The ways in which global businesses are taxed has been on the front pages more in the last couple of years than during the whole of the rest of my career combined. There’s a perception that international businesses, particularly those of a more virtual nature, are paying less tax than they ought to. International tax is pretty complicated stuff and so, if they are paying less, this isn’t down to lack of effort on the part of taxing authorities: it’s just that the rules, when properly applied, can give results that many think look odd.
We’re now half way through a project being run by the OECD called BEPS (Base Erosion and Profit Shifting)which has recently issued seven interim reports, with the final eight reports due out in about a year’s time. The first BEPS report was on the Digital Economy and considered whether we need new taxes to deal with the digital businesses which have been getting themselves on the front pages.
So what has this to do with the OECD? Beginning in the 1920s, the nations of the world have established tax treaty networks to eliminate the unfairness of the double taxation that arose on cross-border trade. As the international tax system has become more established, the inequity of double taxation has been reduced, however, the BEPS concern is that the pendulum has started to swing more towards the apparent inequity of non-taxation.
Although the premise of the Digital Economy working party was that there are “Digital Economy businesses” (the ones on the front pages) which need new tax rules, pretty quickly they concluded that Digital just means “using modern communications technology” and, surprise, surprise, all businesses are at it – some just do it better than others. In tax terms, this gets you to the conclusion that an international tax system designed in the 1920’s for the international communications of that time (trains, boats and telegraph) does not cope well with the modern world: hence the title of this blog.
Whilst it will be a year or so before we know where these changes will take us, the Digital Economy report does give a vision as to what the future may look like. It does this by setting out what aspects of the tax rules need to change. At a very high level, the changes would make it easier for a company based in one territory and selling into a second to become liable to taxes in that second territory. There is, of course, a lot a technical detail behind this broad statement.
One of these details is the way in which the Permanent Establishment rules operate (i.e. what threshold of activity needs to be crossed before a company selling from country A to customers in country B has to declare taxable profits in country B).
The draft report of the Permanent Establishment working party has just come out for comment and this gives us a first clue as to whether or not the Digital Economy report contains the blueprint for the future of the international tax system. The number of references to the Digital Economy report (and its recommendations) in the Permanent Establishment draft paper suggest that, yes, the recommendations made by the Digital action group are being taken seriously by the other working parties.
I’m not suggesting that anyone should change their business model and tax arrangements based on as yet unwritten rules (although I would give the matter serious thought if you’re making changes for other reasons), but I do think it’s worth keeping a weather eye out for these changes and doing some simple scenario planning based on the more likely outcomes.