how measure to tax the digital economy will challenge business … · 2020-07-10 · how measure to...

How measure to tax the digital economy will challenge business structures forever

Tearing up the rulebook

June 2019Susan Seabrook, PartnerBen Jones, Partner

Breakout Sessions1. How innovative in-house teams deliver value in the evolving legal market

2. Tearing up the rulebook: how measures to tax the digital economy will challenge business structures forever

3. How to drive a global diversity agenda: legal and cultural challenges

4. Cross-border investigations: successfully managing global regulators and the cost of getting it wrong

Tearing up the rulebook:how measures to tax the digital economy will challenge business structures forever

The Digital EconomyWhat is the fuss about?

Eversheds Sutherland

What is the fuss about?The Digital Economy:

─ The digital economy gave rise to new business models, including:

─ E-commerce, app stores, online advertising, cloud computing, social media platforms, and online payment services

─ Key features of the digital economy:

─ Mobility with respect to• intangibles,

• users, and

• business functions

─ Reliance on data and

user participation

The perceived tax problem


Tax challenges of the Digital Economy

THE PERCEIVED PROBLEM

Reliance on intangible assets

Massive use of data

Widespread adoption of multi-sided business models capturing value from externalities generated by free products

Difficulty of determining the jurisdiction in which value creation occurs

Relocation of core business functions

International reform proposals

8


OECD’s BEPS Project and Digital Economy Tax Proposals

─ In 2012, the G20 asked OECD to create an action plan to address base erosion and profit shifting (BEPS) by identifying domestic and international actions to address the problem under a specific timeline

─ Subsequently, in September 2013, OECD/G20 countries adopted a 15-point Action Plan to address BEPS

─ The Action 1 was named “Addressing the Tax Challenges of the Digital Economy.” A Final Report was published in October 2015

9


Timing is everything

2013•EC State Aid Cases•EC commenced state aid investigations with respect to tax ruling practices of member states

2015•BEPS Project•Action 1 Digital Economy Recommendations; Action 7 Permanent Establishment Standards; Actions 8-10 Transfer Pricing all have implications for digital economy

2017

•OECD Digital Project•Arises out of Action 1, with Projected Final Report in 2020; Interim Reports issued in 2018 and 2019, followed by consultation document

•Recent public consultation

2017

•US Tax Reform•Significant reduction in corporate tax rate; shift toward a territorial system, with anti-base erosion measures

•Tax on “global intangible low-taxed income,” but no special measures for digital businesses

2018

•EC Digital Proposals•EC releases its proposals for a DST and a long term SDP, with negotiations focused on DST; proposed 2021 start date

•France and Germany set deadlines, after which they will implement unilateral measures

2019•Public Consultation Document•OECD releases possible solutions to address the tax challenges with the digitalization of the economy•Public consultation meeting held on March 13-14


OECD Proposals: The options on the table

•Adjust transfer pricing rules to take into account value of “user participation”

•Minimum tax proposals tied to deductible payments and/or worldwide income

•Adjust transfer pricing rules to take into account “marketing intangibles”

•Update the permanent establishment standards to include “significant economic presence”

Permanent Establishment

Transfer Pricing

Transfer Pricing

Income Inclusion Rule

The US position


Global View v United States ViewDigital Economy

United States: Generally

─ The digital economy is the economy

─ The United States wants a fair, non-protectionist system, that ensures they receive their revenues from the Digital Economy

─ Generally, the United States is taking a “wait-and-see” approach

─ “The United States opposes any digital services tax proposals whether they be French or UK” –Chip Harter, US Treasury official


United States: Concerns


─ The US is against the creation of a tax regime that cannot adapt with the digital economy• fear is in the adoption of a rigid plan which would quickly become

outdated as the digital economy evolves

─ The US believes that if OECD moves too quickly without finding a correct solution, an inferior regime will result in substantial litigation. “Fast is fine, but accuracy is everything”• the US is concerned the rush is based on political pressure from

EU nations and not based around achieving a fair outcome that will work for years to come

• “It’s like a bunch of kindergarteners trying to price a unicorn” –Hernan Allik, Partner, Deloitte Canada


United States: Position


─ Administrable rules on taxing the digital economy will be key to a long term solution

─ “Taxes should be based on income, not sales, and should not single out a specific industry for taxation under a different standard.” – Steve Mnuchin, Secretary of Treasury, Oct 25, 2018

─ The United States Opposes Digital Service Tax on gross revenue


United States: Preferences


─ The United States favors giving more taxing rights to market jurisdiction based on marketing intangibles

─ For the time being the United States will continue to back its Foreign-Derived Intangible Income provisions over EU objections


United States: Potential Plan

Global View v Unites States ViewDigital Economy

─ Possible new global tax plan (announced by Treasury)• introduce a global minimum tax

on multinational companies’ CFCs (≈US GILTI; but applied on a per-country income basis

• allow jurisdictions to tax profits on local marketing “intangibles” used within that (market) jurisdiction (even if investment offshore)

• accompanying “defensive measures” to prevent base erosion – similar to the BEAT

International perspective

18


─ In the absence of consensus on a multinational approach, a number of jurisdictions have enacted or imposed unilateral measures targeting the digital economy

Impatience with OECD driving unilateral measures

Proposed

Enacted/Implemented



Proposed Measures:

Austria

Belgium

Italy

Spain

United Kingdom

Enacted/Implemented Measures

France

Hungary

India

Indonesia

New Zealand

Singapore

Slovakia

Pakistan

Taiwan

Turkey

Direction of travel

21



Intangible Value

─ Under current tax principles, the country where value is created does not decide how that value is taxed

FUNDAMENTAL Problem: Where is the “real value” located?

─ Location of user contribution and data, or

─ Location of physical elements (eg, engineers, servers, buildings)

Minimum Tax

─ Under current tax principles, there is no effective minimum tax rate for domestic corporations

─ Profits are shifted to foreign branches and are not required to be accounted for by their domestic parents


Program of work to develop a consensus solution to the tax challenges arising from the digitalisation of the economy

─ 31/05/2019 - The OECD announced that the international community had agreed on a road map for resolving the tax challenges arising from the digitalization of the economy

─ The 129 members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) adopted a Programme of Work laying out a process for reaching a new global agreement for taxing multinational enterprises.

─ The Programme of Work draws on analysis from a Policy Note published in January 2019 and was informed by a public consultation held in March 2019

─ The Programme of Work will explore the technical issues to be resolved through the two main pillars:

• Potential solutions for determining where tax should be paid and on what basis ("nexus"), and what portion of profits could or should be taxed in the jurisdictions where clients or users are located ("profit allocation").

• Design of a system to ensure that multinational enterprises – in the digital economy and beyond – pay a minimum level of tax.


The US Domestic and Federal approaches to the Digital EconomyAt cross purposes?

Expanding economic nexus principles (within the confines of the Constitution)Formulary apportionment

No change to permanent establishment standardsContinued adherence to the arm’s length standard

US

Sta

te T

axU

S Fed

eral Tax


Challenges and trade-offs

─ Trade-off between precision(detailed determinations) and certainty/predictability(simplified methods)

─ Implementation of new or modified withholding mechanisms to improve compliance and enforcement may be required

─ Administrative burdens to determine taxpayers, allocate tax liability and mitigate risk of non-compliance

Key concerns for business


Key concerns for business

─ Confusion about which types of business activity are subject to tax

─ Potential of double taxation due to varying taxing schemes

─ Tax disputes─ Violation of existing

treaties─ Unanticipated increased

costs to the existing and future digital strategies of businesses

27

Structuring decisions

28


ApportionmentLessons from US State Tax

Apportionment Shift

• Move from costs of performance to market-based sourcing

• Growing reliance on sales factor

Apportionment Serves as a Rough Approximation

• Supposed to match the in-state business activities

• risk of double taxation

• risk of under inclusion – allowing nowhere income

• Taxpayer bears the burden of proving that the income attributed to a state is:

• out of all appropriate proportions to the business transacted in that state; or

• led to a grossly distorted result

Alternative Apportionment

• Acts as a pressure valve for when the standard apportionment formula produces arbitrary and unreasonable results

• but the exception is becoming more frequently invoked with significant litigation surrounding the applicability


Problems and challenges – transfer pricingLessons from US State Tax – apportionment

Historically, few states have engaged in substantive

transfer pricing analysis, but interest has increased

─ Reliance on formulary apportionment

─ States have limited experience with transfer pricing and few resources

─ States have also utilized other solutions, eg, asserting nexus, addback provisions, etc

Instead, states often either:

─ Disregard transactions; or

─ Disallow 100% of tax outcome by arguing that the transactions are per se distortive


To discuss but ideasSlides(s) on structure impact

─ Potentially collapse/unwind historic tax structures where benefits arose from low tax on profits attributed to jurisdiction based on local assets activities where such profits are reallocated to higher tax jurisdictions under DE rules

─ Ring-fence digital operations in separate legal entities – ease of administration/clearer alignment of routine return activities with marketing intangibles

─ Existence of a digital presence / nexus may make a business decision for physical presence in a jurisdiction easier

─ DST type taxes on turnover may result in low margin activities in some jurisdictions being unprofitable and therefore not commercially sustainable

─ Pillar 2 BEAT type rules may fundamentally change how multinational groups fund expenditure and structure group payments (more to equity not debt funding, collapse of treasury company structures in low tax jurisdictions, collapse of treaty reliant structures)

─ [anything else?]

Participating in the conversation


Questions?

eversheds-sutherland.comThis information pack is intended as a guide only. Whilst the information it contains is believed to be correct, it is not a substitute for appropriate legal advice. Eversheds Sutherland (International) LLP can take no responsibility for actions taken based on the information contained in this pack.

© Eversheds Sutherland 2019. All rights reserved. LON_LIB1-#20634638

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