By Tax partner, Kim Jarrett
The ‘tax morality’ debate has held centre stage in tax circles for many months now, with some of the world’s largest multinationals facing intense scrutiny of their tax structures.
In November 2012, the UK Public Accounts Committee held a hearing with senior executives from large US based multinational enterprises operating in the UK to investigate how much tax they were paying in the UK. The tone of that hearing is reflected in comments made by the Committee Chairwoman:
Your entire activity is here yet you pay no tax here and that really riles us.
We’re not accusing you of being illegal; we’re accusing you of being immoral.
Since the hearing there has been a lot of media coverage around the Tax Morality of large multinational enterprises. The concept of Tax Morality refers to companies that execute taxation strategies at a global level which enable them to take advantage of various international tax laws and incentive regimes, and as a result have low tax costs.
Two of the three multinationals grilled by the Public Accounts Committee were players in the digital economy - Google and Amazon. While the 'Tax Morality' debate is a wide ranging one, digital businesses are likely to face significant changes in the way they pay tax as a result of developments in this area.
But is the issue really one of ‘morality’, or is it actually one of tax policy design and the inability of current international tax framework to keep pace with the ongoing evolution of business?
In July, the OECD released its action plan for dealing with the erosion of the tax base, in a drive to develop a tax system that is fit for purpose for today’s multinationals and the digital age. It looks to address some of the gaps in the current tax system which can be ‘exploited by multi-national corporations to artificially reduce their taxes’.
The first action on the list is how to address the perceived inability of the international tax system to deal with the digital economy.
The digital economy
There are many aspects of the digital economy that make it a difficult area to tax. The current international tax rules were developed in a ‘bricks and mortar’ age and generally rely on a company having a physical presence in a country before a tax liability arises.
In the digital age a company can trade with customers in a market without ever setting foot there. There are many different business models operating in the digital economy, and each will have its own characteristics. Add to this the ability to base high value, and highly mobile intangible assets in tax friendly jurisdictions, and you can start to get a sense of why this area is so challenging to tax.
So what is this likely to mean for consumers of digital products, online shoppers and the companies that service them?
Chances are that customers will eventually have to pay tax on that book they just downloaded onto their Kindle, and that great pair of shoes they just brought off an overseas website. Indirect taxes (GST, VAT) are seen as one potential solution to the challenges faced by the digital economy.
A tax bill is working its way through the US that will require e-commerce vendors to customers in the US to pay state sales taxes if sales in a state exceed $1 million per annum, regardless of whether the seller has a physical presence in the state in question. This bill is an attempt to address the issue of web based sales for indirect tax purposes.
Governments (including New Zealand’s) are also reviewing the thresholds at which import GST is applied by Customs Authorities on parcels, and trying to strike the right balance between the amount of tax collected and the compliance costs on Government and consumers.
New Zealand companies selling into overseas markets through online platforms will also need to keep an eye out for changes that may give rise to a company liability for income taxes in their sales markets. Potential changes in the international tax definition of what creates a tax presence (more formally a ‘permanent establishment’ under double tax agreements) are being explored by the OECD.
But one of the most vexing challenges in relation to the digital economy is defining where the value lies in a digital business, and how to address the issues created by the intangible assets that underpin this industry.
One area being explored by the OECD action plan is the attribution of profits based on significant people functions (an approach that India and China thinks has a lot to recommend it).
Another area being explored is “value created from the generation of marketable location-relevant data” which could possibly translate to considering the user base of a jurisdiction as one area of value (e.g. the user base of a website can be used to promote placing advertising on that website).
Finally, the OECD are also taking a close look at the definition of intangibles in the transfer pricing rules, and the profit attributable to these assets, and a recently released discussion draft on this area will be poured over by tax specialists over the coming months.
The direct and indirect taxation issues surrounding the digital economy are vast and complex and yet this is only one of the 15 action items on the OECD’s list. The OECD has set an ambitious timeline to provide a report with the issues raised by the digital economy and the possible actions to address them by September 2014.
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