Еvery day, 20 billion emails and 150 million social media posts are written, and 650 million online searches are carried out in the EU. Global corporate tax rules are over one hundred years old and are out of step with the boom in the digital economy. They were designed for ‘brick-and-mortar’ businesses, meaning that a company should be physically present in a country to be taxed there. Companies that do business and generate value online are now growing far quicker than the economy at large, yet today’s rules cannot effectively tax profits generated largely from consumer data. On average, digitalised businesses face an effective tax rate of only 9.5%, compared to 23.2% for traditional business models.
What are the main problems?
Today’s international corporate tax rules are not fit for the realities of the modern global economy and do not capture business models that can make profit from digital services in a country without being physically present. Current tax rules also fail to recognise the new ways in which profits are created in the digital world, in particular the role that users play in generating value for digital companies. As a result, there is a disconnect – or ‘mismatch’ – between where value is created and where taxes are paid.
Value Creation in the Digital Economy
In the digital economy, value is often created from a combination of algorithms, user data, sales functions and knowledge. For example, a user contributes to value creation by sharing his/her preferences (e.g. liking a page) on a social media forum. This data will later be used and monetised for targeted advertising. The profits are not necessarily taxed in the country of the user (and viewer of the advert), but rather in the country where the advertising algorithms has been developed, for example. This means that the user contribution to the profits is not taken into account when the company is taxed.
Under the proposed new rules, Member States will be able to tax profits that are generated in their territory, even if these companies do not have a physical presence there. A company will be considered to have a significant digital presence in a Member State if it fills one of the following criteria:
- It exceeds a threshold of €7 million in annual revenues from digital services in a Member State
- It has more than 100,000 users who access its digital services in a Member State in a taxable year
- Over 3000 business contracts for digital services are created between the company and business users in a taxable year
This reform addresses two of the main problems that Member States encounter when it comes to taxing digital activities:
- First, it will no longer be necessary for a company to be physically present in a Member State in order for it to be taxed. A significant digital presence will allow Member States to tax profits generated in their territory
- Second, factors such as user data will now be taken into account in the allocation of profits, since they play an increasingly important role in companies’ value creation
What is the interim solution?
The interim tax would target the most urgent gaps and loopholes in thе taxation of digital activities. The measure ensures that those activities which are not currently effectively taxed would begin to generate immediate revenues for Member States. The aim is to ensure a level playing for all businesses, whether EU or non-EU based, large or small, more or less digitalised.
Today’s proposal for an interim digital tax will discourage Member States from seeking their own divergent solutions to the challenges they face which would create a patchwork of national solutions, risking the fragmentation of the Single Market. A significant number of Member States have already started to take such measures.
If agreed first, this measure would only apply until Member States have agreed and implemented the more forward-looking proposed reforms to their corporate tax systems.
How will the tax work?
The interim tax will apply on two main types of digital services, which would not be able to exist in their current form without user involvement. The common feature of such services is that they are heavily reliant on the exploitation of user participation or data obtained from users as a way to generate revenues.
- Firstly, it will cover services where the main value is created by user data, either through advertising or by the sale of the data collected by companies such as social media or search engines.
- Secondly, it will cover services of supplying digital platforms that facilitate interaction between users, who can then exchange goods and services via the platform (such as peer-to-peer sales apps).
The proposal for an interim tax focuses on activities with the biggest gap between the value created and Member States’ ability to tax them – essentially where user participation and user contribution plays a central role in value creation. The tax will be collected by the Member States where the users are located. A number of countries already have a similar tax in place, including Israel, India and some US states.
Revenues would be collected by the Member States where the users are located, and will only apply to companies with total annual worldwide revenues of €750 million and annual EU revenues of €50 million. The first threshold will limit the tax to companies of a certain scale and ensure legal certainty for companies and tax authorities in determining who is liable for tax. At the same time, it will help to ensure that smaller start-ups and scale-up businesses remain unburdened. The second threshold will ensure that the tax only applies to companies with a significant digital footprint in the EU.
An estimated €5 billion in revenues a year could be generated for Member States if the tax is applied at a rate of 3%. This single rate, once applied throughout the EU would help to avoid “tax shopping” and distortions in the Single Market. The proposed rate of 3% was chosen after a careful analysis of many different factors and impacts, including the tax burdens of businesses with different margins.
This tax will apply only as an interim measure, until the updated corporate tax rules to underpin the digital economy have been implemented.
How exactly will Member States know when the tax is due and how will they collect it?
As with all other taxes, the interim tax is based on a system of self-declaration by taxpayers. Member States will be able to carry out tax audits to check that taxpayers are fulfilling their obligations (as they do in the traditional economy). A digital portal, known as the One-Stop-Shop, system will be set up to help companies comply. As part of that system, one Member State will be responsible for identifying the taxpayer, collecting the tax and allocating it to other Member States as appropriate.
When will the interim tax be wound down? How will the transition be handled?
The tax is intended as a temporary solution to help Member States claw back some revenues and to address the immediate risks to EU competitiveness, while the common EU solution is being discussed, developed and implemented by Member States. The more holistic solution will give Member States the right to tax digital activities via new corporate taxation rules and will also capture the concept of ‘user value creation’ – to which the interim tax applies. Therefore, there will be no need for it to remain in place once the final, permanent tax rules for the digital economy have been implemented.