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EU's Digital Sales Tax Could Prompt New MLI

26 April 2018

Tax experts have criticised the EU’s digital sales tax for being unfair towards digital companies and questioned if a new multilateral instrument is necessary to amend the PE definition in tax treaties to include a significant digital presence.

20 April 2018

The European Commission (EC) set out two proposals for taxing the digital economy on March 21. The first proposal, a long-term solution, would enable member states to tax profits generated in their territory and is based on the concept of a virtual permanent establishment (PE). The second proposal is an interim tax on revenues created from certain digital activities.

The digital sales tax would be applied at a rate of 3% on revenues from certain digital activities, such as revenues created from selling online advertising space; revenues created from digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them; and revenues created from the sale of data generated from user-provided information. It would apply to companies with total annual worldwide revenues of €750 million or more and EU revenues of €50 million or more, and would be collected by the member states where the users are located.

However, the measure has generated discussion among tax experts. Philip Baker QC, barrister at Queen's Counsel Field Court Tax Chambers, shared his personal views on the tax at the CFE Forum on Fair Taxation of the Digital Economy in Brussels on April 19. He suggested that a new multilateral instrument (MLI) to amend tax treaties might be appropriate.

The proposals are aimed at companies with a “significant digital presence”. The proposals would supersede double tax treaties between member states and would also apply if a member state does not have a double tax treaty with a third country. However, they would not apply when member states have double tax treaties with third countries. The EC therefore recommends adapting double tax treaties with non-EU countries.

“It will be necessary to change tax treaties because they contain PE definitions that don’t cover significant digital presence. Between member states that is not a problem, but with third states treaties will have to be renegotiated. How realistic is that, bearing in mind the home country of many of these businesses [the US] is not necessarily going to agree?” Baker asked. “What’s critical is the link with the work [being done on taxation of the digital economy] at the OECD, but the disadvantage is that the OECD is a consensus-based organisation and there is no guarantee they will reach a consensus. If there is a consensus, perhaps there will be a new MLI that changes the definition of PE.”

Ring-fencing the digital economy

One of the concerns is the fairness of the proposals as they only apply to certain features of digital companies.

“The digital services tax is very obviously discriminatory as it applies only to the digital sector and only to certain categories within that. It will need to be justified if it is challenged. As to proportionality, it is at 3% on gross, at a fairly low level, but the impact depends on the margin of the company concerned,” Baker said.

The EC has said the proposals are based on fair taxation and will ensure digital business activities are taxed in a “fair and growth-friendly” way. The proposals reflect the EC’s view that a significant part of digital businesses’ value is created where users are based and data is collected.

Aart Roelofsen, deputy head of the international tax division at the Dutch finance ministry, spoke in a personal capacity at the CFE Forum. He said the fairness depends on the comparison, as the proposals contain a comparison between companies and individuals.

“They say to the public ‘if you pay your taxes, Google should pay their taxes’. I think that is a very misleading presentation. Companies are not individuals, companies may pay taxes, but they cannot bear taxes. If we increase the corporate income tax, that will be passed over to either the shareholders or the employees or the customers, and the only real comparison we have to make is between individuals,” Roelofsen said.

Roelofsen, who is also co-chair of OECD Working Party 1 dealing with tax treaty issues, and of the UN Committee on the Tax Challenges related to the Digital Economy, said an effective corporate income tax could help decrease the increasing inequality in income and capital for individuals.

“So from that point of view, any increase in corporate income tax will be welcomed by me personally, including one on digital economy. Regarding the fairness of the EU proposals the question is whether there is a good reason to tax a significant digital presence, why digital companies should be taxed differently from other companies, why the attribution by customers should be taxed with the company somewhere else. Those customers don’t do that for free, they do create value for the company but the company does something else in place for it,” Roelofsen said.

The EC said in its proposal that the new rules do not target or ring-fence any individual companies, sector or nationality. “The common structural approach covers all companies, both EU and non-EU that have a significant digital presence in the union,” the proposal stated.

Questions around compatibility with EU law have also been raised. Baker said this tax on gross revenue looks like a tax on turnover.

“We are only supposed to have one tax on turnover, the VAT, in the EU.  The case law here is complex, and it is difficult to conclude whether a challenge to the tax might succeed,” Baker said.

Potentially long-lived

Some have warned that the interim tax might take away the urgency of developing a longer-term solution and could end up becoming permanent. There have been many examples of temporary taxes becoming permanent, such as the UK personal income tax, which was introduced in 1799 to pay for the Napoleonic Wars and still remains. The EU VAT system, which was introduced in 1993, was only supposed to last for three years.

Bert Zuijdendorp, head of unit for company taxation initiatives at the EC, addressed the concerns at the CFE Forum.

“There are two ways of looking at that. The digital sales tax is a measure to address an urgent need but it is not a sufficient measure for the long term. It wouldn’t satisfy member states in the long run and wouldn’t reduce their appetite to look for a comprehensive solution. The other way to look at it is that an interim measure can also help sharpen the minds to focus on a long-term solution,” Zuijdendorp argued.

The above article was published on www.tpweek.com on April 20 2018 and has been republished with the approval of the Publisher.



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