Taxing digital services: a closer look at the OECD solution
New Zealand's proposed Digital Services Tax would bring with it a laundry list of problems, for not much revenue. Should this country follow Australia's path and instead work with the OECD for a sound global solution to the taxes on global digital businesses, write Graham Murray and Hayden Roberts of law firm Bell Gully.
Ivanka Trump’s presence at the G20 summit in Japan in June drew global attention and spawned many a meme, but somewhat overshadowed what those in the tax world considered the big news. At that summit, the world’s biggest economies agreed to endorse an ambitious programme to address the tax challenges arising from digitalisation.
The ability of multinational technology companies to book profits in countries with lower tax rates regardless of where their customers use their services has attracted regulators’ attention. The OECD's plans to address this have been drawn out, leaving individual countries to consider their options.
Just days earlier, the New Zealand Government’s move to consult on a stand-alone digital services tax featured heavily in the local headlines. Most of that discussion centred on what a local tax might look like, if it progresses, with only passing reference to the OECD solution. However, even as it announced the possibility of a local tax, the Government expressed hope for an OECD solution. Its consultation document says: “The OECD is aiming to get G20 approval of its preferred measures in June 2019. If approval is given, then an OECD solution is more likely. On the other hand, failure to receive G20 approval would be a serious, perhaps fatal blow to an OECD solution (in a reasonable timeframe at least).”
So, with G20 finance ministers on board, what does that OECD solution look like? At this stage the OECD proposals have only been developed at a high level, but are likely to consist of two broad measures.
The first is to lower the bar for when individual countries have the right to tax foreign digital services and the second is to ensure a “minimum tax” is paid by multinationals on worldwide income.
Lowering the bar
Under current international tax settings business profits can typically only be taxed in a source jurisdiction if the enterprise has a sufficient physical presence in that jurisdiction such as a subsidiary, or a “permanent establishment" like a branch office. Profits must also be able to be attributed to that presence, before they can be taxed.
Lowering the bar could take one of three forms, only one of which would be adopted.
The first is a limited proposal granting taxing rights to countries for certain digital services, based on where they are used. The scope of the proposal might be similar to the digital services tax proposed in New Zealand, in which case it would only apply to platforms which generate value from user participation.
The second is a broader “market intangibles" proposal. It would require a multinational to allocate its profits based on certain marketing intangibles created in other jurisdictions, such as customer data and lists, brands and trade names. This proposal would apply beyond the digital economy, and could impact a number of New Zealand exporters.
Finally, the third option is a “significant economic presence" model, which would apply to the digital economy at large, rather than just to platforms relying on user-generated value. This proposal would allocate taxing rights between countries to a multinational's worldwide income under a formulaic method, referencing various factors that indicate a multinational enterprise has an “economic presence” in a particular country.
A minimum tax
The second measure being considered by the OECD is a “minimum tax" measure which seeks to ensure a multinational pays a sufficient level of tax on its worldwide income. This could be achieved through implementation of two rules.
The first rule would apply to a domestic tax resident who has a foreign branch or subsidiary that pays a low level of foreign tax on its profits. A minimum tax rate would be set (at 10 percent for instance) as the rate at which such income must be taxed. To the extent the income was subject to foreign tax at a lower rate, top-up tax would be payable in the jurisdiction of tax residence in order to ensure the minimum tax rate was paid.
The second rule would deny deductions and/or tax treaty relief where a related party payment was made to a foreign company that was not subject to the minimum tax rate on that receipt.
A radical departure
Any long-term OECD solution to this issue looks like it could be a radical departure from current international tax settings. The implementation of these two measures in conjunction would represent one of the most significant changes to the international framework seen in years.
The potential breadth of the measures, and their possible application beyond the digital economy, will mean a number of businesses could be impacted. In particular, adoption of the “market intangibles” proposal may have a significant impact on the worldwide taxation obligations of New Zealand exporters.
If the OECD cannot make sufficient progress on a long-term international solution during the course of 2019, the discussion document released in June indicates the Government will “seriously consider" adopting a stand-alone digital services tax. New Zealand would not be alone in doing so. The United Kingdom has announced the introduction of a DST from April 2020. India and a number of European countries have also enacted or announced DSTs. Australia, however, has recently confirmed it will not implement a DST, and will instead focus on achieving a consensus solution to the issue at the OECD level.
The detail provided in June shows that, if implemented, a stand-alone New Zealand digital services tax would be charged at a flat 3 percent rate on the gross turnover of a defined set of ‘in scope’ digital business activities. Businesses identified by the Government as likely to be affected include intermediation platforms like Uber and eBay which facilitate the sale of goods and services between people, social media platforms like Facebook, content sharing sites like YouTube and Instagram, and search engines.
Despite the well-known names, the benefits are limited. The potential tax-take identified in the discussion document is not large, at between $30 million and $80 million a year. Some may see the tax as improving public confidence in the fairness of the tax system and, potentially, creating a greater incentive for countries to reach an international solution.
These must be weighed against a number of other issues. The discussion document estimates 30 to 50 percent of the cost might be passed on to New Zealand customers. A stand-alone tax could reduce the growth of the digital sector in New Zealand. It would mean double taxation for enterprises with a taxable presence in New Zealand subject to the new tax, including New Zealand companies. They would face income tax on their profits as well as taxation on any revenues that fell into the scope of the new digital services tax. Compliance costs could be significant, set against the relatively low tax take.
A stand-alone tax could also adversely affect New Zealand’s export sector. Some trading partners, particularly the United States, are expected to be opposed to a digital services tax. This could lead to the introduction of retaliatory measures. Arguments could be put forward that it would effectively result in discrimination against foreign companies operating in New Zealand, and therefore breach New Zealand’s international trade obligations.
The digital services tax as proposed by the Government in June brings with it a laundry list of problems while raising only limited revenue. This suggests that perhaps the Government may be better off not looking at a standalone tax as a stopgap measure, and instead follow Australia’s approach and focus on the OECD solution, while contributing to that discussion to ensure the interests of New Zealand businesses are protected.
Bell Gully partner Graham Murray is a corporate tax specialist whose areas of focus include cross-border investment arrangements and double tax treaty issues. Hayden Roberts is a specialist income tax lawyer, and is a senior associate at Bell Gully, a Foundation Supporter of Newsroom