The OECD base erosion and profit shifting initiative, aimed at closing tax avoidance gaps in the international system, is meant to be inclusive. Today roughly two-thirds of the initiative’s members are emerging economies. Yet, as discussions expand to questions regarding who gets to tax what in the digital economy, it is becoming clear that the OECD is an unlikely forum for the task. Instead, institutions like the World Bank or the International Monetary Fund are the obvious conveners. These institutions have the global membership required for such decision-making.
The allocation of taxing rights in the international system dates back to a 1923 report of the League of Nations, which addressed double taxation issues as international commerce grew. The study identifies source and residence jurisdictions as having the greatest economic connections to the income to be taxed. Source countries have primary taxing rights over the income from sales, which usually takes the form of indirect taxes such as the value-added tax. Residence countries tax multinationals’ and employees’ income. Which jurisdiction “goes first” depends on the relative economic ties of the taxpayer, but the existence of a permanent establishment is a prerequisite for taxation on income.
The first question is whether digital platforms should pay taxes at all. The logic of taxation is that some services are most efficiently supplied publicly, so citizens give up some portion of their income to the state in exchange for their provision. Obvious examples include security, both internal via the police and external through the army, basic infrastructure, as well as judicial services that protect private property. Do digital businesses benefit from such investments in countries where they generate profit, even if they are not physically present? They do, hence they should pay taxes. For example, road or internet infrastructure must be available for many online companies to supply reliable services in a country.
The second question is where digital companies should pay taxes. As illustrated in the World Bank’s World Development Report 2019, the digital economy eliminates the need to have a permanent establishment in order to do business in a country. Companies can provide online services from abroad or profit from intangible assets such as software and intellectual property. Digital platforms generate income from the capital of others. Identifying where value is created is not always straightforward, particularly when it comes to the collection and monetization of user data. Digital companies can locate assets (and subsequently profits) in just one country (be it a tax haven or not), even though they are supplying goods and services via the internet globally. Little to no tax on the income generated goes to the government where consumers are located. Yet it is the consumers who make the transaction possible, so economic logic suggests some portion of the tax should be paid in their jurisdiction.
Governments on the source side are eager to establish a claim over revenues generated in their countries, with or without a permanent establishment. However, some have labeled the recent digital tax proposals of the European Union and United Kingdom to be revenue grabs, with no foundation in international tax treaties.
The final question is which institutions can credibly mend the global tax architecture. The OECD has extensive tax expertise to bring to this discussion and has shown early leadership. It has experience as a convening forum, too. But the OECD is an institution set up by the world’s richest countries to advance their economic prosperity. The fact that Brazil, India, and China are “key partners” of the OECD is helpful, but not enough to ensure a fair brokering of the global tax debate.
Without consensus on a harmonized approach double taxation may again become a problem, as it did a century ago. This is why the World Bank or the International Monetary Fund should step forward to take the lead, as globally representative institutions.