International / OECD

A Review of Comments on the Tax Challenges of the Digital Economy

Barry Larking[*]

Issue: Bulletin for International Taxation, 2018 (Volume 72), No. 4a/Special Issue
Published online: 26 March 2018

In this article, the author examines the comments received by the OECD on action 1 of the base erosion and
profit-shifting project regarding the tax challenges of the digital economy.

1. Introduction
Those readers who have read the 500 pages of comments[1] on the OECD’s request for input (RFI)[2] on the tax challenges of the digital
economy – not to mention the 290 pages of the OECD’s final report on action 1 of the base erosion and profit-shifting project[3] or the 500-
plus pages of comments leading up to that report[4] – will appreciate that this is a difficult area on which international consensus is unlikely
to be reached swiftly, if at all. It will also be clear that this is an important area, possibly a turning point for the international tax system.
A common theme among those comments is that raw digital data has no value until it is analyzed and processed. The same arguably
applies to the comments themselves. The purpose of this article is therefore to extract value from the comments by identifying some of
the main themes as well as some noteworthy individual comments.[5] This will necessarily involve a degree of selectivity and subjectivity.
This article focuses on the most recent comments; that is, those in response to the OECD’s September 2017 RFI. Note that the responses
to that request are not limited to academic policy views but include many insights from tax practitioners as well as organizations directly
involved with the business side of the digital economy. Comments may therefore be informed by the particular context of the organization
in question.

2. Why Was a New Public Consultation Needed?

It would have been reasonable to assume that, following the publication in October 2015 of the OECD’s final report on BEPS action 1 and
its overall conclusion that no immediate action was required, this would have been the end of the discussion, at least until 2020 when a
follow-up report was expected. It may, therefore, have been a surprise when no more than two years later, the OECD launched a new
public consultation on the same issue, having already announced an interim report, now expected in April.
While digitization is moving at an unprecedented speed, a cynic might argue that it was not so much its evolution during those two years
that prompted the OECD’s renewed action but the desire not to be outmaneuvered by the European Union, which was already working
on its own digital taxation plans (and meanwhile has announced its intention to launch a package of proposals).

3. Have the BEPS Actions Failed?

That depends on what the BEPS actions were supposed to solve. The Confederation of British Industries (CBI) was not alone in
commenting that “there is currently confusion on what the problem is to which a solution is sought.” The OECD clearly saw two problems
– one BEPS-related and the other more fundamental to the international tax rules as a whole that it described as the “broader challenges”
posed by the digital economy. The digital economy did not create unique BEPS concerns but could exacerbate them, according to the
BEPS 1 report. The OECD expected these concerns to be “substantially addressed” by implementation of the BEPS package, in particular
BEPS actions 3 (controlled foreign corporations), 4 (interest), 6 (treaties), 7 (permanent establishments), and 8-10 (transfer pricing of
intangibles).
There was a lot of support in the comments submitted to the OECD for the view that the BEPS actions would be enough to address all
problems. While it was generally considered too early to assess the full impact of the BEPS project, the Digital Economy Group (DEG)
pointed out that changes are already happening, such as the conversion of remote selling business models to local resellers in response

* Barry Larking is an international tax consultant helping organizations manage technical and policy developments worldwide (www.barrylarking.com). He is
also a principal with the MGroup (www.mgroupglobal.com). Email: Barry@barrylarking.com.
1. OECD, Request for Input on Work Regarding the Tax Challenges of the Digitalised Economy (2017).
2. OECD, Public Comments Received on the Tax Challenges of Digitalisation(2017).
3. OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 – 2015 Final Report (2015).
4. OECD, Compilation of Comments Received in Response to Request for Input on Tax Challenges of the Digital Economy (2014); and OECD, Comments Received on
Public Discussion Draft BEPS Action 1: Address the Tax Challenges of the Digital Economy (2014).
5. Reference to specific respondents’ input to the RFI is for illustration purposes only and does not imply agreement or otherwise with the comments made. Readers are
directed to the full text of the comments in question.

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 to BEPS action 7, and adjustment of functions and risk policy as well as IP onshoring in response to actions 8-10. Many commentators
took the view that any tax problems raised by digitization are problems that have long been inherent to traditional business models. The
BEPS Monitoring Group (BMG,) for example, notes that while “digitalisation enables cross-border sales without the need for the level
of physical presence required under tax rules for a PE. . . . this has already been the case for several decades in relation to services.”
Similarly, the National Foreign Trade Council notes the practical similarity between remote digital sales and a catalog sales business.
It comments that the data collected by remote digital sellers “is not fundamentally different from customer feedback or surveys used by
traditional companies.” A commonly repeated corollary of this view is that if new rules are introduced, they should apply to both traditional
and digital business models to avoid creating market distortions.
The OECD’s concerns regarding the “broader challenges” posed by the digital economy focused on “nexus, data and characterization”
regarding direct tax, as well as collection issues for value added taxes. Many of the comments submitted suggest that the real issue
they were addressing is that the digitization of the economy has led to a significant loss of revenue for market jurisdictions, and
those jurisdictions are having difficulties coming to terms with the new reality. As the Deutscher Steuerberaterverband explains, “The
international tax scheme is built upon a ‘classical’ view of an industrial economy where physical presence is the link to the place where
a company is taxed. With highly digitalized companies this tax base ceases to exist.”
In a similar vein, KPMG International notes that “the digital economy tax debate reflects the dissatisfaction by some countries with large
shares of the digital economy tax base concentrated in jurisdictions where business risk is managed and significant people functions
are performed.” The response, in the words of the International Alliance for Principled Taxation (IAPT), has been to look for ways to
“shift . . . taxing jurisdiction away from countries of development and production towards countries of consumption, without reference to
BEPS concerns.” Or, as KPMG puts it, “to revisit the long-established balance between residency-based versus source-based taxation.”
While the IAPT suggests that this issue is outside the scope of BEPS, others, such as Loyens & Loeff, place it in the context of the BEPS
mantra that profits should be taxed in the jurisdiction in which value creation occurs. The difficult question, they say, is how to determine
where that value is created.
The comments make clear that achieving international consensus on this will not be easy. This was summed up nicely by the United
States Council for International Business (USCIB), which pointed out that “there is only one ‘pie’ and if countries take a larger share of
the ‘pie’ on the basis of the market, they also must agree to relinquishing some of the ‘pie’ previously allocated to other functions, assets
and risks.” The Confédération Fiscale Européenne (CFE) also points out that shifting taxation to consumer jurisdictions could “adversely
impact smaller consumer economies (i.e. smaller countries)” (with the converse also by implication then being true). The Mouvement des
entreprises de France (MEDEF) agrees and cites France as one such economy. The University of Mannheim/ZEW notes a similar issue
for “developed countries with large economies relying on export [that] would lose substantial tax revenue.” Informa warns that absence
of consensus on this “is likely to lead to double taxation in many instances, as states where ‘production’ takes place are unlikely to want
to compensate for over-taxation where sales are made.”
A recurring theme among the comments on this issue is that taxation simply on the basis of the customer location would be a radical
departure from the long-established principles of direct taxation and would not reflect value creation. In the words of the Chartered Institute
of Taxation (CIOT), “the value of [an] item . . . is not changed by its mere sale.”

4. Are New Rules for the Digital Economy Justified?

The OECD concluded in its BEPS 1 report that it would be “difficult, if not impossible, to ring-fence the digital economy from the rest of
the economy” largely because “the digital economy is increasingly becoming the economy itself.” No doubt to reflect this, the OECD’s
RFI now refers to the “digitalised economy” rather than the digital economy. This view is substantially endorsed by many of the comments
submitted in response. Some, like the CFE and the BMG, suggest a somewhat nuanced approach – perhaps reflecting public and political
perception of the problem – by targeting the “giant” internet firms. Not surprisingly, some like the Digital Economy Taxation Think Tank
(DET3) do not share this view. The BMG is one of several groups that suggested a possible quantitative threshold for taxing digital
business. They also point out that the U.K.’s diverted profits tax allegedly only targeted 100 large multinational enterprises.
While not recommending them in its BEPS 1 report, the OECD was in principle open to countries adopting targeted measures aimed
at digital business models. However, many of the comments caution against this for various reasons, even if those measures were
internationally coordinated. Some of these comments (discussed further below) are directed at the specific “solutions” put forward by the
OECD, while others are more general in nature. Regarding these general criticisms, it has been suggested that such targeted measures:

– create a competitive advantage for established firms and a corresponding disadvantage for new entrants (BlaBlaCar, Irish Tax
Institute);
– create arbitrary discrimination between traditional and digital business models (MEDEF, CBI);
– would be unable to keep pace with and adapt to developments in technology and the resulting impact on business models (MEDEF,
USCIB);
– would need a broad scope to be effective, which carries the risk of affecting unintended activity and creates uncertainty (the U.K.
diverted profits tax is a case in point, according to the CBI); and

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 – create a barrier to digital market entry for small, young firms and would generally inhibit innovation (Federation of German Industries
(BDI), BlaBlaCar, KPMG).

5. Why No Immediate Action?

Not only did the OECD expect the BEPS issues arising from the digital economy to be “substantially addressed” through implementation
of the BEPS package, but some of the “broader challenges” would also be “mitigated” by the BEPS package, in particular action 7 on the
PE exception for preparatory and auxiliary activities. The OECD did make recommendations on indirect tax issues; that is, that countries
should apply the principles of the international VAT/GST guidelines, that addressed certain aspects of VAT collection in the context of
remote sales. Three other options were considered by the OECD, but not recommended “at this stage.” The reasons given suggest that
the OECD believed it was sufficient to rely on the BEPS package or the VAT/GST guidelines.
These options were:

– a new taxation “nexus” in the form of a “significant economic presence”;

– a withholding tax on some types of digital transactions; and
– an equalization levy.
The first two had already been put forward in its 2014 discussion draft, and all three were worked out in some detail in the 2015 final report.
The “broader challenges” that these were intended to address related to “nexus, data and characterisation” of payments. Not only did the
latter aspects overlap to some degree, but the OECD also suggested that the three approaches were not necessarily mutually exclusive.
For example, a withholding tax could be used to enforce compliance with net taxation based on a significant economic presence, while
an equalization levy might be a means of attributing income to such a significant economic presence.
The RFI focuses in particular on these options and their respective advantages and disadvantages, and a large proportion of the comments
received is in response to that request. The vast majority of the commentators note disadvantages rather than advantages regarding
one or more of these options.

6. What Is a ‘Significant Economic Presence’?

The OECD suggests that a significant economic presence (SEP) (previously referred to as a significant digital presence) could be triggered
by a combination of revenue above a certain amount from remote sales into a market jurisdiction plus indicators of a “local” digital
presence such as domain name, platform or payment options, or user-related factors such as the number of monthly active users, online
contracting, or local data collection.
Allocation of profits to a SEP is the next tricky issue and the OECD considers both the possibility of adapting traditional profit allocation
principles (based on functions, assets, and risks) as well as alternative methods such as formulary (fractional) apportionment or deemed
profit-based methods. As an alternative, given the difficulties involved under both of those approaches, the OECD suggests applying an
equalization levy in combination with a SEP.

7. What Is a Digital Withholding Tax?

The OECD sees a withholding tax as fulfilling one of two possible functions: either a stand-alone gross-basis final tax to be withheld from
some payments made to nonresident providers of goods and services ordered online, or as an enforcement and collection mechanism
for the SEP option.

8. What Does an Equalization Levy Equalize?

The OECD sees an equalization levy as a way of taxing digital profits under the significant economic presence approach. The idea is that
this would avoid having to adapt existing profit allocation rules and, by making it conditional on the existence of a SEP, it would provide
“clarity, certainty and equity” and relieve the burden on small and medium-size businesses.
The OECD suggests that the levy would equalize the tax treatment as between foreign and domestic suppliers, and refers by way of
illustration to existing country practice in the context of insurance. But there are other views, such as that of the International Observatory
on the Taxation of the Digital Economy (IOTDE) that assume that the goal of a digital equalization tax would be to allow the market
jurisdiction to equalize the tax burden as between the “traditional” and “digital” economy.
The OECD suggests that the levy could be based on one of the following:

(a) all transactions concluded remotely with in-country customers (whether or not through digital means);
(b) supply contracts automatically concluded through a digital platform; or
(c) data and other contributions from in-country customers and users.

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 Alternatives (a) and (b) would be charged on the gross value of the goods or services paid for by in-country customers. A levy under
alternative (c) could be based on factors such as the monthly average users or volume of data collected.

9. Would a ‘Significant Economic Presence’ Work?

The general conclusion to be drawn on the basis of the comments received is that it would not. Problems are noted regarding both
threshold and profit allocation, with most criticism being leveled at the use of data. A commonly expressed view is that raw data has
no value – it is the analysis and processing that generates value. Moreover, as many point out, data collection is not a new activity not
present in traditional business models. Similar comments are made concerning the relevance of users. Regarding other digital factors
such as website traffic, mouse clicks, and so forth, Loyens & Loeff likens these to pre-19th-century window taxes that were abandoned
because of their arbitrary nature in measuring wealth.
Nevertheless, the comments are not universally negative. The CIOT, for example, suggests that “it is possible to conceptualise the
collection of data in a territory, and the deployment of the data back in the territory as part of the supply chain.” However, it follows this
with the caution that the “amount of value attributable is likely to be small in all sectors (compared to the analysis and organisation of the
data).” There is also some support for using data collection, by drawing an analogy with natural resource mining. For example, Ludovici
Piccone & Partners would equate significant “data-mining” carried out by MNEs operating in a digitized environment with extracting value
from oil and other natural resources. However, the analogy is also disputed. For example, the DEG suggests that it “fails to justify an
extraordinary allocation of taxation rights to the jurisdiction where users reside, any more than would be the case for purchasers of luxury
goods, high performance automobiles, or any other item.” The BMG supports the idea of a SEP based on the idea that value is created
through “closer and interactive relationships with customers.” Profit allocation, they (and Jeffery M. Kadet) suggest, could be done by way
of a profit split using users and operating expenses as allocation keys.
Several commentators pointed to the current difficulties of adapting profit allocation rules to new, extended permanent establishment
concepts as an illustration of the importance of tackling the SEP definition issue at the same time as the profit allocation aspects. On a
similar note, the Tax Executives Institute was not alone in recommending against further changes so soon after the BEPS project given
the additional uncertainty that this would create.

10. Is There Support for a Digital Withholding Tax?

Based on the comments received, there would be few hands raised in favor of a digital withholding tax. The OECD had already highlighted
various issues in its action 1 final report, in particular how to define scope, how to ensure compliance, the negative impact of gross
taxation, and possible conflict with EU and trade obligations. Many of the comments received raise similar points.
For example, while it was generally considered important to provide clear rules on what transactions should be covered, this was also
seen as particularly difficult to achieve. Some argued for a broad scope, to avoid distortions, while others, like the CFE, argued for
the opposite, to avoid overkill. Many commentators noted the impracticality of a withholding tax on business-to-consumer transactions
given the inevitable difficulties in ensuring compliance. Difficulties are also foreseen with business-to-business transactions, with several
commentators, including the Italian Banking Association (ABI), the BDI, and the USCIB underlining the practical difficulties in identifying the
relevant transactions and taxable parties, in particular for financial intermediaries if they were charged with administering the withholding.
While some commentators agreed with the OECD’s idea of a mandatory registration system, this was not generally seen as a practical
solution, the ABI predicting that it would require uniform procedures and standards that would be difficult to achieve internationally and
involve additional costs that would most likely be passed on to customers.
The heaviest criticism was reserved for what the OECD had already described as the “negative impact of gross taxation,” in particular the
inability of businesses with low margins to absorb a tax on gross revenue. Many commentators pointed out that this was a real issue (the
DEG gave cloud infrastructure services as an example of a low-margin business), in particular for young and emerging businesses that
either had slim margins or were in loss positions. The OECD’s solution for the low-margin businesses was to adapt the rate to reflect the
profitability of comparable domestic businesses, but as pointed out by the USCIB, this would create additional complexity and uncertainty.
For loss-makers, the OECD suggested a tax refund system, although even this would be inadequate in the joint view of the Association for
Financial Markets in Europe (AFME) and U.K. Finance, which backed up their view by pointing to the existing cumbersome and inefficient
reclaim process for interest withholding taxes. The practical impact, as noted by various commentators, was likely to be either that the
tax would be passed on to customers, or that businesses would exit the market (or not enter it in the first place). Concerns were also
expressed that a withholding tax was not in line with the BEPS principle of taxing profits where they are generated.
Several commentators agreed with the OECD’s concerns regarding potential infringement of EU rules, or trade obligations such as the
General Agreement on Tariffs and Trade or, in the case of services, the General Agreement on Trade in Services (GATS). The IOTDE
points out the potential EU law conflict of a withholding tax even when used, as suggested by the OECD, as an enforcement/collection
mechanism under the SEP approach. Apart from the possibility that rules targeting nonresidents could conflict with the EU’s fundamental
freedoms, various concerns were raised about EU state aid rules, in particular concerning possible carveouts, as well as infringement
of the EU’s VAT rules that prohibit EU member states from levying other taxes on turnover. This is clearly an area that needs to be
examined further.

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 11. Would an Equalization Levy Be Any Better?
Most of the concerns regarding withholding tax were considered equally applicable to the equalization tax option. This was particularly so
for alternatives (a) and (b) noted above, given that they would also be imposed on a gross basis. Another problem with an equalization
tax noted by many is the likelihood that it would be outside the scope of tax treaties, thus exacerbating the double taxation risks. Double
taxation had already been identified as a potential problem by the OECD, and this was a reason for it suggesting that an equalization
levy should be limited to “situations in which the income would otherwise be untaxed or subject only to a very low rate of tax.” The idea of
limiting the levy to “stateless” or low-taxed income was picked up by various commentators, such as DET3 and the CIOT, which suggested
it would also be appropriate for a digital withholding tax (albeit the CIOT recommended first waiting for the outcome of the BEPS package).
There was also a concern that limiting the tax to “digital” transactions under alternative (b) would, as the OECD itself and others such as
the Irish Tax Institute pointed out, create an incentive to choose non-digital ways of conducting the same business.
There was considerable opposition to alternative (c), which would apply the levy based on “data and other contributions gathered from
in-country customers and users.” Many of the concerns expressed on this alternative mirror those expressed in relation to a significant
economic presence, in particular regarding the use of data or other proxies to measure the creation of value. The concerns on this
alternative were summed up by NERA Economic Consulting as follows:
Such a levy would be completely disconnected from the results of the analysis of the value creation process within the company
concerned. Such a levy could also result in disproportionally high charges in certain contexts and would be negligible in other
contexts. We think that such levy would be both arbitrary and ineffective, and would result in radical distortions of the markets.
The IAPT took a similar view, stating that withholding taxes are “ill-targeted to ‘leveling the playing field’ between resident and nonresident
sellers.”

12. Are There Other Options?

The RFI specifically requested input on the unilateral measures introduced or proposed in relation to taxing digital business. Not
surprisingly, most of the responses on this aligned with the comments on the three options put forward by the OECD, given the fact that
most unilateral measures are variations on the same themes. KPMG adds that these measures lead to increased uncertainty, which in
turn “hinders decision making, limits innovation and investment, and broadly undermines the growth of international trade.” TEI highlights
a less obvious but equally important aspect of uncoordinated unilateral – measures in relation to the U.K.’s diverted profits tax:
The DPT in practice appears to be used as an opportunity to review an enterprise’s global activities in greater depth and seems to
proceed from the assumption that any activity within the country or sales made to customers within the country should be treated
as constituting a PE, whether or not the business is digitalized or conventional.
While not explicitly requested, various suggestions were made for alternative approaches. These included the following:

– adjustments to existing transfer pricing rules including revised profit-splitting rules (Maisto e Associati, Kadet);
– home state taxation (that is, taxing MNE’s solely in the ultimate parent jurisdiction) (BMG, Kadet);
– an alternative minimum corporate income tax based on the statutory tax rates in the countries in which the MNE operates or has a
significant economic presence, with disallowance of some payments (Tax Justice Network Israel);
– have regard to the existence of VAT when this is already imposed by market jurisdictions (MEDEF, CBI, Irish Tax Institute, TEI).

13. Concluding Remarks

The extensive input to the OECD’s RFI underscores the importance with which this topic is viewed by stakeholders. The diversity of
the comments points to the complexity of the issues and the likely difficulty of reaching international consensus. Equally, the responses
indicate the risks associated with both quick fixes and uncoordinated unilateral approaches. The OECD’s interim report will no doubt be
awaited with great interest by all concerned.

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B. Larking, A Review of Comments on the Tax Challenges of the Digital Economy, 72 Bull. Intl. Taxn. 4a/Special Issue (2018), Journals IBFD (accessed 21
March 2018)
© Copyright 2018 IBFD: No part of this information may be reproduced or distributed without permission of IBFD.
Disclaimer: IBFD will not be liable for any damages arising from the use of this information.
Exported / Printed on 24 July 2018 by IBFD.