Explanatory Memorandum to COM(2018)147 - Rules relating to the corporate taxation of a significant digital presence - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2018)147 - Rules relating to the corporate taxation of a significant digital presence. |
|---|---|
| source | COM(2018)147  |
| date | 21-03-2018 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
The digital economy is transforming the way we interact, consume and do business. Digital companies are growing far faster than the economy at large, and this trend is set to continue. Digital technologies bring many benefits to society and, from a tax perspective, they create opportunities for tax administrations and offer solutions to reduce administrative burdens, facilitate collaboration between tax authorities, as well as addressing tax evasion.
However, digitalisation is also putting pressure on the international taxation system, as business models change. Policy makers are currently struggling to find solutions which can ensure a fair and effective taxation as the digital transformation of the economy accelerates, and the existing corporate taxation rules are outdated to catch such evolution. The application of the current corporate tax rules to the digital economy has led to a misalignment between the place where the profits are taxed and the place where value is created. In particular, the current rules no longer fit the present context where online trading across borders with no physical presence has been facilitated, where businesses largely rely on hard-to-value intangible assets, and where user generated content and data collection have become core activities for the value creation of digital businesses. There is recognition at international level, by bodies such as the G20, that action is needed to adapt corporate tax rules to the digital economy. The Organisation for Economic Co-Operation and Development (OECD) examined this issue in the context of the OECD/G20 BEPS project 1 . At their meeting of March 2017, the G20 requested the OECD to deliver an interim report on the implications for taxation of digitalisation to the G20 Finance Ministers in April 2018. However, reaching an agreement at global level is likely to be challenging.
Such challenges were identified in the Communication of the Commission on A Fair and Efficient Tax System in the European Union for the Digital Single Market adopted on 21 September 2017. In this Communication the Commission set out its analysis of the tax challenges posed by the digitalisation of the global economy. This was followed by the conclusions adopted on 19 October 2017 by the European Council 2 which underlined the need for an effective and fair taxation system fit for the digital era and looked forward to appropriate Commission proposals by early 2018. The ECOFIN Council in its conclusions of 5 December 2017 3 also looked forward to appropriate Commission proposals by early 2018, 'taking into account relevant developments in ongoing OECD work and following an assessment of the legal and technical feasibility as well as economic impact of the possible responses to the challenges of taxation of profits of the digital economy.'
The current corporate tax rules are built on the principle that profits should be taxed where the value is created. However, they were mainly conceived in the early 20th century for traditional brick and mortar businesses and define what triggers a right to tax in a country ("where to tax") and how much of corporate income is allocated to a country ("how much to tax") largely based on having a physical presence in that country and without reflecting the value created by user participation in that jurisdiction. That means that non-residents for taxation purposes become liable to tax in a country only if they have a presence that amounts to a permanent establishment there 4 . However, such rules fail to capture the global reach of digital activities where physical presence is not a requirement anymore in order to be able to supply digital services. New indicators for significant economic presence are therefore required in order to establish taxing rights in relation to the new digitalised business models.
Once the business is taxable in a country, the profits generated by this business still need to be determined and attributed to this country. In the current corporate tax framework, transfer pricing rules are used to attribute the profit of multinational groups to the different countries based on an analysis of the functions, assets and risks within the value chain of the group. In the context of the taxation of business profits attributable to permanent establishment, a separate entity is hypothesised 5 and the OECD Transfer Pricing Guidelines apply by analogy. However the current rules, which were developed for traditional business models, do not reflect the fact that digital business models have different characteristics than traditional ones in terms of how value is created. This creates a distortion of competition and has a negative impact on public revenues. The digital economy relies heavily on intangible assets such as user data and advances data analytics methods in order to extract value from user data. These business patterns are becoming more and more the value drivers within multinational groups and are difficult to value. The challenge of identifying and valuing intangible assets as well as determining their contribution to value creation within a group requires new methods for attributing profit that better capture value creation in the new business models.
This proposal aims at addressing the issues raised by the digital economy by setting out a comprehensive solution within the existing Member States' corporate tax systems. It provides a common system for taxing digital activities in the EU which properly takes into account the features of the digital economy.
First, this proposal lays down rules for establishing a taxable nexus for digital businesses operating across border in case of a non-physical commercial presence (hereinafter: a 'significant digital presence'). New indicators for such a significant digital presence are required in order to establish and protect Member States' taxing rights in relation to the new digitalised business models.
Second, this proposal sets out principles for attributing profits to a digital business. These principles should better capture the value creation of digital business models which highly rely on intangible assets.
This Directive, once implemented in Member States national legislation, will apply to cross-border digital activities within the Union, even if the applicable double taxation treaties between Member States have not been modified accordingly. It will also apply if a business established in a non-Union jurisdiction operates through a significant digital presence in a Member State, where there is no double taxation treaty in place between the Member State concerned and that jurisdiction.
• Consistency with existing policy provisions in the policy area
This proposal is part of the efforts being undertaken at EU and international level in order to adapt the current tax framework to the digital economy.
At international level, the challenge of ensuring that all actors in the digital economy are fairly taxed on their income was already identified under the Action 1 report of the OECD/G20 BEPS project, and in the OECD interim report on the taxation of the digital economy 6 which was presented to the G20 Finance Ministers in March 2018. The interim report reflects different options to address this challenge and the OECD intends to seek a consensus based solution by 2020.
The Commission acknowledges that the ideal approach would be to find multilateral, international solutions to taxing the digital economy, given the global nature of this challenge. The Commission is working closely with the OECD to support the development of an international solution. However, progress at international level is challenging, due to the complex nature of the problem and the wide variety of issues that need to be addressed, and to reach international consensus may take time. This is why the Commission has decided to take action. The present proposal is intended to contribute to the ongoing work at OECD level, which remains essential in order to reach a global consensus on this topic. By setting out the EU's vision on how to address in a comprehensive way the challenges of the digital economy, the proposed Directive will serve as an example to influence the international discussions on a global solution. The EU should encourage and support a move by global partners in that direction.
At EU level, this proposal builds on the numerous initiatives taken by the Commission with a view to ensuring fair and efficient corporate taxation in the Union 7 .
In a broader context, it should be emphasised that the proposal for a Common Consolidated Corporate Tax Base (CCCTB) would be the optimal solution to ensure fairer and more efficient corporate taxation within the EU. However, the CCCTB with its current scope would not offer a structural solution to some of the important challenges in taxing businesses of the digital economy. This is because the CCCTB has a limited scope (it is mandatory only for large multinational companies) and because the definition of a permanent establishment in the CCCTB follows the one currently applied internationally. Moreover, the profit allocation rules (the formula apportionment) in the CCCTB may not sufficiently capture the digital activities of a company. The rules on a taxable nexus for digital activities should be included in the CCCTB. Furthermore, with respect to allocating the profits of large multinational groups, the formula apportionment approach in the CCCTB should be adapted in order to effectively capturing digital activities. The Commission welcomes the amendments in the reports of the Committee on Economic and Monetary Affairs of the European Parliament on the Common Corporate Tax Base and the CCCTB as a good base for further work on ensuring a fair taxation of digital activities 8 . The Commission stands ready to work with Member States and the Parliament to examine how the provisions in this Directive can be incorporated into the CCCTB.
This Directive is part of a package that also includes a Recommendation to Member States for including corresponding rules on a significant digital presence and profit allocation in their double taxation treaties with third countries, a proposal for a Directive including an interim solution and a Communication setting the context and explaining the articulation between the proposals.
The Commission is recommending Member States to replicate the provisions included in this Directive in the double taxation treaties with third countries since, in case there is a double taxation treaty between a Member State and a non-Union jurisdiction, the rules of the applicable double taxation treaty may override the proposed provisions on a significant digital presence.
In addition the Commission is today putting forward a proposal for a Directive for an interim solution, the Digital Services Tax (DST), as a simple interim solution for the taxation of digital activities in the EU. The DST sets out a tax on the revenues derived from the provision of certain digital services. 9 The DST should apply on a temporary basis until a comprehensive solution is in place.
• Consistency with other Union policies
This proposal is also consistent with the Digital Single Market strategy 10 , where the Commission committed to ensure access to online activities for individuals and businesses under conditions of fair competition, as well as to open up digital opportunities for people and business and enhance Europe's position as a world leader in the digital economy.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
Union's legislation concerning tax other than that on turnover falls within the ambit of Article 115 of the Treaty on the Functioning of the EU (TFEU). This provision stipulates that the measures of approximation under this article shall directly affect the establishment or functioning of the internal market.
• Subsidiarity (for non-exclusive competence)
This proposal complies with the principle of subsidiarity. As digital businesses are able to operate across borders without having any physical presence, both inside the Union and from third countries, uniform rules are needed to ensure that they pay taxes where they make profits. Given the cross-border dimension of digital activities an EU initiative is needed and adds value as compared to what a multitude of national measures could attain. A common initiative across the internal market is required for a direct and harmonised application of the rules on a significant digital presence within the Union so as to ensure a level-playing field for all Member States and provides taxpayers with legal certainty. Unilateral and divergent approaches by each Member State could be ineffective and fragment the single market by creating national policy clashes, distortions and tax obstacles for businesses in the EU. If the objective is to adopt solutions that function for the internal market as whole, the appropriate way forward is only through coordinated initiatives at EU level.
• Proportionality
The proposed Directive is necessary, suitable and appropriate for achieving the desired end. It does not imply a harmonisation of corporate tax rates in the EU and, therefore, it does not restrict Member States' capability to influence their desired amount of corporate tax revenues. It does not interfere with national policy choices in terms of the size of public sector's intervention and composition of tax revenues. It proposes a more efficient way to tax the digital activities of corporate taxpayers operating within the EU in view of a more efficient internal market.
• Choice of the instrument
Distortions in the internal market, as identified earlier, may only be tackled through binding legal rules and approximation of tax legislations through a common legislative framework. Soft law would be a suboptimal choice, as Member States would be free to not to implement it at all or it could lead to a piecemeal approach. Such an outcome would be highly undesirable. It would risk creating legal uncertainty for taxpayers as well as jeopardising the objectives for a coordinated and coherent corporate tax system in the internal market.
Based on Article 115 TFEU, "the Council shall, acting unanimously … issue directives for the approximation of laws, regulations and administrative provisions of the Member States as directly affect the establishment or functioning of the internal market." The Treaty is therefore prescriptive that in taxation other than that on turnover (covered by Article 113 TFEU); legislation shall exclusively be in the form of directives.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Stakeholder consultations
The consultation strategy has focused on three main groups of stakeholders: Member States' tax administrations, businesses and citizens. The two main consultation activities consisted in the open public consultation, which received a total of 446 replies over 12 weeks from 26 October 2017 to 3 January 2018, and a targeted survey sent to all EU tax administrations. As regards a comprehensive solution a proposal for a digital presence in the EU is the preferred approach for more than half of the respondents to the stakeholder consultation. 11 The preferred option coincided for both groups of stakeholders: 14 out of 21 national tax authorities as well as 58% of the 446 respondents to the open public consultation believe that the digital presence in the EU proposal can best address the current problems related to the international taxation rules for the digital economy. Stakeholders were not asked explicitly on their preferred approach vis-à-vis non-EU jurisdictions. The members of the Platform for Tax Good Governance (made up of all EU tax authorities and 15 organisations representing businesses, civil society, and tax practitioners) were also informed about this initiative and their opinions sought out. Spontaneous contributions have also been taken into account.
• Impact assessment
The impact assessment for the proposal was considered by the Commission's Regulatory Scrutiny Board on 7 February 2018. The Board issued a positive opinion on the proposal together with some recommendations, which have been taken into account. The opinion of the Board, the recommendations and an explanation of how they have been taken into account are included in Annex 1 of the Staff Working Document accompanying this proposal. See Annex 3 for an overview of who would be affected by this proposal and how.
The impact assessment of this proposal examined both fundamental reform options and other options for changes within the existing international tax system. Due to either legal and/or political feasibility constraints, more fundamental reforms have been discarded as they represent unrealistic options at this stage. Instead the solution should focus on revision to the existing concept of a permanent establishment and profit allocation rules. At the same time, a solution only within the framework of the proposal for a CCCTB has been rejected on the grounds that it would have a too narrow scope for proposing a structural solution that would also have the chance to push for a solution beyond the EU. The preferred option to address the issue within the EU was therefore a standalone Directive to modernise permanent establishment rules and profit allocation rules.
4. BUDGETARY IMPLICATIONS
This proposal for a Directive will have no implications for the EU budget.
5. OTHER ELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
The rules in this proposal should be integrated into Member States' corporate income tax systems and the Commission's CCCTB proposal, and should ultimately be mirrored by corresponding changes in the OECD Model Tax Convention (OECD MTC) at international level. The Commission will monitor the implementation of the Directive once adopted and its application in close cooperation with Member States.
• Detailed explanation of the specific provisions of the proposal
Contents
This proposal affects corporate taxpayers that are incorporated or established in the EU, as well as enterprises that are incorporated or established in a non-Union jurisdiction with which there is no double taxation treaty with the Member State where a significant digital presence of the taxpayer is identified. The proposal does not affect enterprises that are incorporated or established in a non-Union jurisdiction with which there is a double taxation treaty in force with the Member State of the significant digital presence, so as to avoid causing any breaches of those double taxation treaties. This may be different if the applicable tax treaty with a non-Union jurisdiction includes a similar provision on a significant digital presence which creates similar rights and obligations in relation to that non-Union jurisdiction.
This Article provides definitions of various concepts necessary for applying the provisions in the Directive (amongst others digital services, digital interface, revenues, entity, user and tax period).
A digital service is a service that is delivered over the internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention. This definition corresponds to the definition of electronically supplied services in Article 7 of the Council Implementing Regulation (EU) No 282/2011 of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax, and includes the same kind of services.
In order to exclude a taxable nexus based on the place of consumption only, the mere sale of goods or services facilitated by using the internet or an electronic network is not regarded as a digital service. For example, giving access (for remuneration) to a digital marketplace for buying and selling cars is a digital service, but the sale of a car itself via such a website is not.
Involving minimal human intervention means that the service involves minimal human intervention on the side of the supplier without any regard to the level of human intervention on the side of the user. A service shall also be regarded as requiring only a minimal human intervention in situations where the supplier initially sets up a system, regularly maintains the system or repairs it in cases of problems linked with its functioning.
The concept of a significant digital presence is intended to establish a taxable nexus in a jurisdiction. Therefore, it should be regarded as an addition to the existing permanent establishment concept. The proposed rules for establishing a taxable nexus of a digital business in a Member State are based on revenues from supplying digital services, the number of users of digital services or the number of contracts for a digital service. These criteria are proxies for determining the digital footprint of a business in a jurisdiction based on certain indicators of economic activity. They should reflect the reliance of digital businesses on a large user base, user engagement and user's contributions as well as the value created by users for these businesses. The criteria should cater for different types of business models. Digital business models are very heterogeneous. Some may have a very large user base while others may have a smaller user base, but may still have significant user contributions if each individual user contributes a large value. Furthermore, the criteria should ensure a comparable treatment in different Member States, irrespective of their size, and leave out trivial cases.
For the three user-based criteria mentioned above (revenues, number of users and number of contracts) different applicable thresholds are set. There is a significant digital presence in a Member State if one or more of the following criteria are met: if the revenues from providing digital services to users in a jurisdiction exceed EUR 7 000 000 in a tax period, if the number of users of a digital service in a Member State exceeds 100 000 in a tax period or if the number of business contracts for digital services exceeds 3 000.
As explained in the Impact Assessment 12 it is essential that each threshold is set sufficiently high to safely exclude small cases where profits attributable to a digital presence would not even cover the tax compliance cost for a permanent establishment, thus to ensure proportionality of the measure while operating these three alternative thresholds. The revenue threshold is set to cover the estimated compliance costs for operating an additional permanent establishment, even at low rates. The threshold regarding the number of users should reflect a similar value in monetary terms based on average revenues per user. The threshold on the number of business contracts should reflect that only business-to-business contracts should be taken into account as the value represented by these contracts is likely to be more substantial than that of contracts concluded with individuals. Therefore, a threshold on the number of business-to-business contracts should be considerably lower than a user-based threshold.
The proposed rules for allocating profits to a significant digital presence are built on the current framework applicable to permanent establishments. They confirm the principle whereby a significant digital presence should be attributed the profits that it would have earned through certain significant economic activities performed via a digital interface, in particular in its dealings with other parts of the enterprise, if it had been a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions, taking into account the assets used, functions performed, and risks assumed. Therefore, the authorised OECD approach (AOA) remains the underlying principle for attributing profits to a significant digital presence. This said the framework needs to be adapted in a consistent manner, to reflect the way value is created in digital activities. Indeed, in the functional analysis of the permanent establishment, the criterion of significant people functions relevant to the assumption of risk and to the economic ownership of assets in the context of digital activities is not sufficient to ensure a profit attribution to the significant digital presence that reflects the creation of value. This situation occurs where a significant digital presence operates through a digital interface without any physical presence in a certain jurisdiction or where no significant people functions are performed in the jurisdiction of the significant digital presence.
In the functional analysis of the significant digital presence, activities undertaken by the enterprise through an digital interface related to data and users should be considered economically significant functions relevant to the attribution of economic ownership of assets and risks to the significant digital presence. The attribution of profits should take into account the development, enhancement, maintenance, protection and exploitation of intangible assets in the performance of the economically significant activities by the digital presence even if these are not linked to people functions in the same Member State.
For example, in attracting new users to a social network, the set of intangible assets that would be attributable to the business of the social network plays a key part in guaranteeing the positive network externalities, i.e. that the users are able to connect to a large number of other users. The enlargement of the network which is achieved through the significant digital presence enhances that same set of intangible assets. This set of intangibles would be further enhanced by the processing of user-level data to enable the social network to sell advertising space at a premium since the advertising space is customised to the interests of the users.
It follows that the functions related to the development, enhancement, maintenance, protection and exploitation of unique intangibles would be typical to a significant digital presence. Each of the economically significant activities contributes to the value creation in the digital business models in a unique manner and is an integral part of these models. The profit split method would therefore often be considered as the most appropriate method to attribute profits to the significant digital presence. In this context, possible splitting factors could include expenses incurred for research, development and marketing (attributable to the significant digital presence vis-à-vis the expenses attributable to the head office and/or any other significant digital presences in other Member States) as well as the number of users in a Member State and data collected per Member State.
The proposed rules only lay down the general principles for allocating profits to a significant digital presence as more specific guidelines on the allocation of profits could be developed at the appropriate international fora or at EU level.