Digitising Taxation

Abstract

This Article is an effort to familiarize the non-tax business readers with a leading change in the international taxation arena which may (rather would definitely!) change forever the way countries have been taxing. Due to the limitation of space, this Article does not cover the specificities of this ambitious change and would restrict itself to a general idea about the project.

Introduction

Though the United Nations has been the frontrunner for proposing international coordination among the nation states in most areas of law, it is the Organisation of Economic Cooperation and Development (OECD) which has proved to be the crusader in the taxation regime. One of the reasons for the huge credibility that the OECD today commands is the ‘Base Erosion and Profit Shifting’ (BEPS) project which the OECD started after the global recession of 2008 and delivered its comprehensive report in 2015. The preparation and the release of the report was met with much skepticism and was widely believed to be a “defunct exercise” on the reason that most of the countries would not coordinate with other countries due to taxation being such a ‘near and dear’ sovereign right of every country. Also, lack of implementation powers, a common problem in international law, was another drawback. However, much to the surprise of all and to the praise of the OECD, the BEPS was applied almost throughout the world with very few exceptions. Although the OECD only has around 36 members, the BEPS project is conducted under an ‘Inclusive Framework’ approach that allows interested countries and jurisdictions to work with OECD to develop standards on BEPS related issues. Through such a framework, OECD has extended itself to all the countries of the world and now involves around 135 members under its umbrella.

This success of the first project has allowed the OECD to work towards the second project which now prepares to deal with more detailed and intrinsic issues within the international taxation arena. These second set of initiatives is colloquially referred as “BEPS 2.0”.

Reasons for BEPS 2.0

BEPS 2.0 is tasked to address growing concerns posed by the ‘Digital Economy’. Traditionally cross-border businesses involved two countries such that the businesses had to involve some physical manifestation in the country where the consumers resided. So, for example, if X Corporation registered in Country A wanted to conduct business in Country B, it generally had an office/agent or any other form of physical manifestation in Country B. This physical manifestation has historically been used as the basis for taxing X Corporation by Country B. But since under the digital economy, the consumer residents and the business might not be in the same country and there can be no footprint of the company in the consumer country (examples include cloud services, streaming services etc.), the traditional international tax principles seemed archaic and not walking with the changing times. Importantly, irritated by the loss of revenue due to inaction of the international community, certain countries including France started taking up unilateral steps to tax the digital economy. Such measures were highly criticized.

This problem of digital economy is planned to be addressed under BEPS 2.0 through the two “Pillars”. Pillar 1 concerns the “allocation of taxing rights”; whereas Pillar 2 addresses the “other BEPS issues.” Under Pillar 1, there are three broad taxing proposals which have to be combined to give a “Unified Approach” for the countries. Pillar 2 is a bit more generic dealing with general anti-abuse principles as well as providing solutions to tax multi-national enterprises at a minimum global rate.

Current Status of BEPS 2.0

The OECD released its first public document on BEPS 2.0 November 2019 and gave the world an idea as to what could be the broad structure of the new tax regime. This should normally be followed with negotiations between countries leading to a binding commitment. The OECD has set itself an “over-ambitious” deadline of end of 2020.

Pillar 2 is restricted to anti-abuse principles, whereas, as the following section will introduce, Pillar 1 brings about a fundamental change in the taxing principles of all the states.

Public Consultation Document (Pillar 1)

The new system addressing this problem seems to be taking a “consumer” approach in contrast to the “physical presence” approach presently existent. Under the new system, if a company has a sufficient amount of sale of commodities in a particular country it would be subject to taxation regardless of the fact that the business has no physical presence in the country.

Note that the project is not restricted to the digital economy. Contrary to the general notion that BEPS 2.0’s applicability is limited to the digital economy, BEPS 2.0 is applicable to every form of business which has any consumer base in another country. Moreover, this new approach would be in addition to the existent Permanent Establishment (“PE”) system and not in replacement of the same. It would provide additional taxing rights to the market country and not decrease the presently existing “physical presence” based taxation. Thus, countries were in a PE could be considered to be existent, countries would continue to tax the multi-national enterprises on the present basis also along with the additional taxing authority.

It has been indicated in the consultation document that to be taxed in the market jurisdiction a minimum revenue threshold would be fixed. Thus, if the revenue of a taxpayer passes a particular threshold in a market country irrespective of the existence of a PE, the market jurisdiction would have the right to impose taxes.

Conclusion

Though, it is claimed that the changes planned to be brought about by the BEPS 2.0 is too huge to be accepted by the “Inclusive Framework” promptly, the history of OECD and BEPS have been full of surprises. If the deadlines are strictly followed, it would be no later than 2020 when this fundamental change would become applicable throughout the world.

Such a change, would affect every cross-border business and would dramatically affect the way countries have been taxing. Hence, it is important that every business is updated about the happening in this area of law and lookout for every major change that might affect their revenues substantially.