Monthly Archives: October 2017

Tax Challenges of the Digital Economy

The BMG has made a new submission on Tax Challenges of the Digital Economy in response to the Request for Comments by the OECD in connection with the work of the Task Force on the Digital Economy, preparing a report for the G20.

October 2017

Summary

Digitalisation has further exacerbated the fundamental flaws in international tax rules. The ability to do substantial business in a country without a significant physical presence has long been a problem especially in relation to services. The importance of intangibles and the ability to transfer ownership of such assets to affiliates in low-tax jurisdictions was pioneered long ago by pharmaceutical companies.

Although digitalisation has resulted in important changes in business models, their effects are less significant for those rules than the transformations resulting from the emergence and growth of multinational enterprises (MNEs) since those rules were devised almost a century ago. MNEs have exploited the ‘independent entity’ principle, by creating complex corporate groups and fragmenting their functions to allocate a high proportion of their global income to low-taxed affiliates. The BEPS project has so far aimed only to patch up these rules, and has not resolved the central challenge of how profits should be allocated according to where ‘economic activities occur and value is created’. This requires a paradigm shift, to move away from the independent entity principle, and treat MNEs in accordance with the economic reality that they are unitary firms.

The BEPS issues raised by digitalised products or services are not caused by small companies, such as software firms, selling digital products to customers around the world, but by the giant web-based MNEs. These firms usually do have a significant physical presence in countries where they have a significant level of consumers, but they fragment their activities, and attribute functions such as sales, order fulfillment, production, marketing and customer support to different affiliates.

The main changes due to digitalisation are (i) the closer relationship it both requires and enables between producers and consumers; (ii) the digital services that are often supplied with no direct charge to users, while their inputs are monetised through revenue generated through services provided to other customers, especially advertising; and (iii) the ability that digitalisation gives for some firms to recharacterise themselves as pure intermediaries between producers and consumers. The various unilateral and defensive measures introduced or proposed by countries (diverted profits tax, equalisation levy, etc) may be necessary in the short term but are only interim solutions.

We propose a new definition for taxable presence based on significant presence; a holistic approach in attributing profits to take account of the combined contributions of all the affiliates of a MNE within a country; and a shift towards allocating aggregate profits of all relevant associated enterprises based on factors reflecting the drivers of profit for typical business models.

Offshore Indirect Transfers of Assets

October 2017

The BMG has now submitted its comments on the discussion draft from the Platform for Collaboration on Tax for a Toolkit on Taxation of Offshore Indirect Transfers of assets.

Summary

We welcome this discussion draft, which deals with an important issue of particular interest to developing countries, and was only partly dealt with in the G20/OECD project on base erosion and profit shifting (BEPS).

We agree with the argument it makes that principles of inter-nation equity clearly support the right of the country where an asset is located to tax the gains on its transfer, even if the seller and/or acquirer are not resident in that country. The country is of course free to decide whether and at what rate to tax such gains, taking account of the effects of such taxation on investment in the development of such assets. This right should therefore not be restricted by tax treaties, and we support the proposals in the BEPS project for inclusion in all treaties of a provision equivalent to article 13(4) of the model treaties. This can most effectively be done if all countries sign the Multilateral Convention on BEPS and adopt its article 9(4). This Toolkit should be amended to clearly and unambiguously urge all countries to do so.

In our view, the proposals should extend to indirect transfers of all kinds of assets, without limitation to immovable assets. This is in accordance with the global consensus that profits and gains should be taxed in the jurisdiction where the economic activities giving rise to them are located. The reference to article 13(5) of the UN model in the DD is therefore misleading, and should be amended, to provide countries that choose to tax a wider range of gains the necessary guidance to address movable assets such as shares.

We make a number of other comments which we hope would help improve the DD.