Negotiations intensify with the goal of creating tax rules fit for the digital economy

EU roadmap

Following up on the Digital Tax Package published by the European Commission in March 2018, a roadmap for a new initiative was proposed on 14 January 2021. This Inception Impact Assessment initiative is also referred to as the "Digital Levy". Its publication reflects the realistic possibility of a non-agreement on a global level. The EU is therefore working again on its own plan to address the challenges arising from digitalisation if a more global agreement will not be reached by mid-2021.

Background

The various initiatives of the European Commission and the OECD are a response to the transformation of the digital world. Since the emergence of new technology, the rapid growth in digital activities means that trade can take place without any physical presence in a jurisdiction, leading to an overall increase in worldwide trade.

Digital businesses are also able to generate large revenues by using and monetising consumer and user data, as well as user-created content. The concern is that much of this value created by users is not captured by the current tax systems. Governments claim that, as a result of the characteristics of these digital activities, the place of value creation might not be aligned with the place of taxation. Thus, taxes are often paid in locations different from the place where the value is arguably created.

The European Commission is of the view that the alleged lower tax for digital businesses results in unfair competition with other sectors of the economy, which weakens the sustainability of public finances. As mentioned in the roadmap, this is particularly striking at a moment when the EU Member States are facing a greater fiscal and debt burden as they tackle the COVID-19 crisis. According to the Commission, the EU and Member States will need to avail of all major instruments to ensure a sustainable and fair recovery from the pandemic and secure stable future revenues in a way that is well aligned with the significant economic changes to come.

Digital Levy

The Digital Levy is designed to create a measure that allows for a fairer contribution of digital businesses to the economic recovery. This initiative focuses on the long term, in order to modernise tax rules to better fit the digital sector of the economy. It is explicitly not intended to interfere with the ongoing work at the G20 and OECD level.

Policy options identified by the European Commission include:

• A corporate income tax top-up to be applied to all companies conducting certain digital activities in the EU;
• A tax on revenues created by certain digital activities conducted in the EU; and
• A tax on digital transactions conducted business-to-business in the EU.

Based on these several building blocks, the European Commission plans to develop policy options covering the following:

• Scope and definition– taking into consideration the different business models of companies present in the digital economy'
• International obligations – including the interaction with Double Taxation Conventions and compliance with the rules of the World Trade Organisation;
• Fairness – possible impact on small and medium-sized enterprises, digital companies with a dominant vs. weak market position, or consumers of digital content or goods;
• Potential behavioural reactions – to reduce incentives to avoid payment of the new tax/levy;
• Forward-looking design – anticipating the future evolution of the digital economy, creating a sustainable tax framework and providing tax certainty.

The Digital Levy is open for feedback from 14 January 2021 until 11 February 2021 and is expected to be followed by the publication of draft legislation by mid-2021.

OECD’s Pillar 1 & Pillar 2

The OECD organised a virtual meeting on 14 - 15 January to discuss the many responses received from a recent consultation on draft tax proposals regarding Pillar 1 (shift of taxing rights on certain digital business models to market/user jurisdictions) and Pillar 2 (global minimum taxation).
With respect to the Pillar 1 blueprint, the main concerns expressed were:

1. Scope: some stakeholders suggested a wider scope, while others argued it should be much narrower. A number of stakeholders pointed out problems with Automated Digital Services (ADS) as a category, particularly around revenue-sourcing and administration. Some stakeholders also want to reduce complexity by starting small and building out, starting at a higher level with gross revenue;
2. Support for market revenue threshold for a nexus rule, defining the level of connection between a taxing jurisdiction, such as a state, and an entity, such as a business; and
3. Concerns that nexus "plus factors" will create excess compliance costs.

With respect to the Pillar 2 blueprint, the main concerns expressed were:

1. the need to simplify the proposed rules to mitigate compliance costs and risks of disputes;
2. the strong preference of multinational organisations for deferred tax accounting, rather than carry-forward mechanisms to account for timing differences, and
3. a desire for clear, transparent administrative guidance to reduce the number of jurisdictions for which complex computations are necessary.
   The OECD will continue fine-tuning the proposals, with a view to reaching an agreement by mid-June 2021.

Biden administration

Several countries have expressed a hope that the new Biden administration will support the OECD initiative and some are willing to postpone the global discussions until summer 2021. However, it is not yet clear what the position of the new US administration will be in relation to the international digital taxation.

If no consensus can be reached at OECD level in relation to Pillar 1 and Pillar 2, the European Digital Levy can be seen as a back-up plan. This may also have an impact on national moves to introduce a Digital Service Tax in many countries. Please refer to our website for an overview of national developments.

Bird & Bird partner, Willem Bongaerts, will be speaking at the International Bar Association Tax conference on 4 February on the topic of digital taxation, alongside speakers from the OECD and industry. More details are available here.

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