Businesses creating digital solutions for products and services need to consider the issues relating to tax

Businesses continually adapt their products and services to changes in market demand in order to remain competitive and in the game, by adding technology features (like connectivity, apps and cloud solutions) to meet increasing customer expectations. Digital solutions generate new streams of income and can also reduce costs, and this incremental value they generate will become liable to taxation. Tax is therefore an important issue for businesses to consider when developing their digital offerings.

Over the past few years, a Swiss multinational group (“Swiss Group”) that develops and manufactures industrial solutions has been adding technology features to its physical products in order to meet customer demands and secure its leading market position.

Its products are now offered with connectivity features and a range of software applications in a cloud environment, improving product performance and providing customers with the added benefits of data analytics. Swiss Group also has a reasonably high expectation that its technology offerings will increase significantly over the next few years.

Swiss Group approached Deloitte for tax advice, as it was preparing to set up a digital platform for the worldwide distribution of its software applications to customers. Its main concerns were to understand how other multinational groups are structuring their digital platforms, which distribution model is the most efficient from a tax perspective, which is the best country for setting up a digital platform and what are the main tax consequences that should be factored into their decisions.

At Deloitte, our multidisciplinary team from different tax jurisdictions brought its experience to the task of addressing our client’s concerns. It explored different digital distribution models (centralised, regional and local) and the main pros and cons of each from a tax perspective. The following issues were among those we considered.

The first important decision for establishing a tax-efficient digital business is the choice of location for the business, which depends on factors such as corporate tax rates, tax treaty networks and foreign tax credit opportunities. Either one or multiple locations may be the optimal solution, depending on the destination region and distribution model.

When the creation of value shifts from traditional product manufacturing to digital solutions, transfer pricing policies should be reviewed and adapted, to ensure that profits are allocated to the new areas of value creation.

There is a worldwide trend towards taxing profits in the jurisdictions where customers are located. This is happening in several ways, which have tax implications for decisions about locating digital platforms.

Tax authorities worldwide have become increasingly concerned about base erosion and transfer pricing (BEPS) – tax avoidance strategies to exploit tax rules in order to shift profits from higher-tax to lower-tax or no-tax locations. In recent cases involving major digital companies, the tax authorities have claimed the right to tax profits in their local markets. It also seems likely that some countries will implement changes to multilateral tax agreements to enlarge the concept of ‘permanent establishment’.

The European Union has proposed the introduction of digital taxes, whereby member countries should make changes to their national legislation to tax profits from digital activities where the business has “significant interaction with users”.

Other issues, such as VAT multiple registration requirements and the customs valuations of digital services possibly included in the product price, were also analyzed by the Deloitte team.

The adoption by countries of tax changes into their local law is progressing at an uneven rate, and it is important to monitor carefully the evolution of legislation in relevant countries in order to anticipate their taxation impact.

An important first step for reviewing transfer pricing policy is a rapid assessment of profits and value creation

Some years ago a Swiss multinational (“Swiss Group”) acquired an American multinational group (“Acquired Business Unit”), in order to strengthen its leading position as a provider of technology solutions for industry. Swiss Group then set about the task of progressively integrating the Acquired Business Unit into its business operations.

As part of this process, Swiss Group asked Deloitte for assistance with the evaluation of the tax and transfer pricing arrangements of the Acquired Business Unit, since some intercompany transactions were still based on legacy transfer pricing policies.

At Deloitte, we considered that the best approach would be to start with a simple and quick evaluation of the entire value chain, to provide our client with an overview of the current situation. The aim was to provide a rapid analysis of how profits were reported and to compare this to the actual value drivers of the Acquired Business Unit.

To obtain quick results we applied Deloitte’s proprietary software, the Value Chain Assessment Tool (VCAT), to make an initial assessment of the transfer pricing policy of the Acquired Business Unit. VCAT produces a simple graphic comparison between the reported financial position and the drivers of value through each stage of the value chain.

Using VCAT we were able to provide our client with a preliminary assessment of the overall value chain and profit distribution within it, in order to identify potential risk areas relating to the legacy transfer pricing model.

The success of this approach called for a close relationship with our client and transparency of information, and to this end we ran two workshops. In one of these, we set out to establish the views of the client’s representatives about the main value drivers of the Group, in discussions regarding business strategy and operations. In the other workshop, we developed an initial perspective on potential risk areas identified from our VCAT assessment and possible solutions. To the extent that risk areas were identified, we provided our client with some ideas and suggestions about potential ways for mitigating risk and creating added value.

Our approach has provided Swiss Group with a perspective on areas of risk and potential opportunities for improvement, in a way that communicates the key issues easily to higher management. Most importantly, the discussions we held during the second workshop have led to proposed solutions for building a sustainable transfer pricing model for the Acquired Business Unit.

The exchange of account and financial information across borders with the objective of tax transparency is the new reality. Exchange of information is governed by several overlapping tax transparency regimes. The Common Reporting Standard (CRS) builds on the Foreign Account Tax Compliance Act (FATCA) and exponentially increases the complexity given its multilateral nature. FATCA and the Qualified Intermediary (QI) regimes continue in parallel requiring alignment. In combination with multiple jurisdictions, it is difficult to keep an overview of all relevant documents and perform cross-jurisdiction or cross-regime analysis.

There is no central location or 'golden source' for the key publications from local tax authorities, regulators, other governmental bodies as well as industry groups, so global financial institutions must constantly monitor numerous sources. These institutions must manage regulatory change, risks, run the business, and operate in a profitable way. While working with clients on advisory projects to implement FATCA and preparing for CRS, it became clear that clients needed a central repository of information related to the tax transparency regimes.

We collaborated with a global Swiss bank to develop Taxparency. Our team worked jointly with Deloitte Consulting to develop an innovative solution to the business challenge. Tax advice is usually rendered in the form of extensive memos and opinions. As we were working with a topic where an average of three documents were published each working day, we knew that traditional methods would not suffice.

The Consulting team developed a 'crawling' technology managed by our team of Tax experts, which crawls hundreds of internet sites daily, using only a fraction of the time needed with traditional methods. The client accesses the central repository via a user-friendly platform with easy search functionality, history of superseded documents, and receives alerts for updates on specific jurisdictions and regimes.

Taxparency significantly increased the efficiency in our client’s FATCA and CRS projects and reduced the risk of relying on outdated or superseded guidance. Taxparency automatically informs clients when any new guidance meeting their specified criteria is published, and clients are able to be more targeted with their research and implementation procedures. Colleagues are able to exchange documents, sources and requirements easily and project teams are able to more efficiently obtain targeted information such as reporting deadlines as well as receive notifications upon changes.