Going digital

Feb 18, 2019

Sunday Business Post, 17 February 2019
Businesses take a keen interest in any rule change which might impact on their income and how they collect it.  The same holds true for governments whenever changes are proposed at an international level on the cross-border tax system.

Details of such proposals materialised this week in the form of an OECD consultation on the taxation of the “digitalised economy”.  The OECD, under an initiative sponsored by the club of wealthy nations, the G20, has been looking at the issue of how to tax companies operating in the digital economy for quite some time.  The issue was a strand of their Base Erosion and Profit Shifting project (BEPS) which commenced in 2013. 

BEPS has driven many changes in the international tax landscape, not least the outlawing of some of the more egregious devices used by multinationals to move profits into low tax jurisdictions, or take them out of the charge to tax altogether.  However BEPS was inconclusive on how the digital economy might be taxed.  This consultation is part of a second attempt to work it out.  In effect it’s BEPS 2.

It's useful to bear in mind how the current tax system works to better understand what BEPS 2 is about.  At the moment, companies are taxed, like individuals, based on where they reside.  Sorting out where an individual resides is usually straightforward – you count the number of nights spent in a country and if a particular threshold is passed, the individual is deemed to be tax resident there.  It’s a question of fact. 

The tax residence rules for companies are little different, and have to do with where the company is incorporated, where it is managed and controlled, and the extent to which it might have a physical presence (like a shop) in another country.  These rules still work fine for the most part.  If I buy a product from a company in Ireland, the profits arising to the company on the sale of the product are taxed in Ireland, and that is the end of the matter.  But trade in a digitalised economy is not so straightforward.  Consumers in Ireland can buy products locally, or can order online from companies in almost any corner of the globe.  Not only that, some services can be purchased and delivered entirely online.  Do the tax residence rules for companies still give all the right answers for the exchequers of countries where the business is being done?

Some think not, and that companies should be taxed more by reference to where their markets are, rather than where they might have a management or physical presence.  That's an attractive proposition for larger economies with larger markets (and remember the OECD work here is sponsored by the larger economies).  For smaller countries such as Ireland, this line of thinking might not be such a source of delight.  However, the experience of BEPS 1 has not been negative for this country.  Corporation tax receipts are solid and make up some 18% of the country’s overall tax take, which is high by international standards.  There are lessons from BEPS 1 which may be usefully applied in considering the taxation of the digital economy under BEPS 2.

The first lesson is that countries which don't play ball with the OECD process quickly fall out of favour.  I've yet to see compelling evidence that BEPS 1 resulted in multinational companies paying more tax overall, but what is clear is that the manner in which the tax was distributed across countries changed.  Countries like Ireland which adopted BEPS initiatives quickly, thereby granting some certainty to companies and their investors, seemed to fare better.  Whatever else we do about the BEPS 2 process, we have to engage with it.

The second lesson is that even acknowledging when changes are necessary, individual countries will jealously guard their own interests.  No government will willingly surrender national revenues in the interests of achieving a nobler international tax system.  In practice, that means that changes to tax law as a result of BEPS have tended to be incremental rather than radical, and that in turn should mean that companies will be able to cope with many of the possible future outcomes. 

And finally, the approach of the US to BEPS 2 is critical.  I believe that the previous Obama administration may have been less enthusiastic about the BEPS process than the current Trump administration.  As one observer put it this week, albeit in a different context, “America First” doesn't necessarily mean “America Only”.  As well as reducing the headline corporation tax rate, the US Tax Cuts and Jobs Act of 2017 also carried out some heavy lifting towards eliminating cross-border tax arbitrage.  US Treasury officials certainly regard their new company tax rules as BEPS compliant.  Whatever steer or leadership the US provides to BEPS 2 will be key to its success or otherwise.

Perhaps the main concern that Irish businesses should have about BEPS 2 is the increased compliance burden to cope with future tax rule changes, and the costs that will inevitably follow.  On past experience, much of the additional work of dealing with cross-border corporation tax will be devolved by revenue authorities to taxpaying companies.  That overhead will offer little commercial benefit to the companies affected. 

If only for that reason I'd encourage any company with international trade of any scale to take a look at what the OECD is proposing, and offer some comment.  These proposals are of interest, both from a commercial standpoint and nationally.  It would be a shame if the BEPS 2 outcomes hamper Irish interests simply because we failed to engage.

Brian Keegan is Director of Public Policy and Taxation at Chartered Accountants Ireland