Author: Paul Verhaeghe

1. The main issue in taxing digital activities is the technical easiness for providers in dislocating activity (offered) or income (collection) from the country where the profit tax base is economically triggered (originated).

As said above, the criteria for Permanent Establishments stipulated in existing tax treaties do not allow to allocate digital activities that don’t have a minimal form of physical presence in the country where the profit is originated.

Without Permanent Establishments, such activities escape various measures that seek to amend tax engineering that reduces the profit tax base. The lack of a Permanent Establishment will result in these fiscal measures not applying to such activities.

2. Under European direct tax rules, no definition of digital economy, digital companies or relevant digital activities exists. Taxation of corporate income is a competence that remained with the Member States. The considerations[1] of the Council Directive (EU) 2016/116 of 12 July 2016, laying down rules against tax avoidance practices that directly affect the functioning of the internal market, point in general at the necessity of anti-avoidance measures to apply equally to resident, non-resident and third country competitors.

CFC measures also best reduce tax compliance burdens by exempting entities with low profits or low profit margin for they give less cause to tax avoidance.

Direct tax definitions of digital companies or digital activities best apply these two considerations to avoid tax litigation by companies that consider themselves unfairly taxed where other national competitors are not or less taxed.

The Member States have to implement this Directive by December 31^st 2018. However, to be effective, it requires an established company or a Permanent Establishment in the Member State[2].   This Directive and its national implementations are therefor useful for that group of digital activities that meet the existing fiscal law requirements of Permanent Establishments.

By adopting non-fiscal law requirements of presence to all competitors that seek to exert a same size and type of digital activity, but that fall out of the scope of the Directive by lack of a Permanent Establishment in a Member State, the scope of the Directive and its national implementation could be considerably widened.  These non-fiscal law requirements of presence would then in turn trigger the fiscal law requirements of presence for Permanent Establishment purposes.

3. Under European indirect tax rules, some relevant digital activities presently qualify as telecommunication services or electronically supplied services. They allocate at the seat of the professional client (non-consumers)[3].  Article 24 defines services under this Directive as ‘any transaction which does not constitute a supply of goods’.  All relevant digital activities not relating to goods are taxable services.

It is also relevant to note that Article 24 defines ‘telecommunication services’ as :

“services relating to the transmission, emission or reception of signals, words, images and sounds or information of any nature by wire, radio, optical or other electro-magnetic systems, including the related transfer or assignment of the right to use capacity for such transmission, emission or reception, with the inclusion of the provision of access to global information networks”

Article 56, 1, (k) refers in turn to electronically supplied services that are defined in annex II of the Directive as :

(1) Website supply, web-hosting, distance maintenance of programmes and equipment;
(2) supply of software and updating thereof;
(3) supply of images, text and information and making databases available;
(4) supply of music, films and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific and entertainment broadcasts and events;
(5) supply of distance teaching.

It is clear that a substantial part of the relevant digital activities can qualify under this more specific definition of electronically supplied services.

4. The difference between telecommunication services and specific electronically supplied services relates to the place where the VAT transaction is deemed to happen.

Article 56 states that if these services are provided towards consumers outside the European Union (Community) or from one taxable person to another taxable person inside the European Union (Community) in another country, the place of the service is the address or seat of that taxable person or its fixed establishment (the client).

In order to prevent double taxation, non-taxation or tax distortion Member States can decide that telecommunication services, when offered from outside the European Union (Community) to a taxable person, are considered to take place in the seat of the taxable person or its permanent establishment (Article 57 TFUE).

This rule does not apply to electronically supplied services from outside the European Union (Community) to non-taxable persons (consumers) ; at present, these types of services provided from outside the European Union cannot be located in the European Union (Community) by the Member States for present VAT purposes.

Under the present law a substantial part of relevant digital activities escapes VAT rules on electronically supplied services to non-taxable persons.

5. As stated above, the Council of the European Union decided on 5 December 2017 to review VAT rules[4] and a proposal of Directive and two Regulations on electronic commerce are in process of adoption.

Coming into effect on January 1^st 2019 article 58 of the VAT Directive is to be modified and states that for both telecommunication services and electronically supplied services to non-taxable persons the service is considered to take place where that person lives.

Coming into effect on January 1^st 2021 articles 58 and 59 c of the Directive are to be modified and will state that both goods and all services that involve their shipment are considered to take place where they are delivered.

If the seller of these goods is not established or has no fixed base in the European Union, the new article 369p will obligate that seller and the intermediary appointed by the seller to, prior to the shipment into the European Union (Community), declare :

(a) name;
(b) postal address;
(c) electronic address and websites (of the seller) ;
(d) VAT identification number or national tax number.

Records must be kept by both the intermediary and the provider for control purposes.  The consideration (8) of the VAT Directive reminds that ‘Where the records consist of personal data, they should comply with Union law on data protection.’.

The VAT Directive seems to concern all relevant digital activities in goods and paying services that don’t have a fixed base in the European Union and thus more effectively addresses indirect tax purposes dislocation through activity (offering) or income (collecting).

6. For Member State direct tax purposes they remain competent in taxing profit through relevant digital activities. Next to their tax treaty obligations, Union law also imposes requirements to Member States for that direct taxing purpose.

It is not debated in the present state of the European Union law[5] that each Member State can tax sovereignly in the matter of national or regional corporate tax rates and bases, if done so – in substance – by not hampering the Internal Market and the existing common decisions in indirect tax matters. 

The power of Member States in direct taxation is so indirectly limited by their general obligations (freedoms of the Internal Market, Council Directives, Tax Treaties, constitution) and their obligations under indirect taxation. 

If Article 4 TEU gives free reign to the Member States to act sovereignly, with respect for the treaty’s obligations, then this is not the case for the Commission.  The Commission has no power in direct taxation.

Initiatives in direct taxation must be embedded under Article 5 TEU, which leaves the Council as the authority to decide on these measures and the Commission to suggest and execute them.

7. With regard to the freedoms that are guaranteed by the TEU and TFEU under the Internal Market, the freedom of services is qualified by Article 57 TFEU as those services that are normally provided for remuneration and are not governed by the provisions relating to freedom of movements of the other three freedoms (goods, capital and persons).

How does this affect the power of direct taxation of Member States with regard to users of digital services with free access, such as websites (Google, yahoo,..) and networks (Facebook, Twitter, LinkedIn,..) ?

The logical deduction is that free digital services are not protected under the provisions of the Internal Market that relate to services.  Member States could argue that they can adopt direct tax measures that distort the market of such free digital services.  Such national legislation should however be very careful not to discriminate or to indirectly violate other Union laws.

8. Article 65 TFEU allows Member States to adopt unilaterally restrictive tax measures towards both Member States and third countries that can hamper the free movement of capital and payments. No such provision exists for the other three freedoms under the Treaty.

Article 65 (1) b empowers Member States to :

“take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation (..)”

Arbitrary discrimination or disguised restrictions on the free movement of capital and payments are forbidden (Article 65 (3)).

9. Article 292 TFEU, combined with Article 65 (4) TFEU, could provide the Commission with a legal base for guidelines on direct taxation with regard to third countries.

Article 65 (4) TFEU empowers the commission to state that restrictive tax measures related to third countries that violate the interdiction of restrictions on free movement of capital and payments, are compatible with the European Union law, as far as they are justified by one of the objectives of the Union and compatible with the proper functioning of the Internal market. 

This is a specific power of the Commission that may qualify under Article 292 TFEU.

While not being compulsory for the Member State, such references by guidelines and considerations may increase the chance to uphold their unilateral digital tax measures before the Court of Justice of the European Union[6].

10. In a ruling of 13 November 2014 the tax criteria for Member States under Article 65 (3) TFEU or ‘by overriding reasons in the public interest as defined in the Court’s case-law‘ were once more confirmed[7] by the Court of Justice of the European Union.

Directive 2006/123 of 12 December 2006 on services in the internal market^[8] defines under Article 4 (8) the notion of ‘overriding reasons of public interest’ as :

“means reasons recognised as such in the case law of the Court of Justice, including the following grounds: public policy; public security; public safety; public health; preserving the financial equilibrium of the social security system; the protection of consumers, recipients of services and workers; fairness of trade transactions; combating fraud; the protection of the environment and the urban environment; the health of animals; intellectual property; the conservation of the national historic and artistic heritage; social policy objectives and cultural policy objectives;”

The following general criteria must be observed by the tax law of Member States :

• an objective justification for the restriction by legitimate interest recognised by the law of the European Union,

Such objective justification can be used to target ‘wholly artificial arrangements which do not reflect economic reality and whose sole purpose is to avoid the tax normally payable on the profits generated by activities carried out on national territory’.

Such objective justification can be to ‘safeguard the allocation between the Member States of the power to impose taxes’ [9].

• the restriction must be appropriate to the objectives of combating tax evasion and tax avoidance and not go beyond what is necessary to attain them.

Such an appropriate restriction allows the taxpayer to prove that there is a commercial justification for that transaction without subjecting the taxpayer to undue administrative constraints in giving this proof.

Such appropriate restriction is confined to the part that exceeds what would have been agreed on an arm’s length basis between parties[10].

Such appropriate restriction also requires in more general terms[11] :

‘the principle of legal certainty, in accordance with which rules of law must be clear, precise and predictable as regards their effects, in particular where they may have unfavourable consequences for individuals and undertakings’.

11. In the contribution of the International Observatory on the taxation of the Digital Economy (University of Lausanne, International Bureau of Fiscal Documentation, KU Leuven) to the OECD public enquiry on taxing digital economy[12] a direct tax under the form of a withholding tax charged on some digital activities is proposed as compatible with Union law.

The authors of that contribution also insist on the need to apply the same tax base for all companies that offer the same or comparable digital activities, in order to avoid discriminations and new tax distortions.

12. With regard to a Member State’s obligations under indirect taxation, Article 401 of the Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax states :

“Without prejudice to other provisions of Community law, this Directive shall not prevent a Member State from maintaining or introducing taxes on insurance contracts, taxes on betting and gambling, excise duties, stamp duties or, more generally, any taxes, duties or charges which cannot be characterised as turnover taxes, provided that the collecting of those taxes, duties or charges does not give rise, in trade between Member States, to formalities connected with the crossing of frontiers.”

This Article prohibits any other tax on products and services that constitutes a turnover tax or is triggered by the crossing of frontiers between Member States.  Formal direct taxes may so qualify as prohibited indirect taxes if the following effects occur[13] :

• it applies generally to transactions relating to goods or services;
• it is proportional to the price charged by the taxable person in return for the goods and services which he has supplied;
• it is charged at each stage of the production and distribution process, including that of retail sale, irrespective of the number of transactions which have previously taken place;
• the amounts paid during the preceding stages of the process are deducted from the tax payable by a taxable person, with the result that the tax applies, at any given stage, only to the value added at that stage and the final burden of the tax rests ultimately on the consumer.

Direct taxes on digital activities must respect these specific interdictions without possible exception. A Danish tax of 2,5 % for financing employment measures calculated on the turnover of VAT taxable companies or on the total of paid salaries for other companies qualified under this prohibition for the part of the tax that concerned the turnover tax base[14].

13. An Italian regional tax that constituted a,

(a) non-deductible direct income tax of 4,25 %,
(b)on productive activities of services and goods in general,
(c) that is perceived on a fictional tax base of net-value determined by type of activity,
(d) and that refers to income tax base criteria,

was not considered by the Court of Justice of the European Union as a prohibited turnover tax[15].

The key elements throughout the Court’s ruling in that case was the presence of two elements :

1. a fictional tax base that targets a part of the taxable profit under corporate law that was obtained with collected income (§§ 31 and 33),
2. the non-deductible character of the tax from corporate income tax, preventing its passing on to other economical agents and making it uncertain if the final consumer will suffer this tax in the price he pays (§§ 31 and 34).

14. Having analysed the general frame in which Member States could adopt direct tax measures with regard to relevant digital activities, it is further relevant to define in their business models the need or lack of physical presence in the place where the profit tax base is originated.

The smaller that need, the more relevant is will be to consider adopting non-fiscal law requirements that impose a physical presence where such profit tax base is originated.

All comparable business models should best suffer a same tax regime[16].

To that end, the following business models can be defined :

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[1] considerations 11 and 12
[2] Article 1 : This Directive applies to all taxpayers that are subject to corporate tax in one or more Member States, including permanent establishments in one or more Member States of entities resident for tax purposes in a third country.
[3] Articles 56 and 58 of the Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax
[4] http://www.consilium.europa.eu/en/press/press-releases/2017/12/05/vat-on-electronic-commerce-new-rules-adopted/
[5] The impact of the rulings of the European Court of Justice in the area of direct taxation 2010, European Parliament’s Committee on Economic and Monetary Affairs, ref. online IP/A/ECON/ST/2010-18
[6] The impact of the rulings of the European Court of Justice in the area of direct taxation 2010, European Parliament’s Committee on Economic and Monetary Affairs, ref. online IP/A/ECON/ST/2010-18, p. 7 (introduction) and references under footnote 1
[7] Court of Justice of the European Union, Commission c Great Britan and Ireland, 13 November 2014, C- 112/94, with reference to Commission v Germany, 23 October 2007, C‑112/05, § 72, Commission v Portugal, 7 April 2011, C‑20/09, §§ 59, 60 – 61, Itelcar, C‑282/12, §§ 34 and 36
[8] DIRECTIVE 2006/123/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCI of 12 December 2006 on services in the internal market, OJ, L 376, 27 December 2006, p. 36
[9] Court of Justice of the European Union, SIAT, 5 July 2012, C-318/10, § 37
[10] Court of Justice of the European Union, Itelcar, C‑282/12, § 36 with reference to Test Claimants in the Thin Cap Group Litigation, 13 March 2007, C‑524/04, § 83 ; SIAT, 5 July 2012, C-318/10, § 52
[11] Court of Justice of the European Union, SIAT, 5 July 2012, C-318/10, § 58
[12] OCDE, Tax Challenges of Digitalisation, Comments Received on the Requests for Input – Part II, 25 October 2017, contribution of the International Observatory on the taxation of the Digital Economy, p. 279, points 11, 19, 21 to 24
[13] Court of Justice of the European Union, Banca popolare di Cremona Soc. coop, 3 October 2006, C-475/03, § 29
[14] Court of Justice of the European Union, Commission v. Denmark, 1 December 1991, C- 324/91.
[15] Court of Justice of the European Union, Banca popolare di Cremona Soc. coop, 3 October 2006, C- 475/03, §§ 5 – 11 and §§ 31 – 34
[16] The impact of the rulings of the European Court of Justice in the area of direct taxation 2010, European Parliament’s Committee on Economic and Monetary Affairs, ref. online IP/A/ECON/ST/2010-18, §§ 157, 167 – 170 and 175.