Fiscal Boundaries: Why Digital Tax Is Inevitable

Many states, including Russia, cannot agree that the proceeds of digital giants are leaving the hands of national tax authorities. But the problem can be solved in different ways: take a risk and get more budget revenues or wait for international consensus, explains Svetlana Skripnik, partner of KPMG in Russia and the CIS.

 

The rapid development of the digital economy has shown the limitations of the traditional taxation system based on the principle of the taxpayer’s physical presence. It is no longer able to ensure a fair and efficient distribution of tax collection rights among countries.

The old system essentially leaves jurisdictions without tax revenues where multinational digital corporations (Facebook, Amazon, Google, etc.) receive significant income from a considerable number of users but do not have registered subsidiaries or branches since technology allows you to do business without them.

Redistribution Of The Base

The injustice of this situation has been recognized internationally. The OECD has been trying to tackle the problem since 2015 as part of the BEPS plan to tackle the withdrawal of income from taxation. The work is proceeding in two complementary directions: Pillar I and Pillar II. Their main goals: to formulate the very fair approach to taxing digital companies without reference to physical presence (Pillar I)  

To ensure that digital companies pay the minimum acceptable amount of taxes, regardless of the peculiarities of the tax systems of individual countries (Pillar II). In other words, we are talking about limiting the manipulation of local tax regimes in order to minimize taxes.

However, while OECD members generally agree on the fairness of this initiative, the elaboration of concrete measures is being delayed. It is very difficult to find a unified approach to the distribution of the taxable base of large IT companies that suits all countries claiming their taxes. It is assumed that the agreed mechanism will be presented this summer, but many governments did not wait for the end of the discussion and introduced a digital tax on their own.

It already operates in France, Spain, Italy, Great Britain, Austria, Hungary, Turkey. The rate averages between 2% and 7.5% of digital services revenue generated by users in each country. A number of states are planning to introduce this tax in the coming years. Russia is not going to stay away from this global trend, which, for example, was stated by Deputy Finance Minister Alexei Sazanov.

But so far, the Russian authorities have not decided whether to introduce the tax unilaterally now or wait for adopting the OECD package of measures to adopt the approach agreed within the organization. Each of the options has its own pros and cons.

Revenue Or Profit

It is possible to apply the practice of the mentioned European countries and introduce a tax as a percentage (3%) on the proceeds from the provision of digital services, which is now being actively discussed. This approach has several practical advantages. It is not so challenging to develop a calculation methodology, collect the necessary data, and establish control over the completeness of tax calculation and payment, especially if we start from the ratio of the number of local users to the global one.

This approach is used, for example, by France. Considering the experience gained by the pioneer countries increases the likelihood of successful implementation of the new tax and allows for more accurate forecasting of potential tax revenues. 

On the other hand, this solution comes with a price. It is no secret that taxation measures for digital corporations do not find much support in the United States, where most of the giants of this market come from. Defending national businesses, the United States is considering various steps in retaliation, including imposing substantial import duties on goods from countries that have adopted the digital tax. If these plans are implemented, Russian exports to the United States will be at risk.

The rapid development of the digital economy has shown the limitations of the traditional taxation system based on the principle of the taxpayer’s physical presence. It is no longer able to ensure a fair and efficient distribution of tax collection rights among countries.

The old system essentially leaves jurisdictions without tax revenues where multinational digital corporations (Facebook, Amazon, Google, etc.) receive significant income from a considerable number of users but do not have registered subsidiaries or branches since technology allows you to do business without them.

Redistribution Of The Base

The injustice of this situation has been recognized internationally. The OECD has been trying to tackle the problem since 2015. As part of the BEPS plan to tackle the withdrawal income from taxation. The work is proceeding in two complementary directions: Pillar I and Pillar II. Their main goals: to formulate the very fair approach to taxing digital companies without reference to physical presence (Pillar I) 

To ensure that digital companies pay the minimum acceptable amount of taxes, regardless of the peculiarities of the tax systems of individual countries (Pillar II). In other words, we are talking about limiting the manipulation of local tax regimes to minimize taxes.

However, while OECD members generally agree on the fairness of this initiative, the elaboration of concrete measures is being delayed. It is very difficult to find a unified approach to the distribution of the taxable base of large IT companies that suits all countries claiming their taxes. It is assumed that the agreed mechanism will be presented this summer, but many governments did not wait for the end of the discussion and introduced a digital tax on their own.

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It already operates in France, Spain, Italy, Great Britain, Austria, Hungary, Turkey. The rate averages between 2% and 7.5% of digital services revenue generated by users in each country. A number of states are planning to introduce this tax in the coming years. Russia is not going to stay away from this global trend, which, for example, was stated by Deputy Finance Minister Alexei Sazanov.

But so far, the Russian authorities have not decided whether to introduce the tax unilaterally now or wait for adopting the OECD package of measures to adopt the approach agreed within the organization. Each of the options has its pros and cons.

Revenue Or Profit

It is possible to apply the practice of the mentioned European countries and introduce a tax as a percentage (3%) on the proceeds from the provision of digital services, which is now being actively discussed. This approach has several practical advantages. It is not so difficult to develop a calculation methodology, collect the necessary data, and establish control over the completeness of tax calculation and payment, especially if we start from the ratio of the number of local users to the global one.

This approach is used, for example, by France. Taking into account the experience gained by the pioneer countries increases the likelihood of successful implementation of the new tax and allows for more accurate forecasting of potential tax revenues. 

On the other hand, this solution comes with a price. It is no secret that taxation measures for digital corporations do not find much support in the United States, where most of the giants of this market come from. Defending national businesses, the United States is considering various steps in retaliation, including imposing substantial import duties on goods from countries that have adopted the digital tax. If these plans are implemented, Russian exports to the United States will be at risk.

Joining the OECD initiative, given its global nature, does not pose such risks. But it may turn out to be less profitable for the Russian budget compared to the first option. It is difficult to talk about the scale of the lost income – for example, there is no reliable estimate of Facebook’s revenue in Russia. But the fact is that the OECD proposes to take into account as a taxable base not gross income from the provision of digital services, but profit calculated according to a rather complex three-tier model.

For business, this approach is undoubtedly fairer: the company will not be obliged to pay tax in case of losses. For Russia, a complex profit calculation may mean lower fees. Or, due to the complexity of the model, higher costs of tax administration. It should be borne in mind that the OECD package of measures will not be binding on the acceding countries; accordingly, the Russian authorities will have to adapt the proposed approach to our realities.

This promises to be a tricky process. Suppose the Ministry of Finance wants digital companies to do business according to the new rules from 2022. In that case, there are only six months left to predict possible fees, understand where and how quickly the OECD is moving, and initiate the corresponding law. 

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