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Implications and Challenges for Global Entities

Introduction

The element of corporate residence determines two levels of taxation. Firstly, the domestic law where a company is a resident determines the tax on the worldwide profits. Secondly, access to tax treaties requires a company to be atleast a resident of one of the signatory states. The problems arise when two states adopt different resident criteria. For example, a company can be a resident in two countries and can be subject to double taxation. At the same time, it can be resident in neither country and not subject to any taxation. As an example, Apple Inc. (US) is subject to double non-taxation where Apple has a company incorporated in Ireland, which defines corporate residence as one where the company is managed and controlled, but managed and controlled in the US, where US law defines residence as where the company is incorporated. This is an instance of exploitation of corporate tax residence for tax planning and avoidance.

In the digital age economy, businesses adopt a dematerialised model where determining corporate residence is a challenge. The era of digialisation and technological progress has significantly changed goods production, services provision and strategic decisions. It has brought in new definition of business “places” that are not physical spaces where dematerialised goods and services are delivered. In this light, it is argued that the existing international tax frameworks have not kept pace with the progress of digital economy. From a tax law perspective, there is a lack of a global consensus on how to deal digital economy, which is based on value creation rather than the existing concept of source and residence to determine taxes.

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  1. Konstantin Sakuth, ‘The Concept of Corporate Tax Residence in Light of the Digital Economy’ in Ina Kerschner and Maryte Somare (eds.), Taxation in a Global Digital Economy: Schriftenreihe IStR Band 107 (Linde 2017) 84.
  2. Ibid.
  3. Ibid.
  4. Francesco Farri, Tax Sovereignty and the Law in the Digital and Global Economy (Taylor & Francis2020) xi.
  5. Alessandro Turina, ‘The progressive policy shift in the debate on the international tax challenges of the digital economy: a “Pretext” for overhaul of the international tax regime?’ (2020) 36 Computer Law & Security Review 105382.
  6. In the light of the challenges posed by the digital economy, this research will explore the current tax regime governing digital economy and more important, the area of improvement in the regime that could provide an effective solution.

    Statement of the Problem

    The main aim of this study is to investigate the taxability of the present-day digital economy. In addition, to explore how digital businesses, especially multinational companies such as Amazon and Google, have been able to take advantage of the tax laws and policies written for an industrial age and ill-suited for today’s economy. Analysis of the present-day digital economy is essential for determining how multinational companies have been able to make use of the tax laws and the current policies.

    Objective of the Study

    The main objectives of this study are:

    Investigating the taxability of the present-day digital economy.

    Exploring how multinational companies have been able get advantages of the tax laws and the current policies.

    Deecting how international digital tax affected the economy?

    The questions of the current study are:

    The questions of the current study are:

    How are the one-sided steps initiated by the Member States threatening the domestic market?

    Literature Review

    Digital economy has created a juridical phenomenon independent of the traditional source of law. This phenomenon requires evaluation of all relevant values comprising not just efficiency and productivity, but also equity, consensus and individual dignity. It is in relation to this evaluation suggested that there cannot be a


  7. Francesco Farri, Tax Sovereignty and the Law in the Digital and Global Economy (Taylor & Francis 2020) xv.
  8. positive evaluation as the market law favours the strongest player. The balance of representation with bindings effects of legal decision will be replaced with an imbalanced situation caused by imposition on binding effect of law by the strongest players.

    Digital businesses are disrupting the way transactions are traditionally carried out, monitored and taxed. The tax-disruptive digital elements call for special tax treatment. One such example is the digital automation of business processes were business models attained scale without mass at zero marginal cost. Busines processes are digitally streamlined replacing human workforce. Distribution of digital products does not need physical trade compliances or barriers, which is tax-disruptive. Many of the digital businesses used a multisided digital platform that create value by facilitating connections between users. This is called the ‘network effect’ where businesses exploit the data shared by user to create value of the business, such as seen with Amazon, Facebook, Gmail, to name a few. This poses a tax challenge where it is debatable to decide whether the country where users are located can tax the value created to businesses located abroad. Further, digital economy enables trade transaction without a physical presence of the business. This disables application of tax regulation because of failure to determine permanent establishment of the business in the concerned territory.

    Digital economy is agile and is borderless. National tax laws cannot effectively govern such global change. Digital multinationals can find ways to exploit loopholes in domestic legislations to elude higher taxing jurisdictions. In such digital economy, business capital has quick movements. Digital economy can easily disrupt taxing patterns that demonstrates the taxing regime fails to meet the patterns of digital age. This is found in the criticism against Google when it reported payment of just 6m corporation tax, while gaining 2.5bn of sales in the UK. The same happened with Apple, as mentioned above. Digital economy poses challenges regarding direct


  9. Francesco Farri, Tax Sovereignty and the Law in the Digital and Global Economy (Taylor & Francis 2020) xv.
  10. Cristian Óliver Lucas-Mas and Raúl Félix Junquera-Varela, Tax Theory Applied to the Digital Economy A Proposal for a Digital Data Tax and a Global Internet Tax Agency (World Bank Publications 2021).
  11. Ibid.
  12. Ibid.
  13. Jim Corkery, Jay Forder, Dan Svantesson and Enrico Mercuri, ‘Taxes, the internet and the digital economy’ (2013 23(1) Revenue Law Journal 128-143.
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    Multinational can take advantage of tax competition between nations. They can transfer profits to tax havens in the form of payments for intangible assets located there. The assets’ value is enhanced by returns to scale. Such profits are paid out in dividends. They are treated as income and reinvested without taxation. As seen earlier, the ‘network effect’ allows companies to exploit value gained from users, but concentrate the businesses that generate the income in places allowing easier transfer of profits. Digital businesses choose a tax system that gives them maximum tax benefits. In this light, the domestic and international tax system is facing problem addressing the effects of digital trade. Thus, there are issues associated with direct and indirect taxation. Based on the model of bilateral model tax treaty by the OECD to prevent double taxation of profits, international tax regime empowers taxation of profits to the country where head office is located, and not where the business is operated, except where the permanent establishment is in a different location than that of the head office. The problem is that definition of a permanent as based on the old concept based on premises and personnel cannot be applied to digital economy. Unless a specific and consolidated tax regime is established, taxation difficulties associated with digital economy may never be addressed properly. As opposed to the consideration of a new tax regime, it is also debated that considering the development at the OECD and European Union level, there is no need to have a new tax order for digital trade. The tax rules proposed by the European Commission may distort corporate decisions. It may spur tax competition. This debate does not appear to align with the OECD 2020 observation that recognises the absence of a consensus-based solution and consequential


  15. Marcel Olbert and Christoph Spengel, ‘Taxation in the Digital Economy–Recent Policy Developments and the Question of Value Creation’ (2019) ZEW-Centre for European Economic Research Discussion Paper 19-010.
  16. Pierre Collin and Nicolas Colin, ‘Task force on taxation of the digital economy’ (2013) Report to the Minister for the Economy and Finance, the Minister for Industrial Recovery, the Minister Delegate for the Budget and the Minister Delegate for Small and Medium-Sized Enterprises, Innovation and the Digital Economy accessed 19 July 2021 .
  17. Ibid.
  18. Ibid.
  19. Ibid.
  20. Marcel Olbert and Christoph Spengel, ‘Taxation in the Digital Economy–Recent Policy Developments and the Question of Value Creation’ (2019) ZEW-Centre for European Economic Research Discussion Paper 19-010.
  21. Ibid.
  22. proliferation of unilateral digital services taxes. It may also increase damaging tax and trade disputes, undermining tax certainty and investment. The possibility of a unilateral digital services taxes that is without global consensus may annually reduce global GDP by more than 1%. OECD recognises the possibility of unfairness and lack of equity in the tax systems. These observations are particularly relevant when multinational companies can exploit the gaps and mismatches in tax rules to transfer profits to locations that have low or no taxes (also termed Base Erosion Profit Shifting - BEPS). OECD recognises that most of such schemes are illegal. The problem of BEPS is significantly apparent given that there is a OECD/G20 framework to tackle tax avoidance.

    Based on the positions mentions above, it is, but a natural consequence that the regulations found across the countries are not posing enough challenges to multinationals companies when they are avoiding taxes legally. This practice gives rise to revenue loss and distortion of competition that favours them. For example, Amazon, Starbucks and Apple give taxes at 2% over their profits. However, other producers are paying full taxation and over that labour is overtaxed. The extensive nature of global finance is making countries’ tax regime less effective due to the tax competition. The absence of a unitary taxation adds to the problem. Even the 30 October 2014 agreement in Berlin where 58 nations signed an agreement for automatic exchange of information could not address the problem. The lack of commitment to implement the terms of the agreement, in terms of demonstrating the ability to collect and transmit data and the lack of sanctions for non-compliance to the agreement fail the objectives of that agreement.


  23. OECD, ‘International community renews commitment to address tax challenges from digitalisation of the economy’ (2020) accessed 19 March 2021 .
  24. Ibid.
  25. OECD, ‘What is BEPS?’ (2019) accessed 19 March 2021 .
  26. Francesco Boccia, ‘Introduction: The Digital Economy and Fiscal Policy in the Age of E-Commerce’ in Robert Leonardi (ed.), The Challenge of the Digital Economy: Markets, Taxation and Appropriate Economic Models (Springer International Publishing 2017) 18.
  27. Ibid.
  28. Ibid, 25.
  29. The inability of tax regimes to address problems raised by digitalisation is mainly caused by the regime’s predominant reference to physical presence. As long as proposals to address this problem are directed to tax shareholders and consumers instead of directing at corporate profits, obstacles will remain. A proposal will be to use a sales-based allocation of consolidated profits to be able to tax multinational companies. It may prevent such companies from shifting profits to low-tax countries. This may in turn reduce incentives for tax competition. The main challenge is in forming a unified tax regime or a tax model that could govern digital economy. The United Nations suggest a taxable nexus that is determinable by ‘significant economic presence’. This calls for creating a ‘virtual’ permanent establishment, determined by considering whether or not there is a persistent and sustainable interaction with a country’s economy through digital processes, including digital presence, online contacts, active monthly users, and data collection. The UK has adopted a diverted profits tax (DPT) in 2015 to address base erosion and profit shifting activities. It avoids UK permanent establishment treatment through segregating sales and contracting activities or use of IP licences to strip profit from the UK. However, DPT does not completely handle digitally raised tax issues. The UK government recent position in 2017 is to focus tax value driven by user participation. This was seen in the 2019 targeted royalty withholding tax proposed to focus on IP royalties paid by a non-UK entity to a party in a low tax jurisdiction, where profits were used to pay the royalty that was exploitative of the IP in the UK. Unlike the UK, Italy has a unilateral tax measure targeting digital economy in the form of the Law No. 205/2017, introducing ‘web tax’ applicable to services delivered electronically. It applies digital services by Italian and non-resident entities at 3% of the consideration paid. The tax is applicable only to those with digital services exceeding 3,000 units annually. Services provided to private individuals are exempted. One similarity with the UK is Italy’s 2018 Budget Law, based on guidelines set forth by BEPS Action 7 that

  30. Ben Jones, Susan Seabrook, Sebastiano Sciliberto, Georgina Jones, and Eversheds Sutherland, ‘Taxing the digital economy’ (2018) 1389 (2) Tax Journal.
  31. Antony Ting and Sidney J. Gray, ‘The rise of the digital economy: Rethinking the taxation of multinational enterprises’ (2019) 50(9) Journal of International Business Studies 1656-1667.
  32. Ben Jones, Susan Seabrook, Sebastiano Sciliberto, Georgina Jones, and Eversheds Sutherland, ‘Taxing the digital economy’ (2018) 1389 (2) Tax Journal.
  33. Ibid.
  34. Ibid.
  35. Ibid.
  36. requires the Italian Income Tax Code to provide for ‘a significant and continuous economic presence’ in Italy.

    As seen from the above-mentioned tax regimes and proposals of a new tax regimes, they are all unilateral and inconsistent measures. This raises a potential risk of double

    taxation, with administrative burden and uncertainty. Taxes are national and tax jurisdictions depend on territorial nexus principle and status of a tax payer. The aim of a tax regime is, thus, to tax a creation of value at the place where the value was actually created. The location could be where a business is registered a transaction is taking place. The question is how a geography could be inferred from available data. The problem is describing a digital transaction in terms of geography. Thus, if the parties in a transaction are not located geographically or the regulatory authorities are not aware of the transaction, tax regime’s enforcement is a challenge. The issues so far seen is to determine situations when a state could subject persons abroad to tax; when it could asked another state to provide support in collection of a tax on other entities within its taxing jurisdiction. These issues arise due to deep penetration of digital economy national economic, political and cultural system. Tax issues impact social issues arising out of social spending and the distributive role of the government in terms of income and wealth. The difficulty in locating the source of income in digital economy has disable a state’s ability to tax. Difficulty in characterising income makes it difficult for a state to determine its right to tax the income.

    The ability of businesses in digital economy to move goods and services and capital poses challenges to create an effective, legitimate self-governance. The creation of a

    Ben Jones, Susan Seabrook, Sebastiano Sciliberto, Georgina Jones, and Eversheds Sutherland, ‘Taxing the digital economy’ (2018) 1389 (2) Tax Journal.

    Subhajit Basu, ‘International taxation of e-commerce: Persistent problems and possible developments’ (2008) 1 The Journal of Information, Law and Technology 1-25.

    Stephen J Kobrin, ‘Territoriality and Governance of Cyberspace’, (2001) 32(4) Journal of International Business Studies 687-704.

    Ibid.

    Subhajit Basu, ‘International taxation of e-commerce: Persistent problems and possible developments’ (2008) 1 The Journal of Information, Law and Technology 1-25.

    Ibid.

    Ibid.

    Subhajit Basu, ‘Relevance of E-Commerce for Taxation: an Overview’ (2003) 3(3) Global Jurist Topics 2.

    virtual identity does not mean a clear connection with their actual identity. In this light, it is proposed to create cyberspace norms to govern any users in a digital. Digital vendors cannot avail tax benefits when business with bricks and mortar competitors cannot. There must be a consistent taxing mechanism, or otherwise there would be market distortion and inefficient allocation of resources. Amendment to the taxing regime may, thus, include promotion of technological solutions that could identify residence of the purchaser; enable automatic charge, assess and remit taxes; and enhance information exchange among tax authorities. The resolution is dependent on sharing information and identifying jurisdiction of buyers and sellers.


  37. Subhajit Basu and Richard P Jones, ‘Regulating Cyberstalking’ in Frank Schmalleger and Michael Pittaro (eds.), Crimes of the Internet (Prentice Hall 2008).
  38. Sarah W Salter, ‘E-Commerce and International Taxation’, (2002) 8 (1) New Eng. Journal of Int’l & Comp Law 6-17.
  39. Arthur J Cockfield, ‘The Law and Economics of Digital Taxation: Challenges to Traditional Tax Laws and Principles’ (2002) 56 Bulletin for International Fiscal Documentation 606.
  40. Subhajit Basu, ‘International taxation of e-commerce: Persistent problems and possible developments’ (2008) 1 The Journal of Information, Law and Technology 1-25

Reflection and Conclusion

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