New digital economy taxation rules
In March, the European Commission issued two draft directives on the digital economy: the first one proposes to introduce a tax on digital services; the second one the concept of a virtual permanent establishment.
The draft directives are being presented several years after the OECD issued a preliminary report to address the tax challenges of the digital economy in which it described in detail individual digital economy models and stated that an agreement on how to tax digital activities between the member states was yet non-existent. The European Commission would have preferred a solution on the OECD level but since one is not in sight, it decided to propose a solution within the EU.
The first draft directive on the common system of a digital services tax introduces a special tax rate of 3% on income from certain digital activities. This is intended as a temporary measure until wider agreement can be reached on the concept of a virtual permanent establishment. This tax would be applied from 2020 on gross income from digital activities whose value creation is in large part dependent on their users and which are difficult to capture under the current tax rules. This would involve income from the following activities:
- sale of advertising space on the internet;
- digital intermediary activities allowing users to communicate with other users, thereby facilitating the sale of goods and services between these users;
- sale of data obtained from users’ information.
The tax would be collected by the member state in which users are located and would only involve corporations with total minimum worldwide revenues of EUR 750 million, of which EUR 50 million relates to revenues generated in the EU. By estimation, for member state budgets, the proposed 3% tax rate would generate a yearly income of EUR 5 billion. The EC proposes to establish a single contact point for filing tax returns and paying the tax. Revenues would then be distributed among the members states based on the number of users.
The second draft directive introduces a new concept of a virtual permanent establishment, which would arise based on its digital presence as defined by the directive (such as a web or mobile application, etc.) provided that at least one of the following criteria are met:
- excess of a threshold of EUR 7 million in annual revenues in a member state;
- more than 100 000 users in a member state in a taxable year;
- conclusion of more than 3 000 business contracts for digital services with business users in a taxable year.
The rules specified by the directive will apply to taxpayers in the EU; third-country taxpayers will be involved depending on whether the concept of a virtual permanent establishment is part of the appropriate double taxation treaty. The draft directive therefore recommends that member states adjust their double taxation treaties accordingly. The directive also expects that the digital services tax will be abolished once the concept of a virtual permanent establishment is in effect among the member states.
Both directives must be unanimously approved by all member states. Moreover, the relevant double taxation treaties with non-EU countries will have to be adjusted, which always requires the consent of the other contracting party. The future of both directives is therefore yet quite uncertain.