Following OECD initiatives, the European Commission has put forward two distinct new Council Directive Proposals addressing taxation of the "digital economy" with rules to ensure fair taxation of digital businesses in the EU. The first proposed Directive is designed at providing long term solutions to protect the Corporate Income Tax base of Member States, while the second contains a set of "interim" measures, presumably in response to political pressure, proposing an immediate indirect levy on specific digital revenues.
There is recognition at the international level that current tax rules are not suited to the realities of the modern global economy. These rules, designed for traditional "brick-and-mortar" business models, are consistently proving that they are simply not fit to address digital businesses, with their global and virtual nature and their ability to provide services in a country without being physically present therein.
Moreover, traditional tax rules also fail to recognise the mechanisms through which value is created in the digital economy. For instance, social media companies, collaborative platforms or online content providers often derive profit through a combination of algorithms, user data, sales functions and knowledge, where an end-user can and very often will play a significant role in the value-creation process. Traditional tax rules are often inadequate to allocate the profits generated by the digital economy to the corresponding jurisdiction, as the focus is on elements which can be considered almost "collateral": e.g. the country where servers may be located or where the algorithms have been developed. This approach does not address the significant contribution of the end-user who, for example, is sharing his or her experiences or preferences and allowing this data to be monetised for targeted advertising. Neither does it respond to a reality in which digital businesses largely rely on hard-to-value intangible assets.
Both the EU and the OECD acknowledge that the change has been dramatic since 9 of the world's top 20 companies by market capitalisation are now digital, compared to 1 in 20 ten years ago. As the digital transformation of the economy accelerates and the existing corporate taxation rules are outdated to catch such evolution, the EU Commission has issued two distinct legislative proposals to attempt to remedy the situation and ensure that digital business pay their fair share of tax:
- The first proposal is directed at providing a long-term solution to the issue of taxation of digital businesses, through an amendment of corporate income tax rules so as to allow Member States to tax profits generated in their territory. The corner stone of this proposal would be the taxation of profits where businesses have significant interaction with users through digital channels, thereby shifting to a system where digital companies — which usually operate across borders — pay taxes where their users are located, rather than just where they have a physical presence.
- The second proposal is an attempt to respond to the timing concerns expressed by several Member States, as there is an implicit acknowledgement that the first proposal will take time to be put in place. The UE, therefore, proposes an interim indirect tax to cover specific digital activities which currently escape the EU tax net.
The First Proposal
This proposed Council Directive would address the corporate taxation of companies with a "significant digital presence" (or virtual permanent establishment) in a Member State. For these purposes, a company will be deemed to have a taxable digital presence in a Member State if it fulfils one of the following criteria:
- It exceeds a threshold of 7 million Euros in annual revenues in a Member State;
- It has more than 100,000 users in a Member State in a taxable year; or
- Over 3000 business contracts for digital services are created between the company and business users in a taxable year.
The attribution of profits would then take into account the market values of e.g. profits from user data or from services connecting users or other digital services (e.g. subscription to streaming services).
In the words of the Commission, this system would ultimately secure "a real link between where digital profits are made and where they are taxed" and address the two main concerns with traditional tax rules: (i) physical presence in a Member State will no longer be the only nexus in order to impose taxation on a company; and (ii) value creation elements, typical of the digital economy such as user data, may now be taken into account in the allocation of profits.
The Second Proposal
This Proposed Council Directive articulates an interim indirect digital tax on specific digital activities and would generate immediate tax revenues for Member States. With these measures, the Commission is directly attempting to prevent "a patchwork of national responses" which would adversely affect the single market.
This indirect tax would only apply to companies with total annual worldwide revenues of 750 million Euros and annual EU revenues of 50 million Euros. The tax would be levied at the rate of 3% over the revenues from three main types of services:
- Online placement of advertisement;
- Sale of collected user data; and
- Digital platforms that facilitate interaction between users.
Companies would then be able to deduct the tax as a cost from their corporate tax base, alleviating the risk of being taxed twice on the same income.
Note: Existing double tax treaties
These proposals would supersede double taxation treaties between Member States and would also apply between a Member State and a third country absent a double taxation treaty. However, these rules may not supersede existing treaties between Member States and third countries. The Commission has therefore issued a Recommendation to Member States to take the necessary measures to adapt their treaties, as failure to do so is perceived to risk disrupting the level playing field between EU and non-EU businesses.
Despite the apparent will of the Commission to push through with these measures, it is currently doubtful whether there will be enough support in the EU to achieve enactment. If progress at the OECD level in this same field can be taken as a measure of the speed at which consensus may be reached, then it may unfortunately look like another example of wishful thinking from the EU.
However, companies should not dismiss these proposals too quickly, since Member States may show willingness to "go it alone" and adopt domestic measures inspired in these EU proposed Directives.