Global digitalisation is prevalent in almost every aspect of our daily lives. Multinational Enterprises (MNE), through our ever shrinking “global village”, are expanding across many tax jurisdictions and generating profits in manners which current international tax principles simply aren’t equipped to handle. Africa is no exclusion. Digital companies such as Uber, Google, Airbnb and Facebook continue to invest significantly across the continent. Many tax authorities around the world have shifted their focus to the effective taxation of “Big Tech” who until recently have had carte blanche on where (or whether) to account for profits, not always having “fiscal justice” in mind (a phrase coined by the French Finance Minister, Bruno Le Maire).
To address Base Erosion and Profit Shifting (BEPS) especially as it relates to the digital economy, the OECD/G20 issued (as part of a 15-point Action Plan) BEPS Action 1: Addressing the Tax Challenges of the Digital Economy in 2015. BEPS Action 1 outlines the challenges in taxing the “digital economy” and makes several recommendations. These include modification of the existing permanent establishment (PE) rules, withholding taxes on certain digital transactions, and a tax on bandwidth use. Some of these issues have since been addressed (i.e. ensuring non-avoidance through “auxiliary or preparatory” activities), although others are still being addressed.
BEPS Action 1 has its foundation on the OECD’s 21 March 2018 release, on Tax Challenges Arising from Digitisation – Interim Report (Interim Report). The Interim Report sets the framework against which the OECD aims to report in 2020 on the interconnectedness between digitalisation and international tax. The Interim Report considers many factors dealing with the taxation of the “digital economy” and recommends interim measures. One of these measures include an excise tax on digital service supplies applying to gross revenue received by a digital service provider in a certain jurisdiction (i.e. place of the user). The Interim Report acknowledges that consensus is still needed on the merit or need for interim measures pre-2020. Some countries believe interim measures would result in “risks and adverse consequences”, although don’t believe that these risks and consequences overshadow the need to start curtailing digitization BEPS. The Interim Report provides guidelines on the characteristics of interim measures.
On publication of the Interim Report, the EU Commission also proposed a long and short-term option to turn the digitisation BEPS tide. The EU’s interim suggestion is similar to the proposed excise tax contained in the Interim Report, a Digital Service Tax (DST), and in the long term introducing a “Digital Permanent Establishment” (PE). Introducing a DST as a short-term measure would, if implemented, be levied at 3% on gross “digital services” revenue earned in a jurisdiction by a digital service provider.
DST would apply to revenue derived from supplies of specific digital services (e.g. supply of advertising space, facilitation of digital interactions, data generation through user-provided information, etc.). DST would be collected in the state where of user location and apply only to entities with global revenue exceeding EUR 750 million and EU revenue derived from digital services exceeding EUR 50 million. DST will be deductible against corporate income tax (CIT), which will reduce or eliminate double taxation. DST will cease when the Contracting States agree on the “Digital PE” concept.
The DST (aligning with the Interim Report) is temporary, as it will only exist before Digital PE legislation is agreed on. DST is targeted at large digital service providers, does not “over-tax” (only 3% and deductible from CIT), has little to no impact on start-ups due to the revenue thresholds, and is relatively simple. The only issue seems to be “compliance with a country’s international obligations”, as the proposed DST has been met with animosity from several countries. The USA, for example, with large MNEs dominating the global digital services industry has labelled the DST as a “blatant revenue grab” (Kevin Brady, the House Ways and Means Committee Chairman). Ireland also expressed concern in a slightly less emphatic fashion, and the Irish Government opposed the DST, on the basis that although reform is needed, it must be done on a multilateral basis.
The Digital PE concept will allow contracting states to tax entity profits arising in one state without the need for that entity to have a “physical presence”. The existence of a Digital PE would depend on a “significant digital presence”. An entity will be deemed to have a significant digital presence if it conducts its business through digital platforms such as websites and mobile applications, and if it meets one of the following criteria:
- Annual revenue from the platform exceeds EUR 7 million in the state;
- Users on the platform exceed 100,000 for a given year of assessment; or
- More than 3,000 “online contracts” concluded in a year of assessment.
Allocation of profits to Digital PEs intends to better reflect value creation by digital entities per jurisdiction.
Widening the tax net through the Digital PE concept is certainly an attractive prospect to generate tax revenue in Africa. However, revenue authorities’ application of existing PE legislation remains uncertain at best, without “digital presence” that will further confuse matters. The Digital PE concept may from initial analysis, require significant expenses with regards to administrative systems and highly skilled staff to “police”. Most African countries don’t have capacity to do this. Driving effective taxation of value creation through the PE “nexus” is noble and most probably the answer but resource limitations and financial constraints in developing countries are ever-present. Introducing Digital PEs may, in initially, not be appropriate for tax systems in Africa.
DST provides a more feasible option to developing countries and will contribute a great deal to increase tax revenue across Africa. That said, the introduction of DST raises concerns for MNEs, as the mere hint of another compliance obligation in Africa is enough to send shivers down a CFO’s spine!
A major stumbling block to introducing the DST remains objections by certain countries. American companies dominate the global digital services industry and the DST sets these big tech giants, and by association USA, squarely in the taxation “hot seat”. Ireland, widely known as “accommodating” big techs to book revenue, stands to lose substantial tax revenue if these proposals are adopted. Their tax loss will result from companies that will need to recognise profits and pay taxes where the users are located and not where the company is incorporated. Facebook, for example, announced in December 2017 that it would from now on recognise revenue where it has been earned, and not necessarily Ireland.
While the USA’s objections are noted, their kneejerk reaction reminds (perhaps) of a spoiled child who refuses to share. Similarly, Ireland opposes as they will need to share revenue with the rest of the EU. However, the rhetoric remains whether other countries have the right to share in profits that fairly accrued to their jurisdiction.
A definite solution to the taxation of the digital economy is likely a few years away and there are no guarantees that one solution will fit all, which emphasises the need for interim measures. The DST will hopefully be thoroughly considered and will be the focus point of many deliberations in the near future. However, taxation theory can only go so far. The real problems will come to the fore on implementation. Although it will take a bold tax authority in Africa to make the first move “you learn how to cut down trees by cutting them down” (Bateke people of the Congo).
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