In pursuit of fair taxation of digital economy

Digitalisation has given rise to new tax challenges. As a general rule, business profits shall be taxed in the State where the legal entity has a tax nexus. In this sense, the OECD MC states that an entity is subject to tax on its business profits in the country of which it is a resident. At the same time, a non-resident entity may be taxed in a country of which it is a non-resident if it has a permanent establishment (PE) in that country. According to this, a substantial physical presence is required under the current international tax rules to tax business profits. However, nowadays there is a new way for carrying business and a non-resident company can operate in a State without having physical presence at all in the country. Under the current tax legislation, in most cases this leads to zero taxation in the source State because there is not a substantial physical presence established in that territory. So, the absence of coherent source rules has created opportunities for profit shifting that have been compounded by the phenomenon of globalisation and the fast growth of digitalisation. The problem is heightened where such companies adopt certain strategies that eliminate taxation also in the State of residence. Following these premises, the OECD has launched the Action Plan on Base Erosion and Profit Shifting (BEPS) in an attempt to realign corporate taxation with the location of actual business activities. Particularly, Action 1 of the BEPS Plan deals with the challenges of digital economy. Besides, Action 7 is aimed at countering the artificial avoidance of a PE status. A careful reading of both Action 1 and 7 Final Reports shows that the OECD is determined to expand the definition of a PE and adopt a more flexible concept of it. However, except in the case of the changes in the OECD MC regarding the concept of PE, the OECD has not yet suggested the implementation of specific measures to address the broader direct tax challenges raised by the digital economy. Instead, BEPS Action 1 Final Report simply lists different options, making it clear that countries are free to adopt any of them in their domestic laws in a combined manner or chosen individually. But, as we shall see below, the uncoordinated and unilateral actions undertaken by some countries and the work on the different Actions of the BEPS Action Plan are not enough to address this challenge. On this basis, a destination-based corporate tax has been proposed as an adequate alternative to taxing corporations in an international context in order to build a fair taxation system (DEVEREUX & DE LA FERIA, 2014; AUERBACH, DEVEREUX, KEEN & VELLA 2017; AVI-YONAH, 2016). In a similar vein, the recent European Union’s response to the broader tax challenges raised by the digital economy shows that today’s international corporate tax rules are not appropriate to capture the new business models that make profits from digital transactions in a jurisdiction without having a physical presence on that territory. In this spirit and in the light of the European Commission’s Communication of 21 March 2018 ‘Fair taxation of the digital economy’, new rules are proposed to ensure that digital businesses are taxed in a fair and growth-friendly way in the EU. Specifically, this package of measures contains two proposals: (1) a long-term solution and, as long as consensus on the long-term solution has not been reached, (2) an interim option. The first proposal refers to a reform of the EU’s corporate tax rules for digital activities to ensure that profits are taxed where businesses have significant interaction with users through digital channels (a new tax nexus based on the concept of taxable digital presence, i.e., the introduction of a virtual permanent establishment concept). To attain this objective, the Commission proposes a Directive laying down rules relating to the corporate taxation of a significant digital presence as well as recommendations to Member States for including changes in their double taxation conventions with third countries. Meanwhile, an interim tax on certain revenue from digital activities is proposed to ensure that activities that are currently not taxed would start to generate immediate revenues for the Member States. For this purpose, the Commission proposes a Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services (the equalisation levy option). As far as can be ascertained, the OECD and the EU are pulling in the same direction, although it seems that the European Commission has taken a decisive step towards fair taxation of the digital economy. It remains to be seen whether these proposals are successful or fall by the wayside. I. THE CONCEPT OF DIGITAL ECONOMY AND ELECTRONIC COMMERCE The revolution of IT has made a tremendous impact on all fields of human endeavour. Digitalisation allows companies to make a better use of resources, with lower costs, which translates into greater benefits. All the transformations produced as a result of the irruption of ICT are called Information Society. The European Commission (1993) referred to the rising Information Society as a set of social and organisational changes produced as a result of the emergence of new technologies in the fields of information and communication. The Information Society is one of the key factors that contribute to a country’s economic growth. In this context, the EU concept of «Information Society Services» (hereafter, ISS) was defined as “any service normally provided for remuneration, at a distance, by means of electronic equipment for the processing (including digital compression) and storage of data, and at the individual request of a recipient of a service” (Recital 17). That said, Information Society Services are not solely restricted to services giving rise to on-line contracting but also, in so far as they represent an economic activity, extend to services which are not remunerated by those who receive them” (Recital 18). So, Information Society Services are onerous and are negotiated or concluded by electronic means; in this context, electronic commerce is part of these services. Because of the development of markets, new vocabulary emerged to refer to this economic space: knowledge economy, innovation economy, network economy, economy or digital economy (COHEN, DE LONG & ZYSMAN, 2000). The expression «digital economy» was popularised by TAPSCOTT (1994), but one of the first legal approaches to its legal meaning was achieved in a report published by the US Department of Commerce (1998) entitled The Emerging Digital Economy. Later, the OCDE (2012) stated that the “digital economy is comprised of markets based on digital technologies that facilitate the trade of goods and services through e-commerce”. This way, digital economy and e-commerce are two different concepts, being e-commerce the main drive of digital economy, and despite the fact the two terms are often treated as synonyms. The European Commission High Level Expert Group on Taxation of the Digital Economy (2014) expressed the difficulties to give a definition of digital economy because 1 This concept was introduced by the Directive 2000/31/EC of the European Parliament and the Council of 8 June 2000, on certain legal aspects of Information Society Services, in particular electronic commerce, in the Internal Market (‘Directive on electronic commerce’) that provides the legal basis for the e-commerce and the ISS. 2 In this document, digital economy was defined as an intelligent space integrated by information, access to information and information processing, and communication capabilities. On another note, the Australian Government (2009) defined digital economy as “the global network of economic and social activities that are enabled by information and communications technologies, such as the Internet, mobile and sensor networks”. Furthermore, the OECD (2011) pointed out that “an electronic transaction is the sale or purchase of goods or services, conducted over computer networks by methods specifically designed for the purpose of receiving or placing of orders”. However, as we will see next, digital goods and services are not addressed adequately under this narrow definition. of the ever-changing technologies of the ICT sector, in which changes occur quickly and consistently. So, instead of providing definitions that become obsolete in a short space of time, the Expert Group decided to set as the key features of digital economy the following: mobility, network effect from user participation and interaction and the importance of data. Action 1 BEPS Final Report (OECD, 2015a) also specifies that the digital economy is “the result of a transformative process brought by information and communication technology (ICT), which has made technologies cheaper, more powerful, and widely standardised, improving business processes and bolstering innovation across all sectors of the economy”. Additionally, the Final Report refers to the key features of the digital economy, including: mobility, with respect to intangibles, users/customers and business functions; reliance on data and user participation for the success of operations of the enterprise; network effects with respect to the user participation and integration; the use of multi-sided business models in which the buyer and the seller are in different 3 Digitalisation has enhanced mobility of intangible assets and allows companies to reduce core business costs. This makes difficult to delimit the jurisdiction where the economic activity takes place and value is created. 4 Digitalisation reduces the marginal cost of products and pushes down prices; at this point, competition increases in the quality and utility of the products. 5 ICT reduces the cost of collecting, storing and analysing data provided by final consumers –sometimes, data of a personal natureso that companies are enabled to increase co