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Navigating Corporate Residence in the Digital Age

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 at least 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 either of the countries and still 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.

In the digital age economy, businesses adopt a dematerialised model where determining corporate residence is a challenge. The era of digitalisation 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, Turina (2020) argues 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.

This research will explore the current tax regime governing the digital economy and more importantly, 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:

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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.

Detecting how international digital tax affected the economy

Study Questions

The questions of the current study are:

What are the taxation concerns that could arise in regard to digital economy?

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

This research has the following chapters:

Chapter 1 - Introduction

Chapter 2 - Literature Review: This chapter constitutes the main body of the research. It is divided into further sub-section. This chapter overall discusses taxation challenges presented by the digital economy. It analyses the components of the digital economy that bring out the loopholes in the existing international taxation system. It also analyses how multinational corporations can take advantage of such loopholes to avoid paying taxes.

Chapter 2 analyses the deficiency in domestic regulations by bringing out the unilateral and inconsistent measures adopted by states. It also discusses the available proposals from a traditional tax regime and analyses whether or not they are attempts to locate the traditional structure in the possible tax regimes.

Chapter 3 will discuss the relevant proposal, guideline and such measures undertaken by OECD that aim to address taxation challenges in the digital economy.

Chapter 4 will present the research methodology that is adopted in this research

Chapter 5 will discuss the findings of the literature review and potential solutions to the issues presented in this research

Chapter 6 will present a brief personal reflection by the researcher on this research. It will conclude by giving a summary finding of this research.

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 Farri (2020) suggested that there cannot be a positive evaluation as the market law favours the strongest player. Farru states that 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 where business models attained scale without mass at zero marginal cost. Business processes are digitally streamlined replacing human workforce. Mas and Varela (2021), in this regard, observed that the distribution of digital products does not need physical trade compliances or barriers, which is tax-disruptive. They state that many of the digital businesses used a multi-sided digital platform that creates value by facilitating connections between users. This is called the ‘network effect’ where businesses exploit the data shared by users to create value for the business, such as seen with Amazon, Facebook, Gmail, to name a few. Thus, they argued that such exploitation 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, the digital economy enables trade transactions 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.

Corkery, Forder, Svantesson and Mercuri (2013) observed that the digital economy is agile and is borderless. National tax laws cannot effectively govern such global change. They stated that digital multinationals can find ways to exploit loopholes in domestic legislations to elude higher taxing jurisdictions. In this 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 the 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. In this light, this chapter will explore the taxation challenges imposed by the digital economy, the modes of taxation that could be applied to address the challenges, and the implication of the suggested modes of taxation on international and domestic taxation systems.

Digital economy poses challenges regarding direct and indirect taxation

The taxation issues arising from the digital economy are well recognized by the EU Parliament, OECD, the UK government, and many other bodies including both public and private institutions. The main concern is around the tax planning of the multinational enterprises exploiting the gaps in the interaction between the different tax systems. They have managed to reduce their taxable income, transfer profits to the low-tax jurisdictions where there has been no or little economic activity.

OECD observes that the capability of avoiding tax through legitimate means of tax planning arises from the characteristic of digital economy. This lies in the components of intangible assets, free products, major use of voluminous personal data, adoption of multi-sided business approach that uses value from externalities, and mainly the challenges in determining residence of the value created. Digital economy does not require physical presence of a company in a market country. There is a thin boundary between the consumers and producers. Project bundles are easily created that act as price discriminating tools. The barriers of entry of trade are very low. All these lead to multi-sided businesses and multi-jurisdictions operation of businesses. There are concerns, as OECD observed, around how companies located in multiple locations make value and profits and how they conceptualise source and residence or characterise income for calculating taxes.

Olbert and Spengel (2019) stated that digital economy poses challenges regarding direct (corporate profit) taxation and indirect (consumption) taxation. According to OECD, challenges are because of: conducting business without physical presence; difficulty to create value of personal data; uncertain payment due to new digital products and new mode of delivery; difficulty to calculate value due to intangible digital products; and difficulty to give character to online payment that do not have any intermediary.

The challenges are evident when events such as the 11 million file Panama leaks happen that involve aggressive tax planning and mechanisms in the form of trusts and foundation that can hide large amount of payments. Such events occurred due to tax-disruptive digital elements, to include digital content, distribution and automation that are delivered online. As such, Mas and Varela (2021) claimed that the disruptive elements have introduced complexity to the traditional tax administration and enforcement practices bringing along new economic realities that may make tax norms and economic inapplicable. For example, as Geringer (2021) put it, the digital automation of business processes can make a digital business reach scale without mass at a zero-marginal cost. This happens with business including online sales; subscription plans and license agreements; and online access to an automated or a multi-sided digital platform in return for a price, subscription fee, or a license fee.

The trend amongst EU member states is the introduction or proposal to introduce national measures. They are categorised into DST (Digital services taxes) to manage multi-digital businesses; DAS (Digital advertising taxes) to manage online advertising services; and Unilateral adjustments to PE (permanent establishment) definitions in their income tax codes to manage small or other businesses. Geringer (2021) argued that these measures cannot sufficiently meet challenges of digital economy. For example, the DSTs and DATs can trigger double or multiple taxation adding to the existing corporate tax regime in the residence country. Geringer stated that they may hamper competition and discourage companies from launching into digital business. Also, resident states may retaliate against double taxation. In the case of the third category of measure, domestic tax regimes cannot make broad amendments to PE that it overrides double tax treaties. This makes the third measure inapplicable.

Digital economy produces anonymity, challenges to calculate tax amount, ability to transfer profit to tax havens, taxes in multiple jurisdictions, and inability to locate physical presence of companies. All these factors pose difficulties in collecting taxes.

Exploitation by MNCs

As observed earlier, multinational companies or enterprises 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.

Peng (2016) observed that there is a tax base erosion issues in a digital economy. Pend stated that the rise of the digital economy gave rise to changing corporate structure and this change has been used by multinational companies including Amazon and Apple to avoid taxes. Peng argues that the digital economy transactions offer the companies to take advantage of the loophole in the international tax regime. The assets are intangible and so having a permanent residence in the market will enable them to scarcely show taxable profits. Thus, the risk and capital market areas in the location of the value will not show any actual sales. That way the companies will not show any profit assigned to the permanent establishment. This erodes the income tax base. The OECD has also pointed out the gaps arising from frictions between states’ tax regimes. Such gaps often lead to companies not taxed at all. The incoherent international tax regimes facilitate these gaps. Such gaps have been in existence since the 1920s even before the emergence of the digital economy. The loopholes thus create BEPS (base erosion and profit shifting) that involves double non-taxation or less than the single taxation.

BEPS causes loss of corporate tax revenues and unintended competitive advantages for MNCs. In this regard, Russo (2017) stated that it distorts investment decisions where investment with lower pre-tax but higher after-tax return rates is preferred. As such, the 2012 report, ‘Addressing Base Erosion and Profit Shifting’ by the G20 finance ministers recommended to minimise taxation in the market jurisdiction by avoiding a taxable physical presence or by shifting gross profits or reducing net profit by maximising deduction at the payer level when there is a taxable presence. The report also provided for low or no withholding tax at the source, and low or no taxation at the recipient’s level, and no taxation of any low-tax profits at the ultimate parent’s level.

There are challenges to effectively tax multinational corporations in the digital economy. The domestic and international tax system is facing problems addressing the effects of digital trade. The characteristics of digital economy has made it difficult to create a framework regarding corporate income tax to capture the profits arising from cross-border digital businesses. Even where the focus is on a market country, two pathways could arise. First is a set of rules based on ‘digital presence’ focused on the demand side of the market. Second is the set of rules based on ‘digital investment’ focused on a productive source of income in the market. These pathways need further exploration. This means a quick solution cannot address the issues of the digital economy in regard to taxation.

Deficiency in domestic regulations

Based on the positions mentioned above, it is, but a natural consequence that Boccia (2017) argued that the regulations found across the countries are not posing enough challenges to multinational companies when they are avoiding taxes legally. This situation 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. Boccia claims that 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.

Many states view the international tax framework does not allocate taxing rights to the source jurisdictions where the MNC is carrying on remote sales. This means that the source taxing rights can only arise when the company is trading in a country (not with the country). The UK’s Corporate Tax and the Digital Economy imbibes this principle. It follows the principle to tax an MNC group’s profit in those countries where the MNC undertakes value-generating activities. This means that taxes will apply in the locations where major operating decisions are taking place and where the key assets and risks are controlled. This is also reflected in the principles adopted by OECD and G20 that profits are taxed at the jurisdictions where economic activities take pace and value is created. It is rather the focus on the value creation that defines taxing rights. However, basis on value creation is not precise and is vague. There is no consensus, as OECD observed, on allocating more taxing rights to those jurisdictions where customers or the users are and where there is value creation through remote sales in the jurisdictions that are not covered in the framework that allocates profits.

In the UK context, the digital services tax (DST) is on the gross revenues that a group company from a digital services activity delivered to the UK users. The UK DST provides a threshold that if the total group’s global revenues exceed £500 million, and that of the UK services exceeds £25million, DST will apply. The problem with the definition of the digital services revenues is that, as HM Revenue & Customs, it is broad. There is no connection between the revenues and the underlying activities. Revenues must be attributed to digital services activity upon a just and reasonable basis. In regard to the UK digital services, the UK law excludes online marketplace revenues if the services arise from accommodation or land outside the UK and/or the UK user is a provider related to the transaction.

The UK DST has been criticised to be discriminatory against US companies, particularly tech giants in response to how Google, Amazon and Facebook avoid paying tax when they earn billions of pounds in the UK. The Office of the US Trade Representative Executive Office of the President 2019 investigation found that the UK DST is inconsistent with international tax rules where it applies to income and not to income; it does not connect corporate income with a permanent establishment, and it does not prevent double taxation.

The challenge to domestic regulations is demonstrated by the views about taxing rights that states have regarding the digital economy. The UK DST is an example that a state’s digital tax regime may be used arbitrarily. This establishes that the current regulation framework is facing significant challenges due to the lack of understanding among policymakers about the risks of emerging technologies.

Potential solution are unilateral and inconsistent measures

The inability of tax regimes to address problems raised by digitalisation is mainly caused by the regime’s predominant reference to physical presence. Ting and Gray (2019), while assessing taxation of multinational enterprises regarding the emergence of digital economy, observed that as long as proposals to address the inability of the tax regime are directed to tax shareholders and consumers instead of directing at corporate profits, obstacles will remain. They, therefore, propose the use of a sales-based allocation of consolidated profits that will enable taxing 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 the 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 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 new tax regimes, they are all unilateral and inconsistent measures. In this regard, Basu (2008) stated that it will raise 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 and 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 ask 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 the digital economy has disabled 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 the digital economy to move goods and services and capital poses challenges to create an effective, legitimate self-governance. The creation of a 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.

DBCFT - mode of tackling ineffective taxation regime

Digital vendors should not avail tax benefits that 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. To reiterate, it is suggested that the tax regime must rely on taxing on creation of value at the place where the value was actually created. As a form of tightening anti-tax avoidance rules, Destination-based Cash Flow Taxation (DBCFT) proposes two components. The first is the cash-flow component that allows full expensing of investment and prevents interest expense deduction. It allows taxes on economic rents and does not tax normal returns. The second is the border adjustment, which is destination-based, preventing deduction of any imported inputs and excluding revenues from exports from the tax base.

The first component – cash flow taxation – counts all receipts as income and deducts as expenditure when paid. The receipts and expenditure will include the items purchased and sold as a part of the ordinary conduct of the business or these items along with financial transactions. This is unlike the traditional financial accounting. It governs an immediate deduction for all the expenditures including the capital. It allows deduction on expenditure on capital assets including plants and machinery, or buildings. The cash-flow transaction was found to increase the capital stock by 25%, pre-tax wage rate by 8% and GDP by 9% in the US. It produced additional revenues allowing reduction in personal income tax and maintaining initial debt-to-GDP ratio.

The second component - destination-based taxation – has an international perspective. It governs sales and revenues that are derived from within the jurisdiction. It excludes revenues from exports. Thus, expenses incurred within a jurisdiction are deductible against the sales and revenues. It also includes revenues derived from import of goods and services to the final customers. This component is focused on the destination of the goods and services. Thus if the consumer is local, the revenue is included in the tax base. If they are in overseas export market, the income taxation is in that market. Lamensch (2017) argued that as tax is levied on imports from offshore businesses, states will face difficulties in terms distinguishing between B2B and B2C supplies in order to correctly apply taxes. In using destination-based taxation in a traditional vendor collection model, particularly in a cross border scenario, Lamensch argued that there is no connection between substantive jurisdiction of the taxing States and the enforcement jurisdiction. The reason is that the tax collector is offshore and the states jurisdictional power is within a national boundary.

DBCFT eliminates the key element of residence for tax purposes. It can address issues of taxing mobile factors. It can remove incentives to manipulate transfer prices. It enables the tax system to ignore the intra-group transactions. It allows full and immediate deductions of investments. Companies cannot distort their financing choices as cash flows are excluded from the tax base. Carpentieri, Micossi and Parascandolo (2021), however, presented a few disadvantages of DBCFT. They stated that it uses “destination” as a proxy to exercise taxation rights. However, it does not replace corporate taxation with consumption taxation. It may offer administrative and legal issues. For example, if it is adopted unilaterally, it can create double taxation or no taxation at all. They stated that the cash flow taxation may make the full tax deductibility of an investment co-exist with deductions of costs that are not yet amortised. This can lead to revenue shortfalls. The cash flow taxation can destabilise international agreements based on the traditional concept of profit. For example, if the cash flow tax is not recognised in the agreements against double taxation, credits on domestic tax will lose.

In light, 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. The OECD has recognised deficiency in the international income tax rules, which are based on a "brick-and-mortar" economic environment. The rules cannot meet the challenges thrown by the elements of a digital economy, which are scale without mass, reliance on intangible assets and the centrality of data. OECD, thus, proposes for a comprehensive consensus-based solution that could address allocation of taxing rights and BEPS issues.

OECD Two Pillars Plan

Based on the model of bilateral model tax treaty proposed 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 establishment, 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. At the EU level, the European Commission proposed two initiatives. Firstly, the corporate tax rules must be reformed to register and tax profits where a business has a significant interaction with users through the digital platforms. This allows a member state to tax profits generated in its territory even where the business does not have a physical presence. The Commission proposes a digital presence or a virtual permanent establishment to enable such taxation. It stipulates certain thresholds. The business must exceed €7 million in annual revenues in a state; 100,000 users in a taxable year, and 3000 business contracts with users for digital services in a taxable year. This new system will link the place of profit and the place of taxation. This is similar with what the United Nations suggested, as mentioned earlier, regarding the determination of a ‘significant economic presence’, and the suggestion of a ‘virtual’ permanent’. The basic problem with such solutions is the possibility of establishing unilateral and inconsistent measures.

The second proposal of the European Commission is the introduction of an interim tax covering the main digital activities that escape tax altogether in the EU. This is an indirect tax on revenues arising from activities in which users are key players in value creation. Such revenues are considered challenging to capture. This interim tax will cover activities that are not effectively taxed. It will cover revenues from the sale of online advertising space; intermediary activities allowing users to interest to facilitate sales between the users; and sale of data generated from information provided by users. The threshold is that the tax will be on jurisdictions where users are located and on companies with total annual worldwide revenue of €750 million and €50 million EU revenues.

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 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.

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In consideration of the challenges imposed by the digital economy, as of 5 July 2021, there are 131 countries and jurisdictions that have formulated a new two-pillar plan to ensure that multinational enterprises pay a fair share of tax in jurisdictions they operate. Pillar One requires re-allocation of taxing rights over the enterprise from their home countries to the market that has their business activities and where they earn profits. This plan does not consider the element of physical presence. This plan will relocate taxing rights on more than USD100 billions of profits annually. It will establish a nexus in the market jurisdiction where the enterprise has a significant and sustained engagement. This takes into consideration that customers are less mobile than the business functions. This removes the ability of the enterprise to control the location of customers and to continue with an exploitative tax planning structure. This will reduce tax competition between states. The Pillar One plan is, however, not free from challenges. It will allocate only a portion of the profits to the location of customers or users. Thus, the new taxing right will exist along with the already existing nexus and profit allocation rules. This represents two sets of different rules to calculate the tax base. This imposes a burden on businesses to understand and implement different national tax systems. Hence, Pillar One incurs administration and compliance costs. This does not present a clear picture on the taxation rules, and it does not appear to be able to remove the practice of shifting profit to low-tax jurisdictions. The reason is that a larger part of the profits will be taxed subject to the existing rules.

Pillar Two requires a global anti-base erosion mechanism that protects states’ tax bases. It proposes a global minimum corporate income tax rate at 15% with an expectation to generate over USD150 billion annually. This will also stabilise the international tax system and increase the tax certainty for taxpayers and administrations.

The two-pillar plan has the potential challenges in the area of political acceptance and technical compliances. The plan is argued to likely produce a huge compliance problem. It may find experienced tax experts in difficulty to understand components, such as the IIR credits, formulaic substance-based carve outs, GloBE tax base, or top-down approach to name a few. Further, the finalisation will need a more technical consensus regarding the design features of the global anti-base erosion (GloBE) tax. Divergent views will persist as to the concept of carve-outs, rule order, blending and tax rates. Income inclusion rule (IIR) is the main mechanism for a GloBE minimum tax regarding income from a controlled foreign corporation (CFC). This will present a complicated administration. For example, there will be challenges in arriving at an agreement regarding the percentage of the minimum tax rate. The corporate tax rates can vary significantly at the international level. Differences such as these create uncertainty over whether an international minimum tax rate will reduce profit shifting practices. If the tax is low, say at 10 percent, an incentive will be available to a company resident in another jurisdiction twenty percent corporate tax or more and it can shift its profit to other jurisdictions that offer substantially lower corporate tax. Alternatively, if the rate is too high, there will be challenges in implementing the rate.

The two pillars plan has been criticised due to its challenges and implications of implementation. The GloBE plan is argued to represent a shift by OECD from its stand on BEPS. Comparatively, GloBE can jeopardise the tax sovereignty of a jurisdiction and impose challenges of its implementation in that it may involve amending the domestic law and conflict with existing tax treaties. Thus, when implemented, it will deprive a developing country from granting tax incentives. For example, a deficient enactment of the IIR may trigger applicability of tax sparing clauses, which also protect granting tax incentives. IIR and the clause pursue opposing goals.

The discussion so far projects recurrent findings. Digital economy has disrupted the traditional taxation rules. The characteristics of the digital economy have disabled taxation regimes, both international and national, to address the loopholes in the regime. It is clear by now that the existing regime cannot meet the demands of this emerging economy. The state and international institutions have recognised the challenges and problems caused by the digital economy. Despite identifying the challenges and problems, there has been a constant struggle to find a taxation model to address the challenges and problems. Models suggested by private bodies, government institutions and international bodies such as the UN and OECD seem to have failed. There are still open challenges, which demonstrate the deficiency in the existing taxation regime.

Research Methodology

This research is a secondary data-based research. Literature review is the main research component. It allowed the researcher to identify, review, collect and analyse existing research related to taxation in the digital economy. Digital economy has digital components that disrupt the traditional taxation framework. To have any in-depth understanding, the literature review involved analysing a range of components in the digital economy including practices of multinational companies, interaction between state’s taxation rules, and the loopholes in the international taxing regime that corporations take advantage of. The research involved a range of topics, including taxability of the digital economy, loopholes, corporations’ ability to avoid taxes, and incoherent tax regimes. To address this range of components, given the nature of the research involved, a qualitative research method was adopted to study the multiple aspects of taxation in an international digital economy. This allowed the researcher to adopt an open and flexible research method that could appropriately address the research question and objectives.

The research touched upon the various disruptive components of the digital economy that have weakened international tax regimes. Simultaneously, this research discussed key challenges arising from such disruptive components posing lesser difficulties to corporations to avail the tax-avoidance advantages. To be able to derive these perspectives, this research was based on secondary data collected through a systematic literature review. Such an approach possibly eliminated bias while identifying appropriate literatures. This was done by specifying eligibility criteria and selecting literature that allowed the researcher to collate necessary data evidence. In this regard, it was essential to review whether or not it was justified for MNCs to avail the advantages due to the taxation regimes’ loopholes when the states and international taxation regimes are not providing a coherent taxation regime for digital economy. By doing so, it avoids a one-sided perspective allowing greater focus on the flaws or areas of improvement in the digital economy taxation regime.

The context of the research will thus provide the aspect that states are weighing each other’s practices and measures to extract maximum benefits for their own self interests. Thus, it could be that the states have not been able to understand how to attain such interests and it contributes to the continuing existence of the loopholes. In this light, the secondary data collected in this research is subjective. They are qualitative in nature and hence, are attached with challenges while analysing. For example, this research found that companies such as Google, Facebook and Amazon have earned profits in billions of dollars while paying taxes that are proportionate to the profits. However, the lack of proper regulations enabled them to avail the benefits. Thus, this research focussed on secondary sources to find the implication of such events. It has incorporated recent updates on digital services taxation undertaken by international bodies, including OECD in order to make an informed conclusion regarding the research question.

The research found patterns around the research subject, for example deficiency in traditional tax regime to tackle digital economy, lack of understanding of such economy amongst policy makers, loopholes and avoidance of taxes, to name a few. These patterns are focussed upon in the research to bring better clarity. Thus, this research used a thematic analysis method of data analysis. Themes such as mentioned above have been used to collect, organise, analyse and review the data to understand the discussion and policy patterns. This was done to bring out a range of results and to break down relevant information integrated in the research analysis.

This research was online-based using platforms including Google Scholar, Google Books and other relevant websites (OECD, European Parliament, the UK Parliament to name a few) and journals. A range of literature in relevance with the research topics was identified and reviewed using key words and phrases, separately and jointly, such as digital economy loopholes, deficiency, domestic taxation, OECD challenges, MNCs practices, to name a few.

Findings

The requirement of residence in a traditional tax system does not apply to the digital economy. This seems to be the main cause for all the problems and challenges associated with taxation in a digital economy. The research so far has found a continuous struggle in finding a taxation model that could address the challenges of taxation in a digital economy. Unless an appropriate model is not implemented based on national and international consensus, there will always be possible exploitation of taxation loopholes and difficulties in implementing any proposed rules.

The research so far has found attempts in finding an alternative to the criteria of residence. Digital economy follows a dematerialised model that challenges finding a corporate residence. The inability of the taxing regimes has led to MNCs exploiting the flaws in the system, for example when Google reported payment of just 6m corporation tax, while gaining 2.5bn of sales in the UK. MNCs could scale without mass at zero marginal cost. They could transfer profits to the low-tax jurisdictions where there is no or little economic activity to reduce their taxable income.

This research has found that the attempted solutions to tackle this kind of problems have resulted not in a global consensus, but more of unilateral, diverse actions. As an example, the UK’s DST (Digital services taxes) can be seen as an example using a value creation approach to determine taxes. However, they are argued trigger double or multiple taxation. The deficiency in the taxing system is used by MNCs to gain tax benefits. In regard, the question is not whether their actions are justified or legal. The question is how to take enforcement action against them when the current law does not understand taxation in a digital economy. It does not have sufficient provision to tackle the digital economy. For example, companies use the ‘network effect’ to exploit value gained from users. However, they avoid taxation by concentrating the businesses generating income in places allowing easier transfer of profits.

This research has found that the inability to tackle taxation issues arising from the digital economy has led to tax base erosion issues. Profits from cross-border digital businesses are not captured. The unilateral regimes have divided the nations. Countries are not able to commit to a consensual, enforceable taxation agreement. The absence of a uniform, consensual taxation regime or agreement can also lead to taxation discrimination or arbitrariness practices by states. This was found with the UK’s DST that was held discriminatory against US companies and inconsistent with international tax rules.

One possible solution could be taxation based on location of the activities and where value is created. This approach is found in the UK’s Corporate Tax and the Digital Economy, and in statements of OECD and G20. However, as earlier mentioned, there is a lack of political commitment to address the problems. There is no consensus as to allocating more taxing rights to the jurisdictions where customers and value creation are. This means that no connection is established between revenues and the underlying activities. If only the connection is established through trade agreements and laws, it would have allowed a sales-based allocation of consolidated profits. This would have hopefully located the source of income in the digital economy.

The fact that the measures in place are unilateral and inconsistent, as was seen with the UK’s DST, will always present the risk of double taxation, administrative burden, uncertainty and instability. These risks were even seen with the DBCT and the two pillar plan of OECD. The main cause is in unilateral implementation. As seen with cash flow taxation, if unilaterally implemented, it will lead to double taxation and can disrupt existing international taxation agreements. With regard to destination-based taxation, a potential disconnect is found between substantive jurisdiction of a taxing state and a enforcement jurisdiction. This means there is always going to be administrative and legal issues if states do not commit to and form a consensual taxation regime. OECD also supports this view when it observes that the national and international taxation regimes need a specific and consolidated tax regime to deal with the digital economy. OECD also focuses, through the pillar one plan, on the location that has the business activities and generates profits substituting the element of physical presence. This plan will be effective only when it allocates the entire profits to the location of customers or users. This will avoid double taxation. However, it does not address the possibility of shifting profit to low-tax jurisdictions as the larger part of the profits will still be taxed through the existing rules. The pillar two plan also brings along compliance and administrative challenges with the issues related to fixing the minimum rates. If it is complied with, it will intrude into the state sovereignty.

The possibility of intrusion into a state’s sovereignty through a uniform international tax regime seems to be the key for the inability to tackle taxation issues regarding the digital economy. This research has found all the probable challenges associated with the topic in concerned. All the suggested modes of taxation regarding the digital economy are deficient in one way or the other. However, the research findings have a few common trends. There are two sets of different rules; lack of commitment to a consensual uniform tax regime as an implication of the two sets of rules; chances of unilateral rules that can be arbitrary; and complexity in creating a uniform rule as well as associated administrative and compliance issues.

Reflection and Conclusion

This research has enhanced my understanding about the taxation aspects of the digital economy. This research gave me better clarity on how the digital economy functions as different from a traditional business model. I could understand the challenges faced by governments and international institutions. This research has helped me understand to think over the different aspects in terms of the taxation implication arising from the digital economy. It helped understand the importance of analysing data and putting in a sequence so as to arrive at a critical understanding of the topic in hand.

On one hand, the digital business is fluid in nature with less physical infrastructure involved. On the other hand, the taxation regime is unable to apply the traditional taxation principles on the digital business. The main problem is found by this lack of consensus between the governments to arrive at a model that could address the problem in hand. Alternatively, it could also mean that it is not the lack of consensus but the lack of understanding or deficiency in the existing tools to tackle the problem. They are the barriers against taxability of the present-day digital economy and the reason why and how the multinational companies have been able to get advantages of the tax laws and the current policies. They have resulted in revenue losses to the economy of a country. The lack of a definite model that could be applied internationally has resulted in unilateral and inconsistent measures by states.

The two main causes for problems in taxation in the digital economy is the ‘network effect’ that is used by MNCs like Google and Amazon to exploit the data shared by users and create value for their business; and the fact that digital economy is agile and is borderless with no possibility for applying national tax laws. The constant problem has been the failure to determine permanent establishment of the business, whether it is determining the location of users, or the location of the source of the economy. In such a state, DSTs and DATs do not work effectively as they lead to double or multiple taxation and hampers market competition. This was seen with the UK’s DST that is argued to be an arbitrary and discriminatory digital tax regime.

The continued deficiency has enabled MNCs to exploit the loopholes in. the taxation regimes by transferring profits to a jurisdiction that enables them to pay less tax or no tax at all. In the absence of recognised agreed enforcement measures, MNCs will continue exploiting the taxation loopholes as had been happening since the 1920s even before the emergence of the digital economy. The solution to this problem of base erosion and profit shifting could be found in a combined elements derived from the model suggested by the UK and Italy that focuses on ‘a significant and continuous economic presence’; the DBCFT covering cash-flow component and destination-based register and tax profit; the EU model focused on tax profits in a location that has a significant interaction with users; and the OECD Pillar One and Pillar Two plans. The possible solution is two stage plans. The first stage will involve taxation of the profits wherever the business made irrespective of whether or not there is a significant interaction with the users. Respective jurisdictions where business activities occur can tax the business as per the national taxation regimes. This must ensure that they are not discriminatory that the national taxation rate must also apply to any foreign businesses. The second stage will involve a system of tax credit to be applicable at the location where the business is registered. Here, the states must have a consensual tax credit rate that the MNCs can apply. However, as in other bilateral, global and regional agreements, such consensus will be arrived at through trade negotiation where states will use their power to derive the maximum profit and benefits for their own MNCs.

The weak point of this research is mainly the lack of a technical analysis of the suggested modes of taxation and its implication on taxation regimes. Literature touched upon in this research also did not consider this aspect. This is a future potential of research. However, the main finding has been that the taxation challenge in a digital economy lies not in arriving at a taxation model, but in a political consensus. The current global economy is digital in nature and it is still emerging. New modes of business and its economic operations are being formed. The national and international institutions are also learning and struggling to meet the demands of these new modes. The major fear seems to be the compliance and administration of a new form of consensus and its components, just like that is seen with the IIR credits, formulaic substance-based carve outs, GloBE tax base, or top-down approach of the OECD’s two pillars plan. So far, the repeated observation is that the digital economy has disrupted the traditional taxation rules. The repeated concern is double taxation that will have both the new taxing right and enforcement provisions along with the already existing nexus and profit allocation rules. As long as these concerns exist, there will always be a consequential proliferation of unilateral digital services taxes and the risk of MNCs exploiting the gaps. Thus, if the concern is mainly exploitation by MNCs, the measure should be a temporary control measure to curb exploitation and prevent Base Erosion Profit Shifting. This can be done with agreements between the states, whether, bilateral or regional.

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