Fair Taxation of the Digital Economy

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Fair Taxation of the Digital Economy

On 21 March 2018, the European Commission published two legislative proposals on the taxation of digital activities in the EU. These proposals followed a Communication on a Fair and Efficient Tax System in the European Union for the Digital Single Market issued by the Commission in September 2017 and subsequent conclusions that were adopted by European Finance Ministers at the ECOFIN meeting in December 2017.

The conclusions at ECOFIN highlighted the urgency to agree a tax policy response at an international level and called for close cooperation with the OECD and other international partners.

The Commission also held a public consultation on the matter, which the Institute responded to in December 2017.

What is the Commission proposing?

The Commission published two legislative proposals that would:

Reform corporate tax rules so that profits are registered and taxed where businesses have significant interaction with users through digital channels.
Impose an interim tax on certain revenues from digital activities in the EU.

Reform of corporate tax rules – the long-term measure

The proposed reform of corporate tax rules would enable EU Member States to tax profits that are generated in their territory, even if a company does not have a physical presence within the country.

Under the proposal, a digital platform would be deemed to have a taxable “digital presence” or a virtual permanent establishment in an EU Member State if it satisfies one of the following criteria:

A threshold of €7 million or more in annual revenues in a Member State.
More than 100,000 users in a Member State in a tax year.
Over 3,000 business contracts for digital services between the company and business users in a tax year.

Interim Digital Services Tax – the short-term measure

Under this proposal, an interim tax of 3% would apply to revenues created from certain digital activities, such as revenues:

Created from selling online advertising space.
Created from digital intermediary activities that allow users to interact with other users and that can facilitate the sale of goods and services between them.
Created from the sale of data generated from user-provided information.

Tax revenues would be collected by EU Member States where the users are located and would only apply to companies with total annual worldwide revenues of €750 million and EU revenues of €50 million.

This Digital Services Tax would apply only as an interim measure, until the comprehensive reform of the corporate tax rules described above would be implemented. There would be mechanisms to alleviate the possibility of double taxation.

Digital Levy

In July 2020, the European Council tasked the Commission to bring forward proposals for additional own resources for the European budget. One such proposal was a digital levy. The stated aim of the initiative was to help address the issue of fair taxation related to the digitalisation of the economy. However according to the Commission, the digital levy was not intended to interfere with the ongoing work at G20/OECD level on the reform of the international corporate tax framework. A public consultation on the proposed digital levy was launched in January 2021 and the Institute responded to the consultation in April 2021.

Following political agreement reached at a meeting of the G20 in July 2021, where they endorsed an overhaul of the rules for taxing international companies, the EU announced that it was putting “on hold” work on the proposed EU digital levy.

Current Developments – The Two-Pillar Solution

The European Council in a statement on 25 March 2021 reiterated their ‘strong preference for and commitment to a global solution on international digital taxation’, indicating that they would strive to reach a consensus-based solution by mid-2021 within the framework of the OECD and confirming that ‘the European Union will be ready to move forward if the prospect of a global solution is not forthcoming.’

Political agreement on key aspects of a two-pillar solution was reached by the G7 and G20 in June 2021 and on 1 July 2021, 130 member countries of the OECD/G20 Inclusive Framework on BEPS agreed a Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (the July Statement). Pillar One deals with the reallocation of certain profits from large multinational enterprises (MNEs) to market jurisdictions (i.e., where sales arise) whereas Pillar Two seeks to apply a global minimum tax.

On 8 October 2021, the Inclusive Framework published a revised Statement on the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (the updated October Statement). The updated October Statement contained clarifications on some of the key outstanding issues from the Statement published in July, including setting the effective tax rate for the purposes of the Income Inclusion Rule (IIR) and the Undertaxed Payment Rule (UTPR) at a precise rate of 15%. 137 out of 141 Inclusive Framework member countries, including Ireland, joined the updated October Statement.

You can read more about the key components of the two-pillar solution as described in the updated October Statement here.

On 20 December 2021, the European Commission proposed a Directive to implement into EU law the Pillar Two Global Anti-Base Erosion (GloBE) Model Rules (the Model Rules) published by the OECD on 20 December. The proposed Directive closely follows the Model Rules. However, it extends the scope of the Model Rules to large-scale purely domestic groups to ensure compliance with EU fundamental freedoms. The Commission issued a call for feedback on this proposed Directive until 6 April 2022.

The proposed Directive has been the subject of discussion at the Economic and Financial Affairs Council (ECOFIN) with several compromise texts being published. It includes a proposal for a derogation for six consecutive fiscal years beginning as from 31 December 2023 from the mandatory application of the IIR and the Undertaxed Profit Rule (UTPR) to be available on an optional basis for EU Member States in which no more than 12 ultimate parent entities are located.

The compromise text also notes that while the purpose of the Directive is to implement Pillar Two, there is a need to ascertain that Pillar One is implemented as well. To this end the Directive includes a clause obliging the Commission to prepare a report reviewing the progress achieved at the by 30 June 2023 regarding the implementation of the Pillar One and, if appropriate, submit a legislative proposal to address these tax challenges in the absence of the implementation of the Pillar One solution.

Although EU Member States have made progress on the Directive, they have not yet been able to reach agreement.