National measures on taxing the digital economy

INTRODUCTION: RECENT DEVELOPMENTS IN THE INCLUSIVE FRAMEWORK

In January 2020, members of the Organisation for Economic Co-operation and Development (OECD)/Group of Twenty (G20) Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) released a statement on the two-pillar solution to the tax challenges arising from the digitalization of the economy. The statement reiterated the IF members’ commitment to reach an agreement on a consensus-based solution by the end of 2020. The IF also agreed upon an “outline of the architecture of a Unified Approach on Pillar One as the basis for negotiations”, intending to reach by July 2020 agreement on the key policy features of the solution which would form the basis for a political agreement.

The Unified Approach to Pillar One seeks to create new taxing rights which would allow for taxable presence (nexus) even in the absence of physical presence of a company. Pillar Two seeks to establish a global minimum corporate tax rate and enforce it through four interlocking rules, which would allow both source and residence countries to ensure multinational enterprises (MNEs) pay the minimum rate.

There has been much controversy over the procedure through which the Unified Approach was arrived at. The OECD Secretariat claimed to integrate ‘common elements’ from three competing proposals – user participation, marketing intangibles and significant economic presence – but the resulting Unified Approach to Pillar One seems biased towards the US’ proposal of marketing intangibles. Similarly, the sole proposal put forth by developing countries, the Group of Twenty-Four (G24)’s concept of Significant Economic Presence, has been removed from further consideration. Hence, the Unified Approach to Pillar One has been strongly influenced by the policy approach of the US.

Pillar Two, also known as the Global Anti-Base Erosion (GloBE) proposal, is also largely influenced by US domestic legislation, specifically the US Tax Cuts and Jobs Act (TCJA) of 2017. TCJA’s Base Erosion and Anti-Abuse Tax (BEAT) and the Global Intangible Low-Taxed Income (GILTI) measures bear close resemblance to the undertaxed payments and income inclusion rules of Pillar Two.

Hence, the OECD’s two-pillar approach mostly reflects the policy proposals of the US, something which has been acknowledged by the OECD Secretary-General himself. It is questionable to what extent the interests of developing countries have been taken into consideration. This is yet another instance of the issues developing countries face in articulating their interests in the OECD’s international tax framework, and is arguably profoundly undemocratic. Further, it remains unclear how the two-pillar approach will be implemented, and what would be the extent of voice available to nonOECD members of the Inclusive Framework. One observer has stated, “what is unified in the OECD approach is its commitment to an exclusive process of consensus building that replicates that of the founders of the international tax order, apparently unchanged by developments like inclusive participation and equal footing.”

Accordingly, what followed was unsurprising. In February 2020, the OECD presented the results of an analysis on the expected revenue gains from implementing the twopillar approach. The estimates showed the combined effects of the two-pillar solution would result in an annual increase in revenue collection of USD 100 billion, or up to 4% of global corporate income tax (CIT). While this figure may seem large, it pales in comparison with the estimated USD 600 billion in revenue lost each year due to tax avoidance. Further, as seen in Figure 1, the distributive implications are problematic as high-income countries are expected to benefit marginally more than middle- and lowincome countries, though middle- and low-income countries proportionally face the highest losses from corporate tax avoidance under the current rules.

The OECD’s estimates were pre-empted by prior independent studies that showed the Unified Approach to Pillar One in its current form would disproportionately benefit the US and developed countries. Assessments by Cobham, Faccio and FitzGerald show that the Unified Approach, which has only sales in its formulary allocation key, would yield over USD 8 per capita for the United States, around USD 4 per capita for other Group of Seven (G7) members and USD 2 per capita for the OECD without the United States. For non-OECD members of the G20, and for the G24 and Group of SeventySeven (G77), the projected benefit is between USD 0.08 and USD 0.18 per capita, respectively. By contrast, including employment in the formula would increase those projected benefits to between USD 0.80 and USD 1 for the G24 and the G77. Figure 2 shows the contrast.

Hence, the Unified Approach to Pillar One has questionable benefits for developing countries. It in fact seems to be increasing global inequality, a direct contravention of Sustainable Development Goal (SDG) 10, which seeks to reduce inequalities between countries. That said, even developed countries do not stand to significantly benefit, given the small increase in overall revenue. This combined with the slow pace of multilateral negotiations and increasing public anger over the inability of governments to tax the ever-growing profits of digital giants has led to a proliferation of national tax measures. A recent study estimated that just six prominent companies avoided taxes of an estimated USD 100 billion between 2010-2019. Post COVID-19, Nasdaq, the US stock exchange that is dominated by digital firms, saw the price to earnings (P/E) ratio of the top 100 companies actually go up and cross a 10-year average of 19 and increase to 28 in April, following the March crash in equity markets worldwide. The socalled FAANG companies (Facebook, Apple, Amazon, Netflix, Google) have all seen increased sales and subscribers post the COVID 19 lockdown, with the exception of Amazon which reported less profit than anticipated, though that was because of higher delivery costs due to increased sales. Amazon in fact even announced plans to hire 100,000 new staff to keep up with higher e-commerce orders, implying it expects sales to increase much further.

An increasing number of both developed and developing countries have brought out legislation, several of which involve Digital Service Taxes (DSTs), to tax the profits of these companies. This has been met with severe criticism from the United States, home to some of the world’s biggest digital companies such as the Silicon Six (Facebook, Amazon, Apple, Netflix, Google and Microsoft). The US has accused some of these countries of unfairly targeting American companies , and in some cases, has even threatened retaliatory trade tariffs. DSTs have been attacked for seeking to tax gross revenues, rather than net income. Further, the US has expressed disapproval over the Unified Approach, arguing that it has a discriminatory impact on US-based businesses and has called for “safe harbor” regime to Pillar One, essentially making it optional.

The OECD has been deeply alarmed at these developments and has voiced concerns, appealing to countries to arrive at a multilateral solution and warning that failure to do so would result in a “cacophony and a mess” and “tensions rising all over the place”. It has repeatedly urged countries to withdraw or at least delay implementation of these national measures. Nevertheless, despite sustained pressure, both developed and developing countries are going ahead with bringing out legislative measures on taxing digital companies.

These measures have arguably played a highly positive role in the discourse: they have spurred the OECD into action, and given it a (somewhat extreme) commitment to arrive at a solution at the earliest. Further, they have possibly strengthened countries’ bargaining positions, as they are no longer beholden to the OECD alone for delivering a solution. These measures take on new importance in the current context, where the Inclusive Framework is aiming at coming out with a consensus solution by July 2020 on the “key policy features of the solution which would form the basis for a political agreement.”

Hence, given the importance of these measures, it is necessary to examine them in detail, so developing countries both within the Inclusive Framework and outside of it know what are the options available to them to safeguard their tax base in case the negotiations within the OECD fail to safeguard the interests of developing countries.

The paper groups these options into three: (1) Digital Service Taxes (2) New nexus based on Significant Economic Presence and profit allocation through Fractional Apportionment (3) Withholding Taxes on Digital Transactions. The broad description of each policy option is outlined followed by country-wise specifics, with an emphasis on legal details and revenue obtained, if any. A compilation of all revenue estimates and actuals is given towards the end, followed by a conclusion with the key findings.