April 8, 2014
Canadian businesses that operate in the digital economy will want to follow the recent high-profile initiatives by the Organisation for Economic Co-operation and Development (OECD) in this area. In its Action Plan on base erosion and profit sharing (BEPS), the OECD identified that the wide breadth of the digital economy presents particular challenges to existing international tax rules. The OECD released a discussion draft (the paper) on March 24, 2014 that identifies the tax challenges of the digital economy and summarizes potential alternatives to address such challenges (as originally stated in Action 1 of the plan). The paper contains a detailed exploration of different options to consider for withholding tax, as well as viable options to collect VAT/GST on cross-border supplies.
The OECD has requested comments on these issues and invites interested parties to send comments on this paper by April 14, 2014 in anticipation of a public consultation meeting in Paris on April 23, 2014.
OECD Action Plan — Background
The OECD Action Plan, presented at the meeting of G20 Finance Ministers on July 19, 2013, identifies 15 specific actions that focus on key areas including the digital economy, hybrid mismatch arrangements, controlled foreign corporation (CFC) rules, excessive intercompany interest payments, harmful tax practices, treaty abuse, avoidance of permanent establishment status, transfer pricing, aggressive tax planning, and greater transparency and disclosure. (See TaxNewsFlash-Canada 2013-27, “OECD Action Plan Could Signal a Shift in the Global Tax Landscape [PDF 32.5Kb]”).
The OECD proposes that countries should largely complete the action on tax base erosion and profit shifting in a two-year period, which may present a significant challenge for countries.
In its 2014 federal budget, the Canadian government announced a parallel consultation process on BEPS and has set a consultation period for interested parties to provide input to the Department of Finance by June 11, 2014. Previously, Finance released a statement on July 20, 2013 to declare that it fully endorses the OECD Action Plan.
Finance released Canada’s 2014 budget on February 11, 2014. (See TaxNewsFlash-Canada, 2014-08 "2014 Federal Budget Highlights").
Tax Challenges of the Digital Economy
The objective of Action 1, entitled "Tax Challenges of the Digital Economy", is to identify the main difficulties that the digital economy poses for the application of existing international tax rules, and to develop detailed options to address evolving business models and rapid developments in information and communication technology, while taking a holistic approach and considering both direct and indirect taxation. The paper notes that a thorough analysis of the various business models in the digital sector is needed to examine issues including:
- The ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules
- The attribution of value created from the generation of marketable location relevant data through the use of digital products and services
- The characterization of income derived from new business models
- The application of related source rules
- How to ensure the effective collection of VAT/GST with respect to the cross-border supply of digital goods and services.
Of all the Actions identified under the BEPS initiative, it is believed that the OECD's review of the digital economy could affect almost every business in the global economy. The OECD estimates that adoption of digital technologies, as illustrated by broadband connectivity in OECD countries, is almost universal for large enterprises and reaches 90% penetration in smaller businesses. As outlined in the paper, the digital economy has given rise to a number of new business models that could be affected including:
- Electronic commerce
- App stores
- Online advertising
- Cloud computing
- Payment services
- High frequency trading
- Participative networked platforms.
In the paper, the OECD recognizes that it must take care to avoid introducing specific changes focused on just the digital economy, as the global economy is now a 24/7 digitally connected marketplace. As a starting point, the OECD is considering whether tax should seek to be neutral and equitable between forms of electronic commerce and between conventional and electronic forms of commerce. The paper contains an overview of emerging trends and developments in the digital sector, and notes the key characteristics of the digital economy that magnify risks associated with base erosion and profit shifting.
The paper identifies four major categories of tax policy challenges associated with the digital economy — nexus, data, characterization and VAT/GST. The OECD requests input from the public on the following preliminary options to address these challenges:
- Modifications to the exemptions from permanent establishment (PE) status
- Establishment of a new nexus rule based on digital presence
- Creation of a “virtual PE” rule
- Withholding tax on digital transactions
- Special vendor collection mechanisms for VAT/GST.
The OECD notes that many of these concerns may be addressed in Action 6 (Prevent Treaty Abuse), Action 7 (Prevent the Artificial Avoidance of PE Status) and Actions 8 to 10 (Assure that transfer pricing outcomes are in line with value creation). The OECD also acknowledges it will have to fully consider how the other proposals may address challenges related to the digital economy.
OECD's new definition of PE
The OECD paper considers the option of modifying the definition of PE in Article 5 of the OECD Model Treaty. For example, the PE exception contained in Article 5(4) (which exempts preparatory or auxiliary activities) could be limited to businesses whose preparatory or auxiliary activities do not constitute their core functions. The OECD also considers another option to create a new nexus rule based on significant digital presence. In that case, an enterprise engaged in certain “fully dematerialized digital activities” would have a PE if it maintained a significant digital presence in another jurisdiction.. In addition, alternative PE thresholds could be established, as previously considered by the OECD’s Business Profits Technical Advisory Group.
OECD's withholding tax option
The OECD notes another option to create a final withholding tax on certain payments made by residents of a country for digital goods or services provided by a foreign e-commerce provider. According to the paper, this proposal would address concerns that it may be possible to maintain substantial economic activity in a market, without this activity being taxable in that market under current PE rules because of a lack of physical presence in that market. The task force would need to consider how to address the challenges of withholding such a tax on individual consumers.
Value-added tax implications
Regarding consumption taxes, in particular VAT/GST, the paper mentions that the most viable option for collecting VAT/GST on cross-border digital supplies to consumers may be to require the non-resident supplier to register and account for the VAT/GST on these supplies in the jurisdiction of the consumer. This could equally apply to suppliers selling goods (e.g., low value imports) or digital supplies. However, to minimize compliance burdens, supplier countries should consider simplified registration regimes and registration thresholds. KPMG webcast
KPMG Canada is holding a webcast on April 17, 2014 that will provide an insightful discussion and analysis on the digital economy discussion draft and other recent OECD developments that affect your business. This webcast will also highlight new discussion papers, public consultations and recommendations for change to the OECD Model Tax Convention, the Transfer Pricing Guidelines as well as recommendations for changes to domestic laws. In the first part of 2014, the OECD has released discussion drafts on transfer pricing documentation and country-by-country reporting, tax treaty abuse, hybrid mismatch financing arrangements and taxation of the digital economy. By registering for the webcast, you can prepare for the changes proposed by the OECD.
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We can help
Your KPMG adviser can help you assess the potential effect of the BEPS Action Plan on your business, and to prepare for forthcoming changes to the international tax landscape. For more details on this draft and its potential impact, contact your KPMG adviser.
Information is current to April 8, 2014. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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