Taxation of digital services | Deloitte Nederland


Taxation of digital services

On 21 March 2018, the European Commission published two draft Directives that provide rules for future taxation of digital services.

17 May 2018

Digital taxation

On 21 March 2018, the European Commission published two draft Directives that provide rules for future taxation of digital services, i.e., goods and services supplied online. The current tax system does not adequately accommodate this. In many cases either no or not enough tax is charged - or tax is charged in countries where the actual profit is not effectively realised.

European Commission initiative

As part of its BEPS action plans, the OECD has been investigating for quite some time now how the tax regime should be adapted to provide for digital services, both for profit taxes and sales taxes. As yet, the OECD has been unable to adequately solve this – mainly because of the great disparity in interests of the various countries. Apart from the OECD, the EU also started addressing the issue and this has resulted in the European Commission publishing the two draft Directives referred to above. It is certainly not a given that they will produce any tangible effects, as they will require unanimous endorsement by the Member States. Right now, this is still a question mark but the direction this will take should be clear soon.

Core problem

The core problem can be summarized as follows: the sales and profits of companies mainly trading online (e.g., Google and Amazon) are mostly allocated to countries where they have relatively few operations and where profit tax rates are low. Conversely, hardly any or no profit tax at all is paid in countries where the sales are largely realised, simply because these companies have no tax residence there. And even if they do, it remains to be seen how the profits should be allocated those countries. Think, e.g., of the case where only a server is located in the respective country, or only a distribution centre for goods that are ordered in another country via a server. In such cases, “correct” allocation of profits is not a cut and dried case.

Basic assumptions draft Directive

The draft Directives are based on the assumption that profits should particularly be taxed where the value is created. According to these proposals this is the country where the sales are ultimately realised, i.e., where the ultimate customers reside. These customers can be consumers and companies alike. Under the traditional tax rule the company selling the services or goods also has a physical establishment (a branch office) in such a country. Any profit is then allocated to his branch, which profit can subsequently be taxed in that country.

The thing is, in the digital world there is no branch office in the country were the customers reside, which makes taxation in that country impossible. The EU wants to tackle this problem - and the OECD basically wants to do the same - by the introduction in legislation and in tax treaties of a so-called fictitious branch office or, in tax jargon, a fictitious permanent establishment. In short, a sound fictitious branch office is involved if digital services are offered or deliveries are performed in a country. The country where such a fictitious branch office is located - tax lawyers call this a fictitious permanent establishment - will then have the power to tax. Such taxation will obviously be allocated to the company owning the fictitious branch office, read: companies like Google. This requires the implementation of new rules to determine which part of the sales and the profits should be allocated to the fictitious branch office (transfer pricing rules). We already have such rules and although they are widely applied, they have not yet been aligned to the digital economy and need adjustment.

Digital services tax

Unsurprisingly this is quite a sweeping operation, bedevilled by a host of pitfalls. It will surely take some years before this set-up has been rolled out across the world. On top of this, countries disagree about the contents of its design, and sometimes they are even at odds about whether it is even desirable to have any rules at all. Since the EU, in particular, wants to get this over with, it has come up with a temporary alternative: the Digital Services Tax. This DST would need to bridge the period before the fictitious permanent establishment can be rolled out worldwide.

The DST essentially taxes 3% of the sales generated by a company providing digital services and products in a Member State of the EU, provided certain conditions are met. In this respect, the company is not required to have its registered office in the Member State where the services and products are supplied. This is not a VAT style of levy, as that is due for each separate supply. The DST is a tax on the gross annual revenue: hence, items such as costs cannot be deducted and neither can any tax levied earlier on. If the revenues are subject to a profit tax, too, this DST would have to be deducted as a tax-deductible item. It should be clear that the DST is thus levied in addition to the VAT levied in the Member States. All companies selling digital goods and services and operating in the EU are subject to this tax. This is subject to such companies generating worldwide sales of at least EUR 750 million, while the digital supplies taking place in the EU should at least be EUR 50 million.

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