Taxing the Digital Economy: OECD Releases BEPS Action Plan Stakeholder Comments

When the Organization on Economic Cooperation and Development Task Force on the Digital Economy’s delegates meet from February 3-4, 2014, they will be discussing the recently released comments to the OECD’s BEPS Action Plan. The BEPS (Base Erosion and Profit Shifting) Action Plan was launched during last year’s G20 summit as a measure to reduce international tax evasion and the non-taxation or under-taxation of certain types of commerce, particularly in the digital economy. Essentially, the international community seeks to enjoin companies like Apple, Amazon.com, and Google, among many others, from continuing to organize subsidiaries in tax shelters where they can avoid taxes which would ordinarily be levied in the domestic jurisdictions where the majority of their business is done.

At present, with the international taxation regime leaving gaping holes for modern, savvy e-commerce and tech companies to jump through, there is an abundance of international tax evasion. In an effort to eradicate the now prevalent evasive corporate practices, the OECD will have to recommend, and the international community implement, comprehensive international taxation reforms. The most recent comments submitted by business stakeholders reveal, however, that there is no clear answer to the question of how international tax reforms should be structured. While some have argued that a reversion to older principles of international taxation should be implemented, others have urged the OECD to take account of the unique problems that are posed by modern digital businesses by drafting content-specific rules. See generally OECD, Compilation of Comments Received in Response to Request for Input on Tax Challenges of the Digital Economy (Jan. 2014) available at http://www.oecd.org/ctp/comments-received-tax-challenges-digital-economy.pdf.

Particularly, some stakeholders have advocated that solving the issue of transfer pricing in the digital economy––the process by which a company is taxed according to the pro rata market value of its product or service vis a vis the value of its affiliated companies’ same product or service in other jurisdictions––is crucial to the success of any international tax reform. See Patrick Breslin, A Tale of Two Technologies: Transfer Pricing of Intangibles In the Digital Economy, Tax Management Transfer Pricing Report, Vol. 21, No.23 (2013). Solving this problem is important because, without proper valuation, affiliates in one jurisdiction may face disproportionate tax liability for the income produced by its product or service. And improper valuation may lead to double-taxation. Hypothetically, if  a corporate subsidiary is wrongly assessed a tax deficiency on the basis of Country A’s determination that the product or service that it shares with other affiliates were worth more than what it reported in Country A’s jurisdiction, then affiliates in other jurisdictions may face double taxation; the errant valuation in Country A will create a value imbalance among affiliates, causing an affiliate in Country B to be double taxed unless the value of its product or service in Country B is reduced by the amount of excess taxation that was wrongly assessed by Country A. One can easily see the potential morass that this technical process creates.

Other stakeholders have opined that valuation (transfer pricing) of goods and services is less important; they assert that “permanent establishment”––whether a company or its subsidiaries can be property said to have legal domicile in a country, thus being susceptible to domestic taxation in the places where they do business––is the most critical element of international tax reform. This approach is less technical and ostensibly more intuitive. Under current proposed regulations, a corporation’s distribution centers and warehouses are by law excluded from the permanent establishment requirement, and are thus exempt from taxation at the domestic level. For instance, although Amazon.com holds and distributes goods in Spain and France so that it can quickly process orders, its sales of products in those countries are severely under-taxed because its distribution centers are not considered “permanently established” in those respective countries. Instead, Amazon.com maintains a subsidiary payment-processing company that is permanently established in Liechtenstein, a country with a substantially low corporate tax rate; accordingly, the majority of the company’s profits are taxed in a jurisdiction (Liechtenstein) other than the one in which it  does its primary business (e.g. France or Spain). Basically, those urging for a change to the permanent establishment rules believe that parity could be achieved if income tax correlated with the location of distribution/output.

These are just a couple of the issues that face the OECD and other international stakeholders (e.g. national governments), which reveal the complexities of international tax reform generally.  Which of the above mentioned approaches offers the best chance of success? How would you tackle this issue of you were a member of OECD’s Task Force on the Digital Economy? To what extend to do you believe that remedying Base Erosion and Profit Shifting will better serve the domestic populations in the countries seeking more tax revenue? Are there any global market efficiency problems with foreclosing a corporation’s ability to limit its tax liability?

Sources: Model Tax Convention on Income and on Capital 2010; COMPILATION OF COMMENTS RECEIVED IN RESPONSE TO REQUEST FOR INPUT ON TAX CHALLENGES OF THE DIGITAL ECONOMY; Action Plan on Base Erosion and Profit Shifting

Image Source: Organization on Economic Co-operation and Development

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