Taxation of digital economy: further update on developments in the European Council's ECOFIN
If you’ve been following our updates on the steps the European Council has been taking on how to approach the taxation of the digital economy in keeping with its view that successfully building a Digital Europe requires “an effective and fair taxation system fit for the digital era” (see our last report on the matter) you’ll be keen to catch up on the latest developments.
The latest thinking from ECOFIN
The results of the 5 December meeting of the European Council’s Economic and Financial Affairs Council (ECOFIN) are out, and we’ve highlighted the major points of interest:
- ECOFIN indicated that the tax challenges of the digital economy go beyond the questions of tax avoidance and tax evasion. It stressed that digital businesses should pay their fair share of taxes in the right jurisdiction.
- It seemed to acknowledge the arm’s-length principle as the basis for allocating value to jurisdictions, and indicated that this would require an examination of how value is created, and how profits are generated, within the digital economy.
- It took the view that the permanent establishment is an essential principle when it comes to allocating taxation rights, and that the focus on physical presence leads to a misalignment between where profits are taxable and where value is created. It found that that the absence of a physical presence in a given country by a company that has a significant economic presence there should not prevent that country from taxing profits that such company has generated there, as long as a nexus can be established that takes into account the arm’s-length principle.
- It also took the view that it would be worth exploring whether a virtual permanent establishment together with corresponding adjustments to transfer pricing and profit-allocation rules, could constitute such a nexus. In that respect, it referred to “revenue-based, user-based and digital factors”, among others.
- It underlined the importance of data to the creation of value, and noted that it encourages the reporting of information by digital companies and the exchange of information.
- It urged the OECD to find solutions for upgrading tax treaties (including the OECD Model Convention and Commentary), the Transfer Pricing Guidelines, and Guidance on Attribution of Profits to Permanent Establishments.
- It invites the European Commission to come up with proposals by early 2018 and to assess the short-term options, such as an equalization tax.
Continued alignment with the work of the OECD
At a press conference following the 5 December meeting, Valdis Dombrovskis, European Commission Vice-President for the Euro and Social Dialogue, welcomed the ECOFIN’s conclusions and noted that they would serve as the EU's input to the OECD's work on this topic. He also said the Commission was looking forward to the OECD’s report on taxing the digital economy, which, as we have noted, will be coming out in April next year, and repeated the Commission’s preference for concrete and workable multilateral solutions to this global problem. He added that the Commission is keen to see innovative solutions coming from the OECD-led process on digital taxation, and that the Commission also stands ready to move forward with its own proposals in spring 2018, should that be required.
Remarks on the outcome of the meeting
The outcome of the meeting is generally in keeping with the result of previous Council deliberations, but nonetheless in the view of Loyens & Loeff it triggers a few question marks and points of clarification, and a number of caveats are in order.
For instance, the ECOFIN refers to taxation in the “right” jurisdiction, but it does not spell out just what “right” means in this case. A reading of the document as a whole seems to suggest that it means the jurisdiction from which data is collected. This is generally the country where consumers and users of the online services in question reside (the destination country), and not the country where ‘significant people’s functions are performed’, ‘assets are located’, and ‘risks are assumed’ (the origin country).
But there’s the rub: it is generally accepted that the arm’s-length principle allocates taxation rights to the origin country and not the destination country. Shifting those rights to the destination country would thus be a departure from the arm’s-length principle. This would be nothing less than a major paradigm shift in international taxation practice.
A few important caveats
The latest pronouncements from the ECOFIN aside, the fact remains that a number of thorny questions still need resolving before the European Commission and the OECD can get to the workable solutions that they are after.
First, the mere fact that a business—whether it is a digital company or not—mines data in a given country (usually in exchange for a discount on a product or service or for a free service such as the use of a social-media platform or search engine) does not automatically mean that that business generates profits in that country.
And then there’s the plain fact that, at a more-general level, valuating data is no easy matter. As a rule of thumb, data becomes valuable only if it has been aggregated and processed (the raw data on a single person is unlikely to have any value). Digital companies do not necessarily carry out activities such as data processing in the destination country, so it could be argued that no value is really added in the destination country by the company collecting the data.
Recoqnizing a virtual permanent establishment or other form of nexus doesn’t do anything to change that. The creation of a nexus on these grounds could easily result in the recognition of virtual permanent establishments that do not turn a profit.
Furthermore, it is worthwhile noting that the ECOFIN resolutions of its 5 December meeting make no mention of the Common Consolidated Corporate Tax Base (CCCTB). That obviously doesn’t mean that the CCCTB has been discarded. Loyens & Loeff’s take on this is that the Commission will likely bring the CCCTB back to the table in the context of the taxation of the digital economy.
An elusive consensus
Perhaps as troubling as the real difficulties that some of these issues present, is the lack of concensus among EU Member States themselves on how to resolve them, which disagreement can be clearly read between the lines of these ECOFIN resolutions. The introduction of short-term measures (such as an equalization tax) is just one example.
We’ll continue to follow the efforts that ECOFIN, the European Commission and the OECD are making, and to keep you abreast more generally on developments in this crucial area.
If you would like to discuss the above in more detail, please contact your regular advisor at Loyens & Loeff or any of the contacts persons of our Digital Economy Taxation team.
Pierre-Antoine KlethiSenior Associate Attorney at law / Avocat / Tax Adviser
Pierre-Antoine Klethi, senior associate, is a member of the Tax and Investment Management Practice Groups in our Luxembourg office. He focuses on corporate taxation (including relevant international developments), fund structuring and EU State Aid investigations.T: +352 466 230 429 E: [email protected]
Dennis SchäferSenior associate Tax adviser
Dennis Schäfer is a tax adviser in our Investment Management group in our Amsterdam office. His work focusses on investment funds, both from a manager’s and investor’s perspective, real estate investments and international taxation.T: +31 205 785 456 M: +31 6 12 47 60 89 E: [email protected]