9Dec 18 - Jan 19prefer revenues and profits to be taxed in their physical location, while countries that don't would rather tax where companies a significant digital presence--in other words, where the users are.Digital taxation is now at the heart of the tax agenda for the G20, the United Nations (UN), the Organization for Economic Cooperation and Development (OECD), the European Union (EU) and other regional groupings, and numerous countries. While international consensus exists on how to address indirect taxation of the digital economy, there is significant disagreement on direct taxation. Here are the hot-button issues that policy-makers and politicians are currently grappling with:1. Which jurisdiction gets to taxactivities under the digital economy? A permanent establishment (PE) threshold test is set forth in many national tax laws, is a core provision of numerous treaties, and is addressed in the Base Erosion and Profit Shifting (BEPS) Action 7. Among other things, the PE threshold determines whether a company has a sufficient local, physical presence to be taxed. The fact that many digital service provides have thousands of paying customers in a country but no physical presence--which lets the providers avoid paying taxes--has prompted significant action. For example, the government of India introduced, last year, a six percent equalization levy on online advertising revenue by non-resident e-commerce companies earned in India.2. Where in the production chain isthe value created? Value drivers such as algorithms are highly mobile and can easily be located to tax havens. The established, arms-length principle for pricing intra-company transactions is also harder to apply to knowledge-intensive services that are more likely to be produced by workers and business units spanning multiple jurisdictions. This is further complicated by the fact that such enterprises operating in the digital economy often pursue aggressive growth strategies that forgo short-term profits for longer-term revenue growth, further complicating efforts to value--and thus tax--each link in the production chain.3. How should the value of servicesco-created with users be taxed? The value of social-media companies such as Facebook, Instagram, LinkedIn, Twitter, and YouTube is directly related to the number of customers and the contents they produce--it drives advertising revenue, future user fees, and other income streams. But revenue authorities don't have the instruments--let alone the rights--to tax foreign companies, which benefit commercially from the involvement of their users.4. What should jurisdictions do topromote compliance in e-commerce? Foreign e-tailers' increasing popularity is creating compliance issues. This occurs when e-tailers fail to register for value-added tax (VAT) purposes in the various markets they serve (typically required when national sales exceed a certain threshold) and when customs duties are not paid (e.g., because items are declared as gifts or deliberately undervalued). The response by governments such as the UK has been to enter into agreements with platforms for them to institute compliance measures, e.g., obligating the platforms to share information about their online sales and to enforce VAT-registration requirements with their merchants.5. How should the sharing economy betaxed? Platforms for individuals to share their assets--such as cars (e.g., Lyft and Uber) and houses (e.g., Airbnb)--are challenging conventional business models, modes of regulation, and existing tax structures. The key issues here are determining whether these companies should pay VAT and payroll taxes, and how to verify that private individuals pay income tax on the revenue earned through these platforms.In time, we expect these various tax challenges to be addressed at the global, regional, and national levels--though at different speeds. Countries are taking the first steps to institute new tax rules at the national level. Agreement at the regional and global level of what the tax arrangements need to look like is taking longer, efforts by the European Commission and in the context of the BEPS project notwithstanding. CFOs are well-advised to keep up with legislative proposals in their key markets, engage in consultations led by regulatory agencies, and ensure compliance with local tax codes. Going forward, these will be the best ways to avoid incurring unforeseen tax liabilities, potential penalties and charges--and damage to their reputation. One thing is clear from our work: Existing tax policies--designed primarily with physical goods and locally delivered services in mind--are being aggressively challenged
< Page 8 | Page 10 >