On March 24, 2014, the OECD released a public discussion draft on the Tax Challenges of the Digital Economy, as part of its base erosion and profit-shifting action plan (BEPS project) announced last July (Action 1). According to the OECD, under Action 1 the main difficulties that the digital economy poses for the application of existing international tax rules have to be identified and detailed options to address these difficulties considering both direct and indirect taxation have to be developed. In order to tackle Action 1, the OECD set up a Task Force on the Digital Economy, which prepared the discussion draft.
Many of the key features of the digital economy exacerbate opportunities for BEPS. The work on the actions identified in the BEPS Action Plan will take into account these key features in order to ensure that the proposed solutions fully address BEPS in the digital economy including restoring taxation on stateless income.
Nevertheless, the draft acknowledges that a number of the other measures of the BEPS Action Plan will, in effect, also restore taxation, e.g. Action 6 (Prevent Treaty Abuse) and Action 7 (Prevent the Artificial Avoidance of PE Status) will restore source taxation. Other measures will contribute to restoring taxation at the level of both market and parent company jurisdiction. These measures include those being developed in order to implement Action 2 (Neutralise the Effects of Hybrid Mismatch Arrangements), Action 4 (Limit Base Erosion via Interest Deductions and Other Financial Payments), Action 5 (Counter Harmful Tax Practices More Effectively), and Actions 8-10 (Assure that transfer pricing outcomes are in line with value creation).In addition, the work on strengthening CFC rules will also contribute to restoring taxation in the jurisdiction of the ultimate parent company.
The draft then mentions several options to address the specific challenges of taxing the digital economy. One option is to modify the definition of permanent establishment (PE) in Article 5 of the OECD Model Treaty, for example by limiting the PE exception contained in Article 5(4) (which exempts preparatory or auxiliary activities) to businesses whose preparatory or auxiliary activities do not constitute their core functions. Another option is to modify the definition of PE to create a new nexus based on significant digital presence. In that case, an enterprise engaged in certain “fully dematerialized digital activities” would have a PE if it maintained a significant digital presence in another country’s economy. Yet another option is to provide for alternative PE thresholds as previously considered by the OECD’s Business Profits Technical Advisory Group.
A fourth option is to create a final withholding tax on certain payments made by residents of a country for digital goods or services provided by a foreign e-commerce provider. According to the draft, this proposal would address concerns that it may be possible to maintain substantial economic activity in a market, without this activity being taxable in that market under current PE rules because of a lack of physical presence in that market. The task force would need to consider how to address the challenges of withholding such a tax on individual consumers.
As regards consumption taxes, in particular VAT, the discussion draft mentions that experience, notably within the EU, has shown that the most viable option for collecting VAT on cross-border digital supplies to consumers is to require the non-resident supplier to register and account for the VAT on these supplies in the jurisdiction of the consumer. However, in order to minimize compliance burdens on these suppliers countries should consider the use of simplified registration regimes and registration thresholds.
The OECD has invited interested parties to comment on this discussion draft. The deadline for submissions is April 14, 2014.