On October 24, 2018, South Korea’s Ministry of Strategy and Finance (MOSF) released a document summarizing recent statements by senior South Korean officials about the need to introduce a digital tax. Currently, many non-resident multinationals (e.g., Google) pay no corporate income tax in South Korea due to lack of a physical presence (e.g., servers) in the country. The MOSF document discusses ongoing multilateral discussions and the European Commission’s (EC) March 21, 2018 proposed digital tax directives. On October 19, 2018, South Korea’s Finance Minister and Deputy Prime Minister, Kim Dong-yeon, told the National Assembly (i.e., Parliament) that while non-resident companies that provide services in South Korea may be subject to VAT, they are not subject to corporate income tax, unless they have servers or some other physical presence in South Korea. Mr. Dong-yeon said that is why his cabinet is evaluating measures that would subject such non-residents (e.g., Google and Apple) to South Korean corporate income tax.
The MOSF document refers to the U.K.’s diverted profits tax (DPT) as a means to address tax avoidance by non-resident companies, but does not say whether the MOSF is considering similar measures. The purpose of the DPT is to discourage multinationals from using aggressive tax planning to divert their profits from the U.K., and reduce their U.K. corporate tax liability. The DPT applies to the following transactions:
- A U.K. resident company (or a U.K. permanent establishment (PE) of a non-U.K. resident company) enters into arrangements with a related person where that person or the transaction(s) lack economic substance resulting in a reduction of the U.K. company’s (or U.K. PE’s) taxable profits.
- A person, whether or not a U.K. resident, carries on an activity in the U.K. connected to the supply of goods, services or other property made by a non-U.K. resident company in the course of its trade in a way that avoids creating a U.K. PE.
Editor’s Note: South Korea has not announced when it plans to release any digital tax proposals, or when they would enter into force, if enacted.
Action 1 of the OECD BEPS project focuses on tax challenges arising from the digital economy. Key features of the digital economy include e-commerce, online advertising, cloud computing, and online payment services. A subsidiary of the Committee on Fiscal Affairs, the Tax Force on the Digital Economy (TFDE), was established in September 2013 to develop a report identifying issues resulting from the digital economy. The conclusions are included in the Action 1 recommendations.
The digital economy raises specific tax challenges with respect to nexus, data, VAT, and characterization for tax purposes:
Nexus – The increase in digital technologies and the reduced need for extensive physical presence to carry on a business can raise questions as to whether the current rules to determine nexus with a jurisdiction for tax purposes are appropriate.
Data – The growth of information technologies has permitted companies in the digital economy to gather and use information across borders. Issues arise with respect to attributing value created from the generation of data through digital products and services, and characterizing for tax purposes a person’s or entity’s supply of data in a transaction.
VAT – The digital economy creates challenges for VAT systems, particularly when private consumers acquire goods, services, and intangibles from foreign suppliers. The issue stems from the absence of an effective international framework to ensure VAT collection in the jurisdiction of consumption. Therefore, jurisdictions incur an increased administrative burden and high compliance costs.
Characterization – The development of new digital products or means of delivering services creates uncertainties with respect to the appropriate characterization of payments made with respect to new business models, specifically in relation to cloud computing.
On March 16, 2018, the OECD released Tax Challenges Arising from Digitalisation – Interim Report 2018 (Interim Report). According to the Interim Report, countries in favor of introducing interim measures understand that the measures should be compliant with a country’s international obligations; temporary; targeted; minimize over-taxation; minimize impact on start-ups, business creation, and small businesses; and minimize cost and complexity.
The Interim Report contains:
- A detailed analysis of the impact of digitalization on business models and value creation, identifying three features of highly digitalized business (HDB) models: cross-jurisdictional scale without mass; reliance on intangible assets; and data and user participation
- An update on the implementation of BEPS measures most relevant to digitalization (i.e., Actions 7 (PE), 8-10 (transfer pricing), 3 (controlled foreign company (CFC)), 5 (harmful tax practices) and 6 (treaty abuse)).
- A description of unilateral measures potentially relevant to digitalization, characterizing these as: alternative applications of the PE threshold (“significant economic presence” in Israel and India); withholding taxes; turnover taxes (India’s Equalisation Levy, Italy’s Levy on digital transactions, Hungary’s advertisement tax, and France’s tax on distribution of audio-visual content); or regimes targeting large MNEs (U.K.’s DPT, the U.S. base erosion and anti-abuse tax (BEAT), and Australia’s DPT and multinational anti-avoidance law (MAAL)).
On March 21, 2018, the EU released two legislative proposals to ensure that digital business activities are taxed in a fair and growth-friendly way in the EU. 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 (PE) in a member state if it fulfils one of the following criteria:
- Exceeds a threshold of €7 million in annual revenues in a member state.
- 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 revenues a year could be generated for member states if the tax is applied at a rate of 3%.
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