Taxation of the digital economy and the EU new rules for Google, Facebook and Co
The EU plans to implement a new tax regime covering what is often referred to as a digital permanent establishment when a significant digital presence exists, in tax lingo the digital PE. Different to the meaning of this term a digital PE might include many things, but it is far from being an “establishment”; rather it is an established fiction. In short a number of criteria such as turn over made in a country, the number of users reached, or the number of contracts concluded online, lead to a taxable nexus in a jurisdiction and to the allocation of certain profits to it and that taxes would be imposed thereon. Besides that, the EU intends, in the near-term, to introduce a new tax on revenues gained from digital activities characterized by a high involvement of users until the planned implementation of the proposed digital PE is concluded. Such services are e.g., specifically targeted advertising or the provision of platforms and marketplaces. The EU in this regard explicitly points among others at Facebook, Google, AirBnB or Uber.
On 18 March 2017 the Communiqué of the G20 Finance Ministers and Central Bank Governors asked the Task Force on the Digital Economy to deliver an interim report on the implication for taxation of digitalization to the G20 Finance Ministers by April 2018.
On 1 March 2018 the finance ministers of France, Germany, Italy, Spain, the UK and the two EU Commissioners Valdis Dombrovskis and Pierre Moscovici sent a letter to the Argentinean finance Minister, as current chair of the G20, addressing the fact that tax laws, as they stand today, allow businesses engaged in the digital economy, which are mostly run by multinationals, to decouple the place where they are paying taxes from the places where their value is actually created. The finance ministers and the EU believe that this decoupling creates market distortions and undermines the sustainability of the corporate tax system.
Also the European Union is working on finding a solution to that problem (see communication of the commission COM(2017) 547 from 31 September 2017). The latest outcomes were presented in a press release from 21 March 2018 which is shortly described in the following.
3. Fair Taxation for the Digital Economy
In a preliminary paper named “Taxation of Digital Activities in the Single Market” dated 28 February 2018 the EU identified certain factors which in combination are deemed to be responsible for the mismatch between where taxation of the profit takes place and where value is created for certain digital activities:
- businesses can supply digital services where they are not physically established – “scale without mass”
- development of specific software such as social platforms which allow user interaction – “reliance on Intellectual Property assets”
- value from the business perspective comes from the participation of the users in the digital activities that they offer – “user value creation”.
To avoid a shifting of profits from where value is created due to these factors, the Commission puts forward two proposals for EU actions to be taken. The first one is a rather long-term, common EU solution for digital activities (the “Common Solution”), while the second one is an interim solution (The “Interim Solution”) to address urgent gaps in the taxation of such digital activities:
- The Common Solution would introduce a regime to impose corporate taxation on a “significant digital presence” in EU Member States,
- the Interim Solution would establish rules relating to a digital services tax on revenues resulting from the provision of certain digital services within the EU.
3.1 The Common Solution
The Commission’s Common Solution for the taxation of the digital economy proposes to issue a directive for the corporate taxation of a “significant digital presence” (the Digital Presence Directive). Such directive should oblige the Member States to implement provisions on taxation of significant digital presence and appropriate profit allocation rules into national law. To avoid possible “treaty overrides” caused by the implementation of the directive, the Commission should issue a recommendation setting out proposals to amend the Member State’s double tax treaties.
The Commission envisages that a company will be considered having significant digital presence in a Member State if:
- by itself or together with associated enterprises, an entity derives realized revenues from digital services in a Member State exceeding € 7 million in a tax year;
- the number of active users of the digital service in a Member State in a tax year exceeds 100,000; or
- the number of online contracts concluded exceeds 3,000.
The proposed directive also lays down rules to determine the profits which are attributable to the significant digital presence. Generally, the attribution of profits shall be based on a functional analysis and shall consider economically significant activities performed by the significant digital presence (digital PE). According to the directive economically significant activities performed by the significant digital presence which are decisive for the attribution are the following:
- collection, storage, processing, analysis, deployment and sale of user-level data;
- collection, storage, processing and display of user-generated content;
- sale of online advertising space;
- making available of third-party created content on a digital marketplace;
- supply of any digital service not listed in the points above.
3.2 The Interim Solution
The second proposal is regarded as an interim measure applicable until the Common Solution is finally implemented. The planned measures should cover situations in which there is a massive mismatch between the places where value is created and where profits are taxed. According to the Commission this is the case when there is a high involvement of users in digital activities. Like the Common Solution outlined above, this second proposal intends to implement an EU directive (“Proposal for a directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services”; “Digital Service Tax Directive”), which obliges Member States to introduce a new tax on digital activities.
The objective scope of that tax should cover the revenues of a business resulting from the exploitation of digital activities that are characterized by “user value creation”. Those are services supplied for consideration consisting in the valorization of user data, e.g., selling specifically targeted advertisement space or the sale of such user data. The preliminary paper especially highlights Facebook, Google, AdWords, Twitter, Instagram, or Spotify’s free version. Further, providing digital platforms or marketspaces for users (i.e. intermediation services) and where such users supply goods or services between themselves (e.g., AirBnB, Uber) fall within the objective scope of the proposed directive.
Subjectively the proposed directive targets on businesses carrying out supplies of the digital services falling within the objective scope (see above) meeting (cumulatively) the following requirements:
- Annual worldwide total revenue above € 750 million and
- Annual revenue from the provision of digital activities in the EU is above € 50 million
The proposed directive states that the place of taxation shall be where the users are located. Digital activities consisting in the valorization of user data (e.g., selling specifically targeted advertisement space) or the sale of such data should be taxable where the respective advertisement is displayed or where the users have supplied the data, which is being sold, respectively. This may lead to a tax liability in a Member State irrespective of whether the parties to the advertising contract are located in that Member State. Consideration for the provision of digital platforms or market spaces should be taxable where the user is located.
Tax base comprises of the gross revenues from carrying out the digital activities within the objective and subjective scope of the directive. According to the proposed directive the planned tax rate should be 3%. Potential taxpayers will be obligated to declare and pay the tax in the member states where the respective supply takes place. In order to simplify compliance as regards declaration requirements, a One-Stop-Shop model is proposed to be implemented so the potential taxpayer has the possibility to meet his obligations towards all member states it is active in, in only one Member State.
The further development and implementation of the measures outlined is to be expected. However, businesses operating in the digital economy should be prepared for the upcoming changes in the legal environment.
The information provided in this newsletter is general in nature and does not constitute legal advice. BINDER GRÖSSWANG Rechtsanwälte GmbH cannot assume any liability in respect thereof. Before entering in commercial transactions, professional legal advice should be sought.