In September 2013 the Task Force on the Digital Economy (TFDE) was established with the goal to develop a report identifying issues raised by the digital economy and detailed options to address them by September 2014. The work that has been done has resulted in BEPS Action 1 - Addressing the Tax Challenges of the Digital Economy.
The digital economy cannot be seen in separate from the rest of the economy. Both are part of the same eco system and it can even be argued that over time the digital economy is becoming the prevailing economy. From a tax perspective it is not possible to ring-fence the digital economy from the rest of the economy. The digital economy brings about additional features as compared to the non-digital economy. These features include mobility, reliance on data and network effects. It is about the connectivity without borders between people, organizations and machines. Enablers of the digital economy are the internet, mobile technology and the internet of things.
According to the TFDE the digital economy does not generate unique BEPS issues but some of its key features can lead to increased BEPS risks. These risks are found to be relevant for work on other actions of the BEPS project. Accordingly the identified risks has been taken into account in the BEPS Actions as below.
- The list of exceptions to the definition of Permanent Establishment (PE) has been modified. It is agreed that each of the exceptions is restricted to activities that are otherwise of a “preparatory or auxiliary” character, and to introduce a new anti-fragmentation rule to ensure that it is not possible to benefit from these exceptions through the fragmentation of business activities among closely related enterprises.
In BEPS Action 7 – Preventing the Artificial Avoidance of Permanent Establishment Status, the exceptions list has been restricted to activities that are of an preparatory or auxiliary character. These are activities not being of an essential part of the business. Splitting up such activities in smaller parts or in other words fragmenting them to make them seem not essential parts of the business is taken care of with the anti-fragmentation rule.
- The definition of PE has been modified to address circumstances in which artificial arrangements relating to the sales of goods or services of one company in a multinational group effectively result in the conclusion of contracts, such that the sales should be treated as if they had been made by that company.
This means that sales agents acting on behalf of the parent company are seen as a permanent establishment if they are effectively concluding the contract locally. Even independent agents are seen as permanent establishments if they have some form or sort of exclusivity with the company they represent.
- Legal ownership alone does not necessarily generate a right to all or any of the return generated through exploitation of an intangible. Instead those group companies performing the important functions, contributing the important assets and controlling economically significant risks through the actual transaction (chain) will be entitled to an appropriate return.
This has been added to the Transfer Pricing guidance and is aimed at preventing empty companies holding title to one or more intangibles on paper and collecting the revenue in lieu of the companies having the expenses, carrying the risks and bringing in the knowledge. The aim is to bring economic value creation in line with returns.
Aligning Transfer Pricing Outcomes with Value Creation is the subject of BEPS Actions 8-10, which will be explored in a later article.
- BEPS Action 3 - Designing Effective Controlled Foreign Company Rules has been adjusted to include definitions of Controlled Foreign Company (CFC) income that would subject income that is typically earned in the digital economy to taxation in the jurisdiction of the ultimate parent company.
The measures of Action 1 have been incorporated in the work of the other BEPS Actions. No own measures are resulting from Action 1 and we can see Action 1 as a supporting action to the work on other actions. The work on BEPS Action 1 itself will continue as the digital economy continues to develop as well as part of the post-BEPS monitoring process. A report reflecting the outcome of the continued work in relation to the digital economy is scheduled for 2020.