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Tax challenges of digitalisation: the view from the OECD

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2018 was a pivotal year for building international cooperation on addressing the tax challenges of digitalisation. Countries agreed to revisit on nexus and profit allocation rules as highlighted in the OECD’s interim report published in March 2018, and are now working to develop a global consensus-based solution. The OECD hopes to present a clear way forward in 2019, with a view to helping countries reach a sustainable long-term solution in the final report to the G20 due in 2020.

Where we started

Since the launch of the OECD/G20 base erosion and profit shifting (BEPS) project in 2013 and the delivery of the BEPS package in 2015, we have witnessed great international development to tackle aggressive tax planning. It is remarkable that today, 125 countries and jurisdictions participate on equal footing in the OECD/G20 inclusive framework on BEPS to ensure that the agreed measures are implemented in a coordinated way. We also saw the widespread implementation by countries of the four BEPS minimum standards, in the areas of: harmful tax practices (Action 5); treaty abuse (Action 6); country by country reporting (Action 13); and dispute resolution mechanisms (Action 14).

While the BEPS project adopted a holistic approach to address the multiple causes that were pressuring the international tax framework, one of the most pressing matters were the tax challenges caused by the digitalisation of the economy. The continuous evolution of technology and the widespread adoption of information and communication technologies have drastically changed business models and revolutionised how products and services are produced, delivered and valued. While it is true that over the last decades these developments have been the cornerstone for innovation and economic growth, they have also been disruptive and threatened the effectiveness of traditional tax rules and principles.

The BEPS project noted that the existing legal framework did not keep pace with the rapidly changing economic environment, which exacerbated the risks of certain tax avoidance practices. To address these concerns, the OECD’s Committee on Fiscal Affairs established the Task Force on the Digital Economy (TFDE), which in 2015 prepared the BEPS Action 1 report on addressing the tax challenges of the digital economy. The report identified the key features of digitalisation, how these affect the international tax framework, and concluded that it was difficult to ring-fence the ‘digital economy’ from the rest of the economy for tax purposes. Furthermore, the report explored a series of measures to address the broader tax challenges of digitalisation, specifically issues concerning nexus, data and characterisation of income. No solution was recommended at this time because there was no consensus among countries on what the approach should be. For this reason, the report acknowledged that although some countries may feel the need to act quickly and could potentially opt for unilateral action, it would be crucial to comply with obligations previously assumed though bilateral tax conventions and other international treaties. Countries also agreed that it was important to continue to monitor developments in this area, and in particular, to evaluate the effects of other BEPS measures on the tax challenges of digitalisation.

The state of play

Looking back, 2018 can be considered a pivotal year for international cooperation on addressing the tax challenges of digitalisation. A year ago, the prospect of achieving a global solution, given some countries’ positions, did not allow for optimism. Today, countries have demonstrated great willingness to collaborate on these issues, including the United States, and there is a strong display of unity and commitment within the international community to develop a sustainable regulatory framework at the highest political level.

In March, the OECD secretary general presented the Tax challenges of digitalisation: interim report 2018 to G20 finance ministers. The interim report acknowledged the divergences among countries on the tax implications of the digitalisation of the economy, the complexity of the issues at hand, as well as the political pressure some countries face to act as soon as possible. While the interim report did not endorse the use of short term, temporary measures, given that no consensus was reached on their need or merit, it did provide a framework for countries that wished to adopt such measures until a long-term, global solution is found.

In addition, the interim report highlighted that countries agreed to revisit on nexus and profit allocation rules, fundamental concepts linked to the allocation of taxing rights. Regarding long-term solutions in the direct tax area, the interim report identified that the different perspectives among the members of the inclusive framework generally fell into three groups. The first group considered that the reliance on data and user participation could lead to misalignments between the location where profits are taxed and the location where value is created. However, they considered that these business models do not undermine the principles of the existing international tax framework and thus they did not support wide-ranging change. The second group believed that the ongoing digital transformation challenges the effectiveness of the existing international tax framework, and therefore that challenges are not limited to purely digitalised business models. Finally, the third group was of the view that the BEPS package has addressed most concerns of double non-taxation, even though they noted that it is still too early to fully assess the impact of all BEPS measures. They considered there was no need for any significant reform of the international tax rules.

In parallel, last March the European Commission also presented a proposal to tax digital business activities which included both short and long term plans. In the short term, the European Commission would like to introduce an EU-wide digital services tax (DST), and in the long term to reform corporate tax rules through the introduction of a taxable ‘digital presence’. These measures at first sparked concerns about a spur of countries regulating unilaterally, especially with regards to the introduction of a taxable ‘digital presence’. However, the majority of the DST concerns have been appeased thanks to the proposed introduction of an ‘inverted sunset clause’, meaning the DST would only apply if countries failed to reach a long-term agreement within the OECD before 2020. At this stage, the EU Council did not agree to adopt the DST and the debate is expected to continue in the coming months. It is important to highlight that regardless of what short term measures some countries choose to implement, most of EU member states are in favour of fostering a cooperative environment that ensures a global long-term solution prevails.

In July, the TFDE held a meeting to develop concrete proposals based on the general positions identified in the interim report. Significant progress was made at the meeting and several solid proposals were put on the table. While the UK proposed to build on the concept of user participation, the United States proposed to explore a broader solution based on transfer pricing and marketing intangibles. In addition, France and Germany expressed an interest in exploring a global anti-evasion measure, which would ensure minimum levels of effective taxation.

In November, the inclusive framework’s steering group held a meeting to advance on the subject and identify the current status. This meeting concluded that the proposals are a good basis to move forward and that a general agreement could be reached, subject to further adjustments. This approach was discussed at the TFDE meeting in December. It was agreed to propose a general policy direction for the inclusive framework to approve at its plenary meeting to be held in January 2019.

What comes next

The OECD’s work on digitalisation does not only address international tax rules and principles. Another important aspect covers the broad effects that technologies, such as blockchain and crypto assets, have on taxation. The use of these technologies can be beneficial for both taxpayers and revenue authorities, considering that they allow for enhanced registration and authentication of taxpayers. Therefore, they could increase security and confidentiality while facilitating taxpayer compliance and revenue collection. However, these technologies may also raise concerns given the widespread uncertainty on how to tax the value created through these assets. Furthermore, these technologies may potentially threaten tax transparency developments, given that they are able to hide the identity of those sending and receiving payments. These technologies and their implications for revenue collection and tax compliance in general must be further analysed, and the OECD is now working on it.

Beyond the positive results and the general spirit of collaboration up until now, it is important to stress that much work will be needed in the coming months, at the technical and political level, to develop a global consensus-based solution. The OECD is undertaking the role of facilitator and wishes to offer continuous support to address the tax challenges arising from digitalisation. Thus, as progress increases and work develops we will continue to engage with stakeholders to promote a coherent solution that levels the playing field between countries and provides certainty for enterprises and taxpayers.

For 2019, our expectations will be to present a clear way forward in the update that will be presented in June 2019, and to help countries to reach a global long-term solution in the final report to be delivered in 2020 to the G20.