Under the current international tax framework, companies are generally taxed in the jurisdiction where physical assets, capital, and labor are located. The source of income and residence of the taxpayer are also considered. Due to significant growth in the digital economy, jurisdictions are struggling with taxing rights based on nexus and profit attribution where suppliers lack physical presence.
Businesses are able to operate in countries with only a digital presence. Highly digitalized businesses can rely heavily on mobile intangible assets and user participation. Any change to the allocation of taxing rights under the corporate tax system must be implemented through changes to the attribution of profits to entities and countries. In addition, user participation is an important driver for value creation, and should be considered by jurisdictions in taxing digital businesses.
European proposals on taxing the digital economy
On March 21, 2018, the EU released two legislative proposals on taxing digital business activities. See the Commission’s press release. The first proposal aims to reform corporate tax rules so that profits are registered and taxed where businesses have significant interaction with users through digital channels. A digital platform will be deemed to have a taxable ‘digital presence’ or a virtual permanent establishment (PE) in a member state if it fulfils one of the following criteria:
- It exceeds a threshold of €7 million in annual revenues in a member state.
- It has more than 100,000 users in a member state in a taxable year.
- Over 3,000 business contracts for digital services are created between the company and business users in a taxable year.
The second proposal represents an interim tax, which covers the main digital activities that currently escape tax altogether in the EU. The tax will apply to revenues created from activities where users play a major role in value creation, and which are the hardest to capture with current tax rules, such as revenues created from (1) selling online advertising space; (2) digital intermediary activities, which allow users to interact with other users and which can facilitate the sale of goods and services between them; and (3) the sale of data generated from user-provided information.
Tax revenues would be collected by the member states where the users are located, and will only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million. An estimated €5 billion in annual revenues could be created for member states if the tax is applied at a rate of 3%.
Australia – potential interim measures to tax the digital economy
Digital advertising services
Australia could impose an interim measure on revenues earned from providing digital advertising services to Australians. The measure could apply to advertising income earned from digital advertising that is: (1) directed at Australian users; (2) paid for by Australian businesses; or (3) paid for by Australian businesses and directed to Australian users. The interim measure should not create a loophole for businesses to avoid the measure by making payments for Australian digital advertising services to offshore entities. It may be difficult to apportion a share of advertising published overseas and targeted at a global audience, but viewed by Australians.
Digital intermediation platforms
Where a platform charges a fee or commission, an interim measure could apply to that commission or fee where the underlying service or product has a connection to Australia. Possible options for determining whether a sufficient Australian connection exists include: (1) all fees received for a platform service where the customer is located in Australia; (2) all fees received for a platform service where the supplier is located in Australia; (3) fees received for a platform service from either an Australian supplier or customer; or (4) all fees received for a platform service where both the customer and supplier are located in Australia.
In determining how to impose an interim measure, Australia should consider the collection mechanisms and compliance processes. Imposing a withholding obligation could present significant challenges, particularly in relation to business to consumer transactions. A system of vendor registration similar to that in place for cross-border GST transactions could be considered. Any Australian interim measure could be transitioned once international consensus on a longer-term solution is reached.
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