, and the Where of Tax, meaning where taxation should be applied, as most transactions are virtual and have no physical presence.
New ways of doing business with no physical presence are indicators of the changes required and the new paradigm not only for the International Tax System, but also for the Economy itself. As an example, we can see the following economic models arising intricately within economic behaviour and the day by day tax implications that go with it: (i) the online retailer model, where large platforms sell goods or connect buyers and sellers in return, e.g. Amazon; (ii) subscription model platforms charge a subscription fee for continued access to a digital service, e.g. Netflix and Spotify; (iii) online marketplaces such as eBay, online employment agencies, accommodation sites such as Booking or Uber.
In sum, these new business models include electronics, app stores, online advertising, payment services or just platforms. The key feature of digital economies is that the digital goods are mobile, and this is entirely different from the traditional model brick-and-mortar businesses.
President Jean Claude Junker, in his 2017 state of the Union address to the European Commission, spoke about the struggle that policy makers are having in the fight to apply fair taxes to the digital industry. In the informal ECOFIN meeting in Tallinn, on the 16th of September, Member States supported the Commission to present solutions during 2018. The ministers agreed to develop new tax rules and the European Commission announced that the proposals might be presented in the spring of 2018.
Member States should have a coordinated position to make a greater impact on the taxation of profits in the digital economy. The principle of corporate tax is that profits should be taxed where the value is created, which is difficult in a digitalized world. Therefore, European common policy must pave the way to creating a new system which enables us to determine taxation rights, to define where business is performed with no physical presence and how to define profit within these new business models driven by intangible assets, data and knowledge.
In the European Council document of 30th November 2017, conclusions responding to the challenges of taxing profits within the digital economy define changes to present and develop in 2018. They refer, in particular, to the concept of permanent establishment, which must be changed in the new framework of international tax rules, because a business with a significant digital presence will have a virtual permanent establishment. In addition, some Member States are speaking about the introduction of specific taxes for the digital economy.
Change to the rules of taxation in the digital economy is also at the core of political debate within the Single Market. Recently, Google was acquitted in court from paying the French state an enormous amount in taxes. They claimed that they did not have a physical presence in the country, nor any responsibility under French law, when selling technology in France, which meant that the Tax Authorities could not collect corporate income from Google’s activities (The Guardian, July 12th, 2017).
Clearly, there is a need to correct the gaping flaws in the International Fiscal System, where tax rights can only be applied when there is physical presence. We live in hope that further solutions currently under review by the EU, and which are being put forward for approval by the spring, will take into consideration the difficulties identified above.
[i] David Tillinghast, ‘The Impact of the Internet on the taxation of international transaction’ (1996), 50 Bulletin for International Fiscal Documentation.
[ii] United Nations Departments of Economic and Social Affairs, “Protecting the Tax Base in the Digital Economy” (2014).
Picture credits: Untitled by Max Pixel.