Tax Administrations and control of the Digital Economy

Alfredo CollosaAlfredo Collosa    31 January 2020
Tax Administrations and control of the Digital Economy

I will hereby attempt to briefly comment on the situation of an issue as current and complex as the control of the digital economy by the Tax Administrations (TAs).

In the final OECD reports on the BEPS Action Plan in 2015, it was concluded that it was impossible to precisely delimit the digital economy, given that it was evermore becoming the economy in itself.

However, the digital economy and its business models have some key characteristics that are relevant from the fiscal perspective, namely: mobility of intangible assets, users and business functions, importance of the data, network effects, proliferation of multiphasic business models, trend toward monopoly or oligopoly and volatility.

Many enterprises have adopted world entrepreneurial models, centralizing functions at the regional or world level and not at the country by country level. Even for the small and medium enterprises it is possible to become “micro multinationals” which operate and maintain staff in multiple countries and continents.

The following models stand out among the different business models of the digital economy:

  • Electronic commerce.
  • Applications stores.
  • Online advertising.
  • Computerization in the cloud.
  • Network participative platforms.
  • High frequency negotiation.
  • Online payment services.

As we may see, the digital economy concept includes different aspects ranging from electronic commerce, the so-called collaborative economy, electronic money, cryptocoins, games and online advertising, among others.

For the European Commission, the term “collaborative economy” refers to business models which facilitate activities by means of collaborative platforms that create an open market for the temporary use of merchandise and/or services frequently offered by individuals.

According to Oxfam, it currently represents 15% of the Gross Domestic Product (GDP), but it is estimated that within a period of 5 and 10 years it will reach 25 %.

With it and the new ways of doing business in the fourth industrial revolution, there are substantial losses in tax collection and likewise increased inequality, since the actual direct taxes which these taxpayers end up paying are much lower as compared with that paid by other production factors such as labor.

In addition to the evasion being produced, standing out is the fact that the digital economy is generating, in many countries, an unfair competition with the countries’ enterprises which have a physical presence and carry out similar activities.

These new working forms likewise create difficulties for distinguishing the various actors vis-a-vis social security, thereby worsening the problem of lack of financing of the pensions systems.

All of this creates a great impact in such regions as Latin America and the Caribbean (LAandC), which is characterized by a high level of inequality in the distribution of revenues and above all, a scarce redistributive capacity of the fiscal policy.

There is a high tax evasion level in the region, which according to ECLAC amounted to 6.3% of GDP in 2017, or 335 billion dollars. In VAT it represents 2.3% of GDP, while in income tax it is 4.00% of GDP.

The problem worsens, since at the international level the countries have not yet agreed on how to adequately tax the digital economy and much less, the type of control actions that should be undertaken by the Tax Administrations (TAs).

This is due to the fact that the current tax systems are not adapted to the new ways of doing business.

According to the international fiscal system, in order to pay taxes in a country there must be a physical presence therein, while many of the digital economy businesses may carry out activities in different countries without a physical presence.

A debate is currently in process in the world of taxation, regarding how the digital economy should be taxed.

Precisely, the source of the debate is not only the substantial amounts which the States fail to collect, but also the enormous inequality generated, when comparing the actual direct taxes which these “digital giants” end up paying, with those paid by other production factors such as labor.

According to its BEPS Action Plan, the OECD recently said that the countries and jurisdictions participating in the inclusive framework of the OECD/G20 BEPS shall intensify efforts for arriving at a global solution to the increasing debate on how to tax multinational enterprises in a rapidly digitalized economy.

 

The new international debates shall be focused on two central aspects.

The first one will deal with how to modify the existing rules that divide the right to tax the income of multinational enterprises among the jurisdictions, including the traditional transfer pricing rules and the arm’s length principle, in order to take into account the changes resulting from digitalization.

A second aspect seeks to establish a minimum tax level that would correspond to the multinational enterprises in the digital economy and other areas. This would assist the countries in protecting their tax base from the attempts by multinational groups of transferring their profits to low or null taxation jurisdictions.

Recently, on 7/6/2019 the G20 ministers proposed the creation of a digital tax intended for the digital giants, which would be applied on a global basis and not where they have physical presence. The tax would be applied according to the significant economic presence in a specific country, the volume of data and other intangible assets such as the number of users.

On its part, the EU is also fully debating this issue and different countries members thereof, have already proposed unilateral solutions consisting of specific taxes to be applied to businesses of the sector. In March, Brussels proposed the establishment of a 3% tax on revenues -not on benefits- of those companies billing over 750 million Euros. Although there has been progress in indirect taxation, the situation has not been the same in the case of direct taxation within the EU.

On the other hand, the IMF issued a document entitled: “Corporate Taxation in the global economy” showing the different problems faced by corporate international taxation and the different options to face them.

The document highlights the need to maintain and take advantage of the progress that has been achieved in international cooperation in taxation in these past years.

The Tax Administration Forum has published a communiqué with the results achieved in the meeting held in Chile in March 2019, which was focused on four priority issues:

Compliance with BEPS and tax certainty.

  • Improve cooperation.
  • Support the digitalization of the tax administrations, and
  • Improve training of the agencies in the developing countries.

During the forum, emphasis was placed on cooperation focused on two areas: the “Common Reporting Standard” (CRS), for expanding and improving the analysis derived therefrom and the digital economy, to ensure effective trade taxation through the digital platforms.

With respect to digitalization of the TAs, it was agreed to explore the use of new technologies, analytical tools and data analysis for improving compliance, reducing the administrative burden, creating efficiency and improving taxpayer services. It was also agreed to further collaboration in this sphere.

Other organizations, such as ICRIT, propose an approach different from that of the OECD, stating that the most fair and effective approach would be to tax the multinationals as individual businesses and no longer considering each subsidiary as independent. In other words, they are in favor of the so-called unitary approach. They propose that multinationals be treated as unified enterprises, combined with a global effective minimum tax of 20-25%, which they consider would significantly reduce the financial incentives whereby multinationals transfer benefits between jurisdictions and so that the countries may reduce their tax rates.

So far, many countries have adopted unilateral solutions to tax the digital economy.

At this point, I would like to warn about the risk run with said solutions of collecting taxes unilaterally from these taxpayers. It would be that direct as well as indirect taxes may end up being transferred to the users (consumers), with which the inequality one endeavors to combat may very probably be increased.

On the other hand, because of all that has been mentioned, I understand that the digital economy involves a great challenge for the TAs.

What should the TAs do with respect to this issue?

They cannot remain inactive awaiting for solutions originating from the International Tax Organizations (case of the OECD) with respect to its form of taxation. I understand they must begin acting by promoting the necessary regulatory changes, designing new control strategies and policies, as well as strengthening cooperation and collaboration, within the national as well as the international sphere, between the TAs and the different entities involved in the subject.

Transparency and Information Exchange are key for combating tax evasion in its various aspects.

To this end, it is important to analyze all the best practices, at the regulatory as well as managerial level, for arriving at a better strategy for the control of the digital economy by the TAs of the region.

For example, these best practices may be analyzed in relation to the following issues:

  • Electronic commerce.
  • Collaborative or digital platforms.
  • Digital coins.

This would be in addition to those issues dealing with social security, always from the standpoint of our TAs.

It is important to consider those digital economy cases of a sector or activity wherein the TAs of some country of the region may have already applied a control strategy, by pointing out the problems they had to face and likewise analyzing the results of the measures.

Thereafter, on that basis, strategies should be proposed for increasing the levels of voluntary compliance, reducing the inequalities originating from unfair competition with the enterprises having physical presence and carrying out similar activities and likewise, in relation to social security as a result of the actions of the various actors.

It is important that the TAs may get to know and familiarize themselves with these new juridical businesses between the different intervening parties to thus be more efficient in their activities.

It is necessary for the TAs to have available information regarding the agents and their economic activities, as well as the regulatory capacity for determining their obligations and managerial capacity for efficiently applying the legislation.

Among other aspects, one should analyze such issues as who sets the price, who is the owner of the goods or services offered, whether the platform acts as intermediary or direct supplier, to mention only a few of these aspects.

To sum up, I endeavored to provide some ideas on an issue as current and complex, of which I am convinced that the TAs must play the leading role.

(*) first published in CIAT Blog

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