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New Rules Proposed on Digital Taxation

On 21 March 2018, the European Commission proposed two Directives concerning the taxation of the digital economy. The proposals’ goals are to ensure fair corporate taxation, to foster a competitive economy and to generate sustainable tax revenues in the EU’s Single Market.

Following criticism that digital giants such as Facebook and Google pay too little tax in Europe, the Commission aims to level the playing field for all businesses. According to its statistics, the average annual revenue growth of the top digital firms is 14%, compared to between 0.2% and 3% for multinationals which trade in physical goods and services. However, companies with digital business models pay less than half the effective tax rate on average, just 9.5% compared to the 23.3% paid by traditional business models.

Current corporate tax rules are believed to no longer be fit for the realities of the modern global economy where companies make profits from digital services in a particular country without being physically present. Designed during the pre-internet era, tax rules have hitherto not taken into account profits generated largely from consumer data, through the provision of online services.

Current tax rules also fail to recognise the new ways in which profits are created in the digital world, in particular the role that users play in generating value for digital companies. A remedy to this issue is to tax companies according to where their digital users are based. This provides the necessary link between where profits are made and where they are taxed.

The Commission proposes two approaches towards changes in taxation: a common EU solution for digital activities in the long term and an interim tax to remedy the issue in the meanwhile.

The proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence proposes to extend the concept of a permanent establishment so as to include a significant digital presence through which a business is carried on. According to the new rules for the taxation of digital activities, companies would have to pay tax in each Member State on profits from user data (e.g., the placement of advertising), services connecting users (e.g., the online marketplace, platforms for the “sharing economy”) and other digital services (e.g., subscriptions to streaming services), provided that they have a significant digital presence.

This shall be the case if the company reaches one of the following thresholds: revenues from the supply of digital services exceed EUR 7 million, the number of users exceeds 100,000, or the number of online business contracts exceeds 3,000.

In order to prevent Member States taking unilateral measures and thereby creating a legal patchwork which would fragment the Single Market, the proposal for Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services proposes an interim tax. This interim tax is only to apply until the comprehensive reform has been implemented.

The interim tax of a proposed 3% would apply to revenues made from three main types of services, where the main value is created through user participation:

  • the sale of online advertising space,
  • the sale of user generated data,
  • and digital intermediary activities which facilitate user interaction, i.e., which allow users to interact with other users and which can facilitate the sale of goods and services between them.

Thus, the 3% tax will apply to revenues created from activities where users play a major role in value creation and which are felt by the Commission to be the hardest to capture with current tax rules.

The companies concerned would have to pay the 3% tax to the Member State where their users are located, but only if the company reaches the relevant total annual revenue thresholds of worldwide EUR 750 million and EU revenues of EUR 50 million.

In sum, the Commission proposes:

  • a permanent solution for the taxation of the digital economy in the EU, enabling Member States to tax profits made in their territory, even if a company does not have a physical presence there. The proposed rules would ensure that online businesses contribute to public finances at the same level as traditional 'brick-and-mortar' companies. Hong Kong companies should note that this proposal is accompanied by a ‘Recommendation’ (EU Recommendations are non-binding instruments) to Member States to amend their Double Taxation Treaties with third countries so that the same rules apply to EU and non-EU companies.
  • In addition, the proposed interim tax for digital services would apply to the most urgent gaps and loopholes in the taxation of digital activities. The measure would ensure that those activities which are not currently effectively taxed would begin to generate immediate revenues for Member States.

The proposals will have to be submitted to the EU Council of Member States’ ministers for adoption and to the European Parliament for consultation.

Content provided by Picture: HKTDC Research
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