Cross-border taxation of digital transactions presents many challenges to countries and multinational companies. Some countries have acted unilaterally to impose digital taxes, while international organizations have been working to develop multinational approaches. Given the nature of the challenges and the currently fragmented solutions, the Association of International Certified Professional Accountants is asking policymakers and multinational organizations to cooperate in developing global approaches to the taxation of transactions in the digital economy.
On Oct. 23, the Association issued a policy paper, Taxation of the Digitalized Economy, making recommendations. The policy paper does not take a position on any of the issues it raises, but is intended to "educate, enlighten, and stimulate the discussion" on how the new digital economy should be treated and taxed globally.
The policy paper applies the Association's Guiding Principles of Good Tax Policy in discussing the issues. Those principles include equity and fairness, meaning that similarly situated taxpayers should be treated similarly; certainty in how a tax applies; effective tax administration, meaning costs for governments and companies should be as low as possible; encouraging economic growth and efficiency by not unduly impeding the economy's growth; and producing appropriate government revenues, meaning that governments should be able to anticipate a predictable and reliable revenue stream to fund their operations.
The paper discusses a number of proposals that are being developed by international organizations and proposals that have been implemented or proposed by individual countries. The Association emphasizes that several important principles of international taxation remain to be addressed in digital taxation and should be done in a coordinated manner.
The Association calls for these proposals to provide a means to avoid double taxation when income may be sourced to two jurisdictions. In the past, double taxation has been avoided by tax treaties and foreign tax credits. But taxes based on turnover, including value-added (VAT) type of taxes, or digital taxes such as the European Commission's proposed digital service tax based on gross revenues, operate outside the scope of tax treaties, and therefore relief from double taxation is not available. The digital service tax is a proposed 3% temporary tax on gross revenues from online advertising, digital intermediary activities, and the sale of data generated from user-provided information that the European Union would impose to tax gross receipts there. The tax is called a temporary tax because the EU is proposing to replace it when a more permanent international solution to the problem is found.
Because the digital economy involves a different type of business model, where economic activity may occur without any physical presence, traditional international tax concepts such as permanent establishment, physical presence, and significant people functions are not easily translated to the digital realm. Nonetheless, a number of countries have unilaterally begun to tax digital transactions, including virtual service permanent establishment rules in Saudi Arabia, the significant economic presence tests in Israel and India, a tax on digital transactions in Italy, and, in 2018, the United Kingdom's proposal to impose a corporation tax on digital businesses.
Many jurisdictions are proposing to tax digital transactions based on the user's location, but the Association does not think that is a feasible way to proceed. For example, determining where a user is located would require disclosing a user's IP address, which would create privacy concerns for users. Instead, the Association believes that a digital tax based on the residence of the provider of a digital good or service is predictable, thus allowing service providers to manage their affairs with some certainty.
The policy paper urges all countries to work within an international framework to develop a fair tax system for the digital economy. It recommends that this involve adopting internationally recognized standards of the definition of a permanent establishment to prevent double taxation, providing competent authority relief to resolve controversies when income or value is taxed more than once, and adopting globally agreed-upon standards of taxing based on the provider's residency and not source-based taxation.