On July 22, 2018, the Swiss Federal Council (a seven-member executive council of the federal government) issued a press release regarding discussions by the Swiss representative at the G20 annual meeting of finance ministers and central bank heads in Argentina on digital tax developments. Switzerland agrees that multilateral discussions on these developments led by the OECD should continue, with a final OECD report on digital tax to be issued in 2020. “Switzerland wants the principle by which taxes are levied where the add value is created, to apply also to digital services.”
The G20’s final communique reaffirmed a commitment to address the impact, of a shift to a digital economy, on the international tax system by 2020, without giving additional details.
The OECD Secretary General, Angel Gurria, presented several reports at the July 2018 G20 meeting, including one that summarizes work by the BEPS Inclusive Framework from July 2017 to June 2018 (“2018 Progress Report”). The 2018 Progress Report outlines major developments and tax challenges of the digitalized economy, the entry into force of the BEPS multilateral instrument, and demonstrates countries’ progress in implementing the OECD BEPS package.
Background
On March 16, 2018, the OECD held its ninth round of Tax Talks, a webcast covering its release of the Tax Challenges Arising from Digitalisation – Interim Report 2018 (Interim Report). The Interim Report is a consensus-based document, which was presented during the G20 meeting in Argentina on March 19-20, 2018.
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. A chapter on adapting the international tax system (specifically profit allocation and nexus rules) to the digital economy considers how these three features of HDB models interact with those rules and may result in profits not being taxed in the jurisdiction where value is created.
- An update on the implementation status of BEPS measures most relevant to digitalization (principally, Actions 7 (PE status), 8-10 (transfer pricing), 3 (controlled foreign company (CFC) rules), 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 diverted profits tax (DPT), the U.S. base erosion and anti-abuse tax (BEAT), and Australia’s DPT and multinational anti-avoidance law (MAAL)).
The following reflects the impact that the BEPS recommendations have had on tax planning and structuring considerations of MNE groups:
- IP holding companies using preferential tax regimes (IP regimes)– tax benefits from IP regimes can only be granted to the extent that R&D expenditure has been undertaken primarily by the taxpayer. This is referred to as the “nexus” approach.
- Treaty shopping– It is now more difficult to establish conduit companies and/or special purpose holding companies in low-tax jurisdictions.
- Cash boxes– Cash-rich entities in low-tax jurisdictions that provide funding to develop valuable intangibles, but do not control the risks associated with their investment, cannot receive higher than a risk-free return on funds under revised transfer pricing rules.
- “Trade structures” based on remote sales– It is increasingly difficult for digitalized businesses to remotely supply online products or services into a market without creating a dependent agent PE in that jurisdiction, where the sales force of a local subsidiary habitually plays the principal role leading to the conclusion of contracts, which are routinely concluded without material modification by the overseas supplier. A local subsidiary does not need to formally conclude contracts to create a dependent agent PE. In addition, the remote sale of physical goods through online platforms can create a fixed place of business PE.
Next steps include a review by the OECD of “profit allocation” and “nexus” rules, with an interim report in June 2019, and a final report in 2020.
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