Taxes on the Digital Economy (a Complex Issue)

Last month this Newsletter reported on the French proposals to tax the major US digital companies. President Trump arrived at this month’s G7 meeting, hosted by France, huffing and puffing about trade wars if such taxes were applied by the Europeans. After some smooth diplomatic persuasion by the French President Macron, President Trump returned to the States apparently convinced to everyone’s surprise that the Organisation for Economic Co-operation and Development (OECD),  “the rich man’s club”, should be left to decide how to deal with the issue. The OECD has a long history of quietly proposing guidelines on difficult trade issues which the G7 and G20 subsequently support (SA as a G20 member should follow – but does not – the OECD guidelines on ecommerce tax, known as BEPS).

As background to this debate, the EU has agreed to adopt a united position on the pending OECD digital tax programme thanks to the vocal support of the Scandinavian countries. The OECD proposals so far are more about revamping transfer pricing rules instead of imposing a turnover tax, they contain the fundamental principle of reallocating profits. For small countries that have a thriving sector exporting high-tech hardware and software, the idea of having to reallocate profits to large countries where their enterprising and innovative companies have an established market share is not very appealing. The EU is now looking at 2 documents in order to “frame” the debate that will take place among EU finance ministers over the next few months. The first deals with the so-called “Pillar I” which is the OECD work programme on profit reallocation. The second addresses the so-called “Pillar II” which attempts to lay down minimum corporate taxation. In the case of both pillars, these EU papers have scoped out concerns about revenue loss, double tax disputes, legal conflicts and tax administration problems that EU member states will have to address in trying to reach a consensus.

In the case of profit reallocation (“Pillar I”), there are 3 different methodologies under consideration with examples of how a multinational company would apply them. These include the modified residual split method, the fractional apportionment method and the distribution-based approach. In the case of the modified residual split method, the Finnish presidency stated that the total profit to be split would have to be determined, as this could mean group-wide profits, profits of an entity or profits determined on an aggregated entity basis.

A fundamental question that tax practitioners have been asking since the OECD unveiled its digital tax work programme in March concerns how the new profit reallocation rules will mix and match with current transfer pricing rules based on the arm’s length principle (ie avoidance of double taxation). It is obvious from the options outlined in the 2 papers that trying to design a new taxing right system is a highly complex process which raise questions about the likelihood that the EU being able to reach any unified approach, but whether the OECD Inclusive Framework will finalize its work by January 2020, as it promises.

As readers can see this is an area in which tax lawyers thrive, and normal people are left perplexed. However there is a solution which is (relatively) simple – the “sales-only” approach. This basically means that all of the tax revenue from the profits from sales of exporting companies to another country would go into the importing country’s government coffers. For exporting countries both large – such as Germany, France, Japan, Italy and Canada – and small, the “sales-only” approach triggers alarm bells. So much that when G-7 finance ministers met in France, they made their opposition clear. For the outsider, it is not clear why country A which sells to country B would not agree that any thing sold online should not pay all taxes in the receiving country, however, obviously this is highly unpopular among tax specialists for reasons not clear to the amateur. We will continue to follow this debate, not only because it will affect the global digital economy but also because it will have a direct effect on products sold online from Africa into the Developed countries.

And while we are on the subject of taxes, readers will recall that this Newsletter covered the introduction of taxes on Social Media in Uganda last year. We are glad to say that Uganda’s revenue services have reported that the controversial social media tax has raised just USh49.5 billion, falling well short of the expected USh284 million. Users abandoned the internet and it was claimed by commentators that the taxes attacked freedom of speech and discriminated against the poor. Another tax on mobile money was withdrawn when the economy lost 2% in less than a month as the direct result of the tax. We now hope that the Social Media tax will also be abandoned.