Tax avoidance by the world’s wealthiest is pervasive in the global economy. Rich individuals and corporations look for jurisdictions that have low or no tax on personal or corporate income, on dividends, on capital or R&D expenditure. Then they base their business activities there, at least for the purposes of taxation. The excuse is that such avoidance is legal. And it is. But public outcry has increased pressure on governments to close loopholes in the international tax architecture that make these schemes possible.
Estimates in the 2019 World Bank’s World Development Report suggest that multinationals shift 40-50 percent of their profits to jurisdictions with low or no taxes. Governments worldwide are deprived of billions in revenue, particularly in the largest markets such as Brazil, India, France, and the United States.
The OECD Base Erosion and Profit Shifting (BEPS) initiative, launched in 2013 and involving more than 115 countries, negotiated the most comprehensive package of measures to reduce profit shifting to-date. Certain measures, if fully adopted by governments, would better align profits and taxes with the location where value is created, and the package includes guidelines on transfer pricing. But solutions for the digital economy have been delayed.
Updating tax regimes for the digital economy is especially pressing. While policymakers ruminate over potential coordinated actions, the largest tech companies are amassing vast wealth. Several firms are starting to crowd around the $1 trillion mark in terms of market capitalization. As a result, some governments are moving quickly to find their own solutions. Extending indirect taxes such as value added tax or goods and services tax to the online delivery of goods and services, such as apps, games, software downloads, ebooks, music, and video streaming, has been the most popular approach so far. Such measures are in place already in Australia (10 percent), Colombia (17 percent), Egypt (14 percent), Japan (8 percent), Kenya (16 percent), Morocco (20 percent), and the Russian Federation (20 percent), among others.
Taxing profits directly is less straightforward. The virtual nature of digital businesses makes it easier to book profits in low-tax jurisdictions. What is more, digital firms often generate profit out of intangible assets that are difficult to tax, such as customer data. A number of countries have widened the definition of a permanent establishment to collect corporate income tax from companies that conduct business in a country without having a physical presence. This is what Israel did in 2016, extending corporate income taxes (25 percent) to foreign companies with a “significant digital presence” involving Israeli users. Kuwait and Saudi Arabia have adopted similar rules, and India released plans to incorporate the concept of “virtual economic presence” into its corporate income tax system starting in 2019. India’s amendment would build on its 6 percent levy on digital advertising, which has been in place since 2016.
In Latin America, Uruguay is breaking new ground. In 2017, the government adopted a law extending the collection of both value-added and income tax to foreign digital companies whenever consumers are in Uruguay. The rules apply the value-added tax (22 percent) and non-resident income tax (12 percent) to companies providing online services, such as Netflix, as well as platforms (“online service intermediaries”), such as Airbnb.
The European Union also aims to incorporate virtual permanent establishment into corporate tax rules. Whether this proposal and the 3 percent interim levy will pass, however, remains to be seen. Tax matters require unanimous agreement at the EU, and several countries stand to lose under a reformed system. In the meantime, EU members with greater appetite for reform in this area—such as Hungary, Italy, Slovakia, Spain and the United Kingdom—look set to pursue measures unilaterally.
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