In my halcyon days as a tax adviser, a client conference meant lots of numbers thrown at a stark white screen via an overhead projector, the small audience looking pale and bored under the harsh fluorescent lighting. We, the professionals, were geeks that nobody wanted to talk to unless we were saving their cash, or saving their hides.
It transpires that a quarter of a century is a long time in tax, and in recent years we have found ourselves in conference centers bathed in blue light, no numbers in sight, talking (and talking) about ‘paradoxes’ and ‘paradigm shifts’, and other intelligent concepts that have as much to do with tax as that other famous three-letter word ending in ‘x’. It isn’t that much has really changed. It is just that we have learned to talk-the-talk and walk-the-walk in our designer suits. The meaning of the words – or their dubious relevance – doesn’t really matter. Conferences are all about the sound bytes and the press coverage. The public face of tax has had a makeover. Meanwhile, real tax consulting – exactly as in the good old days – continues to be undertaken by consenting adults behind closed doors.
It is, therefore, with some trepidation and a shaking pen, that I find myself writing about – what might actually be – both a ‘paradox’ and ‘paradigm shift’ in international taxation.
I refer, of course, to the OECD’s invitation for public input on the possible solutions to the tax challenges of digitization. The topic is not new (see Tax Break October 5th 2018), and is, indeed, Action 1 (of 15) of the Base Earnings and Profit Shifting (BEPS) initiative that has been monopolizing the attention of tax practitioners for the last five years. However, it has for some time been looking like it would be sacrificed on the altar of disagreement and procrastination, as it requires a complete rethink of two of the pillars of the existing century-old system – nexus (connection to a country) and profit allocation (between countries).
On February 13th, the Inclusive Framework on BEPS (comprised of just about every self-respecting nation in the world – not to mention a few others) came up with a Public Consultation Document, the member countries having previously been divided on any way of moving forward. To be clear, it is stressed that the comments are ‘without prejudice’ (which I think means countries are not committed). Different countries have different interests – in the rawest of terms developing countries that are not hi-tech originators have a major interest in attracting tax from digital companies interacting with their populations, while the United States would ideally like to keep as much of Google and friends’ taxable income as possible for itself. The indisputable paradox here is that – in a world veering more and more towards trade wars and protectionism – they were able to come up with a series of alternative proposals, any one of which – if adopted – will represent a paradigm shift in international taxation affecting everybody.
There are three proposals for tampering with profit allocation and nexus, with the aim of ensuring that taxable profit is allocated according to where value is created.
The first proposal focuses on ‘user participation’. This is fairly specific to the ‘highly’ digitalized economy – social networks, search engines and on-line marketplaces, where the activities and participation of these users contribute to the creation of the brand, the generation of valuable data, and the development of a critical mass of users, which helps to establish market power. For this purpose, nexus would no longer be only to where the company physically undertakes its business. but also to where the users build part of its profits, with suitable allocation of those profits.
The second proposal is based on ‘marketing intangibles’ such as brand and trade name which are reflected in favourable attitudes in the minds of customers and so can be seen to have been created in the market jurisdiction. There are also other marketing intangibles, such as customer data, customer relationships and customer lists derived from activities targeted at customers and users in the market jurisdiction, supporting the treatment of such intangibles as being created in the market jurisdiction. Once again the definition of nexus would need to be expanded beyond the physical and profit allocated accordingly.
The third proposal relates to ‘substantial economic presence’ via digital technology and other automated means. Such presence could be evidenced by: the existence of a user base and the associated data input; the volume of digital content derived from the jurisdiction; billing and collection in local currency or with a local form of payment; the maintenance of a website in a local language; responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services such as after-sales service or repairs and maintenance; or sustained marketing and sales
promotion activities, either online or otherwise, to attract customers. Same again, in terms of revolutionary forces in international tax.
As already mentioned, each of the proposed methods requires an overhauling of ‘nexus’, until now based on a level of physical presence in a jurisdiction, and ‘profit allocation’ which – even in the BEPS world – suffers from the vagaries of the Old World Order.
Pending public comment – the deadline for which has been extended to March 6 – the bets are on ‘Marketing Intangibles’ over ‘User Participation’, the former catching a wider cross-section of the digital industry in its net. ‘Substantial Economic Presence’ was a late arrival at the ball, and – if the digital tax revolution is consummated – will likely be confined to the role of chaperone.
Will anything happen? There is no question that the BEPS project has achieved a momentum that could not have been predicted five years ago. The Americans are said to favour ‘marketing intangibles’ – although when they calm down from the sound bytes, soft blue light and dark suits, they might start to run the boring numbers and discover it (and any other change) is not in their best interests.
So, it looks like ultimate success in achieving the paradigm shift rests on the continued goodwill of the United States, which in the current political climate would be a paradox par excellence. But, we are living in interesting times.