OECD Interim Report on the tax challenges arising from digitalisation

The OECD’s Interim Report on the tax challenges of the digital economy highlights the broad disagreement amongst its members as to whether there is a need for fundamental changes to the international tax rules allocating taxing rights in relation to digitalised business models.

The OECD has released an Interim Report into the “Tax Challenges Arising from Digitalisation”. The report notes that there is, at this stage, no general consensus among participating jurisdictions as to whether, and if so what, further measures to tackle taxation of digital services are needed. As such, the agreement to the publication of the Interim Report is in many ways an agreement to disagree.

Nevertheless, the members participating have agreed to further pursue a “coherent and concurrent review of the nexus and profit allocation rules” and work towards a “consensus-based solution” with a final report due in 2020. In the meantime, with a broad international consensus seemingly a long way off, the EU seems set to progress its own proposals.

Background

The tax treatment of the digital economy was specifically addressed by the Organisation for Economic Co-operation and Development (OECD) in Action Point 1 of its Base Erosion and Profit Shifting (BEPS) Project. In its final Report, the OECD essentially concluded that, because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes. Nevertheless, there was broad agreement that the OECD and G20 countries should monitor developments to determine whether further work should be carried out and report on its conclusions by 2020.

Since the Action 1 report, focus has shifted back to the tax treatment of the digital economy as a number of jurisdictions concluded that more was needed to ensure fair taxation of businesses acting within that industry. As a result, the G20 mandated the OECD to bring forward delivery of an Interim Report, resulting in the release by the OECD of a “Request for input on work regarding the tax challenges of the digitalised economy”.

In the meantime, EU Finance Ministers have agreed to progress proposals to address the tax treatment of companies operating in the digital economy, see “Taxation of the digital economy” and the EU Commission has released a communication, “A Fair and Efficient Tax System in the European Union for the Digital Single Market”, seeking to influence developments in relation to the taxation of the digital economy and ensure that the EU acts in a co-ordinated manner.

In addition, several jurisdictions have commenced implementation of unilateral, domestic measures. In the UK, HM Treasury has recently released an updated position paper entitled, “Corporate tax and the digital economy: position paper update”, designed to inform the UK’s input into these ongoing international developments.

OECD Interim Report

The Interim Report provides an in-depth analysis of the main features frequently observed in certain highly digitalised business models and value creation in the digitalised age, as well as the potential implications for the existing international tax rules. It describes the complexities of the issues involved, the positions that different countries have in regard to these features and their implications, and which drive their approach to possible solutions.

However, the Interim Report recognises that, at present, the attitude of jurisdictions to a long term solution range from those countries that consider no action is needed, to those that consider there is a need for action that would take into account user contributions, through to others who consider that any changes should apply to the economy more broadly.

The Report notes that the attitude of members fall broadly into three groups:

• Those that consider that the current rules as applied to certain digital business models may lead to misalignments between the location in which profits are taxed and the location in which value is created. This group does not believe that these factors undermine the principles underpinning the existing international tax framework as a whole.
• Those that consider that the ongoing digital transformation of the economy, and more generally trends associated with globalisation, present challenges to the continued effectiveness of the existing international tax framework for business profits. This group consider that the challenges are not exclusive or specific to highly digitalised business models.
• Those that consider that the BEPS package has largely addressed the concerns of double non-taxation, whilst also highlighting that it is too early to fully assess the impact of all the BEPS measures. These countries are generally satisfied with the existing tax system and do not currently see the need for any significant reform of the international tax rules.

Accordingly, whilst the Interim Report states that members have agreed to undertake a coherent and concurrent review of the fundamental concepts which determine the international allocation of taxing rights in this area - namely the “nexus” and “profit allocation” rules - the consensus-based solution, which is the OECD’s aim, remains a distant goal.

Interim measures

In the absence of any agreement on a longer-term and broadly acceptable solution, the OECD recognises that many countries wish to take more immediate action in the light of political and financial pressures. As a result, the Interim Report suggests a framework of design considerations for any such interim measures, including ensuring that any such measures should: be in compliance with existing international obligations; temporary, targeted and balanced; minimise over-taxation; designed to limit the compliance costs and not to inhibit innovation. In particular, the Report considers an interim measure in the form of an excise tax on the supply of certain e-services within their jurisdiction that would apply to the gross consideration paid for the supply of such e-services.

Comment

The OECD and its members will continue to seek to work towards an internationally agreed solution, with a further update to the G20 in 2019 and a final report promised for 2020. However, with such divergent views evident on this topic, it seems far from certain that it will prove possible to reach any consensus at all.

In the meantime, it seems likely that the EU will seek to progress its own interim solution with a view to influencing the work of the OECD in the longer term. The UK has already made its position clear and may seek to introduce a measure targeted at situations in which a large UK customer base contributes significant value to online suppliers, such as social media, auction and other intermediary service sites, in the absence of wider consensus.