Author: Paul Verhaeghe

1. Next to the extensive report filed in October 2015 by the OECD that addresses avoidance of Permanent Establishment criteria in general under Article 5 of the OECD’s tax treaty model, a more specific action was undertaken towards taxing digital economy.

The OECD launched a two-week public inquiry on taxing digital economy [1] in October 2017. The reporting participants can be roughly divided into three groups of stakeholders :

• Digital companies (Blablacars, Spotify) and companies who have developed significant digital activities (Sony),
• Intermediaries (banks, certified/chartered accountants, tax-lawyers, tax-consultants),
• Civil society (professors, tax justice groups and individuals).

2. Digital companies invoked their positive impact on overall growth and innovation for questioning the need of taxing their activities by other means than the existing rules. They seem to fear excessive taxes and double taxations.

The company with large digital activities (Sony) invoked that technology and competition have forced them to switch their business model to downloadable content through accounts, rather than material carriers of music through shops.  This company requests that criterions of taxation should not lead to a new increase of tax compliance burdens.

3. The bulk of the intermediaries questioned the possibility to distinguish clear criteria between a digital and a non-digital company.

They generally express fear for arbitrary taxation that hamper growth or indicated that no taxation (withholding tax, equalization levy, transaction tax) is possible without violating various rules and tax treaties.

Dutch tax lawyers[2] resumed these concerns in concise terms :

“The apparent consensus is that profits should be taxed in the jurisdiction in which value creation occurs. The difficult question is how to determine where value is created.”

“Based on the above, we come to the conclusion that it will be very difficult from a corporate tax point of view to treat the digital economy separately or differently from the rest of the economy in a world that is becoming increasingly digitalized.”

“If we cannot separate digital from non-digital, we should perhaps not even try.”

4. Whereas Milanese tax lawyers[3] see the unfolding technology of clouds as an ultimate shift from territorial tax criteria of production towards territorial tax criteria of consumption.

They also indicate that the users’ data, which is collected by providers, is used for various commercial purposes. This personal data has an important economic value.

These participants propose to apply the definition of Permanent Establishments under Article 5, § 2, (f) OECD MC (any other place of extraction of natural resources) for personal users’ data as extracted in the territory of the State the users reside in.  They further suggest the tool of a world level profit split of the group the provider belongs to calculate the profit tax base of the data collected of these users.

5. It is however in the author’s view strongly debatable if Article 5, § 2 (f) OECD MC could apply on digital activities without at least the physical location in the Member state of one or more servers or terminals that access those servers in an office of that provider based in the territory of that State.

In general, an economy of goods offered clear criteria where and how the value was created.   In economies where services became the main contributor to wealth, the same criteria were more or less maintained for as long as the client had to come to the offices where the services were made available to him.

Digitalization makes it increasingly difficult to maintain territorial production criteria and leads to serious tax distortions under the obsolete profit base criteria.

Other economical entities, potentially worldwide based, are willing to pay for publicity these users see or for the data, containing the users’ preferences, for marketing purposes. It is therefore logic to adapt the tax system in general to this new reality.

But if one reads Article 5 OECD MC as a whole, they consider software, hardware and most of all – indirectly – humans, as a natural resource; which is a highly questionable view with regard to the contracting parties intent when they agreed on Article 5, § 2 (f) OECD MC.

The author nevertheless found it to be an interesting view that triggered his search if criteria other than Article 5, § 2 (f) OECD MC could be less debatable through various non-fiscal compliance requirements.

6. The third group of stakeholders to the OECD public enquiry consists of civil society They express their concerns in general ways on the problem of income tax base and profit tax base distortions through activities that are hard to locate and to economically quantify.

A participating group[4] stated a paradigm shift in international tax is needed :

“The main changes due to digitalization are

(i) the closer relationship it both requires and enables between producers and consumers;

(ii) the digital services that are often supplied with no direct charge to users, while their inputs are monetized through revenue generated through services provided to other customers, especially advertising; and

(iii) the ability that digitalization gives for some firms to recharacterise themselves as pure intermediaries between producers and consumers.”

While awaiting this shift in international tax, this participant group pleads for temporary tax measures to address distortions without further waiting.  Other participants[5] suggest reviewing permanent establishment definitions and use the issuers of credit cards for the purpose of collecting a withholding tax on payments through these cards.

7. A possible definition of digital economy can be considered as formed by all activities that allow creating value through digital means. They relate to users, goods and services in general and even trading in particular.  Classic criteria of goods and services do not suffice to value the wealth created by the digital economy[6].

Technical innovations over the past decades have set in motion a considerable reduction of the costs for clients to access companies wherever they are located in the world and have increased the types of services that can be offered by these companies.

A company that mainly communicates with the bulk of its national clients through digital means such as websites, mails or call-centres should be considered subject to digital tax measures when a given % of orders is dealt through exclusive digital tools.  Even if this company supplies goods to consumers, such as gas, electricity or water.  Even if it is a bank that offers applications on smartphones that no longer needs human interfaces for trading on the stock market or all sorts of internet banking.

Free users and their collected data represent an increasingly important economic value for advertising and marketing that pose problems in terms of determining the size and allocation of their created wealth.  The data collected from paying users can be considered of even higher relevance for advertising and marketing purposes, and should as such give cause to an even higher economical value of these data.

8. Tax distortions are more easily organised in a digital economy. They relate to :

• Income originated in the Member State from a digital activity offered in that Member State, is taxed differently if that income is not collected inside but outside the Member State.

The profit tax base originated in the Member State is delocalized by allocation of the collecting of income.

• Even when all originated income is collected through a company or a Permanent Establishment in the Member State, allocating a part of the offered digital activity outside the Member State gives cause to annihilate or substantially reduce the profit tax base formed by that collected income.

This eroding of the profit tax base originated in the Member State is triggered by allocation of the digital activity outside the Member State.

Both types of dislocations can occur in the same business model and reinforce each other’s effects on preventing taxation in the Member State where the profit tax base is originated.

9. A possible relevant definition for digital companies relates to all companies that mainly or exclusively operate digitally in their contact with clients. Their main resource is data and data processing of its clients. They are different from other companies with digital activities that also need physical storage for goods or tools.

Their working costs allow an easy start-up.  It basically suffices to have an access to the Internet and a server and to scale the server up as the number of users or clients grow.  Such companies can be easily transferred or reorganised for tax engineering purposes.

10. The smaller the digital company, the higher the relative cost for tax compliance for doing business outside the Member State it is based in. The digital company has to compete with larger competitors, both inside and outside the Member State, that effectively suffer lesser corporate income taxes through tax engineering.

If competition is fierce in price setting, equally sized digital companies located in Member States with lower corporate tax rate and profit tax base, have a higher competition advantage in offering their services at a lower cost.

This creates a distortion of the Integrated market and can force companies to incorporate themselves in the Member State with a lesser tax rate or base in order to create an advantage over their competitors in other Member States or to neutralize that advantage.

11. A possible definition for relevant digital activities are business models with increased risks of tax distortion through optimization of allocation of digital activities and/or income :

• Companies that offer both free and paying digital services to users.
• Companies that sell goods for the digital economy would typically include high percentages of royalties or patent rights in their price or mainly offer goods through digital activities.
• Companies that mainly offer services through digital activities form the fourth business model. Digital trading and web-based tools of payment activities form a sub category of that business model.

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[1] OECD, Tax Challenges of Digitalisation.  Comments received on the Request for Input – Parts I & II, 25 October 2017
[2] OECD, o.c., Part II, Loyens & Loeff Amsterdam, 13 October 2017, p. 134 – 143
[3] OECD, o.c., Part II,  Ludovici Piconne & Partners, p. 144 – 150
[4] OECD, o.c., Part I, The BEPS Monitoring Group, p. 20
[5] OECD, o.c., Part II,  Prof. Saturnina Moreno and M. José Ángel Gómez, 12 October 2017, p. 275 – 278
[6] OCDE, Tax Challenges of Digitalisation, Comments Received on the Requests for Input – Part II, 25 October 2017, contributions of Prof. Dr. Christoph Spengel, Ann-Catherin Werner and Marcel Olbert, p. 305, point A.3 with reference to footnote 9, point C.2 and D for various other tax suggestions