Position
Taxation of Digital Business Models EU proposals on "taxation of the digital economy": digital tax and digital presence
Federation of German Industries (BDI)
As of September 2018
Taxation of Digital Business Models
Contents Summary ...............................................................................................................3 1.
Current debate on taxation of the digital economy ........................................4
2.
EU proposals on taxation of the digital economy ..........................................4 a) Digital Services Tax .................................................................................. 4 b) Significant digital presence ........................................................................ 7
3.
Digital business models in German industry .................................................9 a) Typical digital business models ................................................................ 9 b) Examples of digital business models for industry ................................... 10
4.
Open questions and long-term solutions ......................................................11
About the BDI .....................................................................................................12 Publishing information ........................................................................................12
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Taxation of Digital Business Models
Summary The BDI supports the target of establishing internationally coordinated standards for a legally secure taxation of company profits. Distortions in competition and tax loopholes need to be prevented, and both national and European go-it-alones in legislation avoided. Profits from digital business models can, in principle, be taxed within the current system. However, the debate on the distribution of profits from digital business models is gaining strength. 1. Digital tax will cause high collateral damage to German industry ▪
The current EU directive proposal for an EU digital tax to "tax the digital economy" bears the risk of causing extensive collateral damage to German industry and the German tax authorities.
▪
The proposed digital tax would lead to double taxation and would damage rather than benefit German industry, which is right in the middle of the process of digitally transforming their business models.
▪
The proposal to deduct the digital tax as a cost from the corporate income tax base is not enough to avoid double taxation on business.
▪
The BDI therefore expressly warns against a rash introduction of an EU digital tax.
2. Delineation between "digital economy" and digital business models of industry not possible ▪
Delineating between the "digital economy" and "traditional industry" is not possible as, in the course of Industry 4.0, industry is also increasingly applying digital business models.
▪
On account of the dynamic development of business models in German industry, new digital business models always risk becoming liable for additional taxation. This damages the competitiveness of Germany as a European business location.
3. Digital presence harbours high risks for business and the German tax authorities ▪
The introduction of a "digital presence" as a so-called long-term solution harbours significant risks for the strongly export-oriented German industry and the German tax authorities.
▪
An effective taxation of digital business models can only succeed in the long term on a global level and must be implemented in accordance with the OECD.
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Taxation of Digital Business Models
1. Current debate on taxation of the digital economy Since the BEPS project of the OECD and G20 countries from 2012 to 2015, taxation of the digital economy has been a subject of debate in tax policy originally with the objective of securing tax revenues. These concerns have been triggered by the business models of large US companies that enable economic activities in states and markets without having a physical presence in the traditional sense, i.e. a permanent establishment. In March 2018, the European Commission published two directive proposals on taxing the digital economy. In the opinion of the European Commission, the challenge of structuring "fair taxation" lies particularly in the fact that the user of a digital service – so far as the user provides personal data – contributes to the creation of value which is not located in the country of residence of the company supplying the service (country of origin) but in the country of residence of the user (market country). The OECD published an interim report on the challenges of the digital economy in March 2018 and announced that it would present its final report on this topic by 2020. 2. EU proposals on taxation of the digital economy On 21 March 2018, the European Commission presented two legislative proposals, the "Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence" (COM(2018) 147 final) and the "Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services" (COM(2018) 148 final), designed to ensure the taxation of digital business activities in the EU. a)
Digital Services Tax
As an interim solution, the Commission proposes the introduction of a three percent tax on income from digital services, called the Digital Services Tax. Services covered by the tax The tax would be applied on a company's total annual worldwide revenues from the following services: - Sale of online advertising space - Digital intermediary activities which allow users to interact with one another and that can facilitate the sale of goods and services between them (intermediation services and intermediation platforms) - Sale of data generated from user-provided information through a digital interface (sale or commercial exploitation of user data).
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Taxation of Digital Business Models
Limitation according to size Only companies over a certain size would be liable to pay digital services tax. It would only apply to companies above both of the following threshold values: ď€ ď€
Total annual worldwide revenue over 750 million euros per year Total annual revenue of digital activities in the categories described of more than 50 million euros per year in the EU.
Tax revenues would be collected by the member states where the users are located. User location would generally be determined through the IP address of the user, or, if more accurate, any other method of geolocation. This information would be used to split revenue between the EU member states. The tax rate would be three percent of the revenue allocated to the member state. Companies that provide the service would calculate and declare the tax themselves. BDI assessment The BDI emphatically advises against the introduction of a unilateral digital tax in the EU. The current EU directive proposal for an EU digital tax to "tax the digital economy" bears the risk of causing extensive collateral damage to German industry and German tax authorities. Furthermore, it is questionable under constitutional law whether the EU has the legislative competence to introduce the digital services tax as a new tax in Germany.1 Further, as a new type of tax in Germany, the digital services tax would lead to high additional administrative obligations for both the tax authorities and the taxable companies. In the event that no agreement is reached on the directive proposal for a digital tax and that individual member states nonetheless pursue the idea of a "taxation of the digital economy", then these countries could agree on the basic key points of an additional tax regime without being obliged to implement it. This nonbinding political agreement would at least prevent the different member states from introducing several different versions of a digital tax and thus lighten the ensuing administrative workload. Risk of collateral damage to the detriment of German industry The current EU directive proposal on a digital tax bears the risk of causing extensive collateral damage to the detriment of Germany industry and German tax authorities. Delineating between the "digital economy" and the "traditional industry" is not possible as, in the course of Industry 4.0, industry is also increasingly applying digital business models. It is not possible at this time to calculate the exact extent to which digital business models of industry would be affected by the EU's proposals on taxation of the digital economy because of the dynamic development of these business models. 1
Federal Constitutional Court decision on nuclear fuel tax of 13 April 2017 (2 BvL 6/13)
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Taxation of Digital Business Models
Limiting the scope of the tax by laying down threshold values will not exempt Industry 4.0 companies operating in Germany as most industrial companies in Germany are above the threshold values of annual revenue of over 750 million euros and annual revenue in the EU of over 50 million euros. Double taxation of companies Companies will thus end up being taxed twice, once for national tax on profits and then the additional digital tax. The following examples demonstrate that this taxation is excessive, which the currently envisaged deduction of DST as a cost from the corporate tax base only reduces marginally. Offsetting the digital tax against corporate income tax paid worldwide would be the only way to really reduce double taxation on companies, provided that the profit margin is high enough to result in a previous corporation tax charge. Companies with low profit margins operating in highly competitive industries would be particularly hard hit by the proposed digital services tax. Overall, an additional digital tax would significantly increase the tax burden on European companies, which tend to already have much lower profit margins than US companies of the digital economy. Example 1 on the impact of DST (profit margin 5%)
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Taxation of Digital Business Models
Example 2 on the impact of DST (profit margin 30%)
b) Significant digital presence The proposed long-term solution is an introduction of a so-called significant digital presence designed to tax profits that are generated in a member state without a physical presence of the company – such as a subsidiary – in that member state. This would result in a supplement to the term permanent establishment as defined by national and double taxation legislation. The proposed directive intends to tax the online value added of companies at the location of the user at the time of consumption. As with the digital services tax, the tax would be charged by the member state in which the user uses a device (IP address). A "digital presence" is established if digital services are provided through a digital interface. Definition of "digital services" Digital services are services provided electronically, through the internet or an electronic network, the supply of which is essentially automated and involving minimal human intervention and would not be possible without information technology (see Art. 7 VAT Implementing Regulation). User location would be determined through the IP address or, if more accurate, any other method of geolocation. Examples of different kinds of digital services: The making available of digital products in general, e.g. software, upgrades, etc. Intermediation services that provide a presence in electronic networks for commercial or personal purposes, e.g. a website or webpage Services generated automatically by a computer via the internet or similar electronic network on the basis of specific data input by the service recipient Allocation of a right to offer a payable service on a website that acts as an online marketplace Webhosting, provision of advertising space, etc.
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Taxation of Digital Business Models
Minimum levels (threshold values) The volume of these services has to exceed specific threshold values, i.e. one or more of these conditions must be met: - Annual revenue of more than seven million euros in a member state. - More than 100,000 users in a taxable year in a member state. - Conclusion of more than 3,000 business contracts for digital services between the company and business users in a taxable year. Allocation of profits If the conditions specified above apply then the corresponding profits would be allocated according to this "digital presence". Profits would be attributed on the basis of the authorised OECD approach (AOA), but in modified form: The key criterion would not be significant people functions, but user functions. User functions include the following activities: ď€ ď€ ď€
Collection, storage and processing of data on user level Selling of online advertising space Provision of digital services or third-party content through a digital marketplace, etc.
Furthermore, the transactional profit split method would be applied where the taxable person does not prove that a different method is more appropriate. BDI assessment Long-term system changes, such as the introduction of a digital presence, can only be achieved through a global harmonisation of tax framework conditions. There are good reasons that a company's country of residence has so far been used to determine which tax legislation applies, as this is the country in which the company operates with a considerable deployment of resources. Taxation based not on the production but on the sale of goods would create fundamental conflicts in taxation between individual states. A new distribution of the right to tax can therefore only be implemented in international consensus, as recommended by the OECD. High risks for the German tax substrate The introduction of a digital presence or a virtual establishment harbours considerable risks for the strongly export-oriented Germany industry and the German tax authorities. Taxation of a virtual establishment in the sales market does not correspond to the traditional concept of permanent establishment with taxation on corporate profits in the company's country of residence. Taxing corporate profits at the location of the customers instead of at the location of value creation would lead to high losses of tax revenues in Germany.
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Taxation of Digital Business Models
Legal uncertainty and high compliance costs for industry Further problems are the high legal uncertainty for companies and extensive new auditing and documentation obligations that would be needed to effectively implement tax compliance regulations on a "virtual permanent establishment". The concept of a "virtual permanent establishment" would need to be debated in-depth, as recommended by the OECD in its interim report on BEPS Action Point 1. Concrete criteria would need to be defined if an "economic presence" is taken as grounds for a right to tax. Possible indications would be generated revenue, the existence of a local digital platform, the number of local users of a digital service, the number of contracts concluded through a digital platform or the volume of data collected from users. New standards for splitting profits Also regarding the allocation of profits, the directive proposal only includes general stipulations and a reference to the Authorized OECD Approach (AOA) that is applied in foreign tax legislation to delineate profits between affiliated companies or between the parent company and subsidiaries. The exact allocation of profits from digital value added and of expenses for intangible assets is still an open question and one that requires in-depth discussion. 3. Digital business models in German industry Delineating between the "digital economy" and digital business models of industry is not possible as Industry 4.0 is digital and conventional business models are turning into digital business models across all industries. It is not possible at this point to precisely determine the extent to which digital business models of industry would actually be affected by the EU's proposed taxation of the digital economy. This would require a detailed determination and analysis of the digital business models of industry. a) Typical digital business models The OECD has identified the following typical business models of the "digital economy"2: (1)
Multi-sided platforms (platforms between network participants and users)
This category comprises mainly digital platforms that generate value added between the platform operator and the customers or network participants. Examples: Airbnb, Facebook, Amazon, Marketplace (2) Resellers Companies in this category buy products including the respective distribution and exploitation rights and resell them. Examples: Spotify, Amazon e-commerce 2
OECD Final Report on BEPS Action Point 1, 52, 54 and OECD Interim Report, 24, 51 ff.
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Taxation of Digital Business Models
(3) Vertical integrated firms As opposed to companies in the previous category, these companies are not just intermediaries but also sell their own products. Examples: Netflix (4) Input suppliers (individual customer solutions) These companies provide customer-specific solutions upon special request. New digitalised value chains are emerging particularly in industry in the provision of extensively individualised software, networked applications and digital infrastructure. Examples: Cloud, Computing, Intel, Gmail The groups specified above as examples of typical digital business models are a starting point for a classification of economic activities. The fact is that all economic sectors are increasingly applying information technology and using digital intermediation platforms and sales channels to penetrate new markets. The German industry, whose business models are undergoing a dynamic transformation, is also becoming increasingly digital. b) Examples of digital business models for industry Example from the electronics industry: In a community-based parking system data of vehicles are reported to a cloud and processed into digital parking space tickets. Recipient vehicles are then sent information on the location of free parking spaces.
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Taxation of Digital Business Models
Example from the car industry: A carmaker collects data on an ongoing basis on the use of its sold vehicles and can analyse this data to calculate the upcoming demand for replacement parts in a country. The local sales partners provide this information to the carmaker and contracts on the supply of replacement parts are made automatically and sent directly to the local sales partner.
4. Open questions and long-term solutions In the opinion of the BDI, it is not expedient for the EU to pre-empt the work of the OECD with unilateral directive proposals. Long-term developments such as the digitalisation of business models and the associated changes in taxation can only – if at all – be addressed through a worldwide harmonisation of tax framework conditions. The EU should wait for the final report of the OECD in 2020 and continue the debate on a long-term solution for the taxation of digital value added. Alongside an introduction of a minimum tax rate for corporations in all EU member states as proposed by the German-French convergence project, other alternative approaches to tax profits are also being discussed, such as the imposition of a separate tax at source for digital services. These alternatives also raise numerous questions such as how to delineate between business models covered by this kind of tax at source, especially in the B2C area. Another point which needs clarification is in transfer pricing, particularly the question of which regulations should be used to determine the value contribution of data transfer and how to conduct an arm's length test of digital business models, particularly if no suitable non-domestic comparables are available.
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Taxation of Digital Business Models
About the BDI The BDI conveys the interests of German industry to political decision-makers and, in the process, supports business enterprises engaged in global competition. The BDI has at its disposal a wide network in Germany and Europe, on all major markets and in international organisations. The BDI provides political support for the opening up of international markets as well as information and economic policy consultation on all topics related to industry. It is the umbrella organisation of Germany industry and industry-related services, representing more than 100,000 enterprises with around eight million employees. Membership is voluntary. Fifteen organisations in the individual German states support the interests of industry at the regional level.
Publishing information Federation of German Industries (BDI) Breite Strasse 29, 10178 Berlin www.bdi.eu T: +49 30 2028-0 Contact persons Dr Monika WĂźnnemann Head of Tax and Financial Policy T: +49 30 2028 1507 m.wuennemann@bdi.eu Cedric von der Hellen Deputy Head of Tax and Financial Policy T: +49 30 2028 1602 c.hellen@bdi.eu BDI document number: D 0960
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