Corporate tax and the digital economy Response by the Chartered Institute of Taxation

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1 Corporate tax and the digital economy Response by the Chartered Institute of Taxation 1 Introduction 1.1 We refer to the government s position paper on Corporate tax and the digital economy published in November We welcome this update of the government s thinking and the opportunity it provides to respond and continue to contribute to the ongoing debate in this difficult area. The CIOT was pleased to have the opportunity to meet with HMT and HMRC on 29 January 2018 to discuss this position paper and our comments below build on the discussions at that meeting. 1.2 The CIOT has been involved in this debate since the digital economy was identified as an action point of the G20/OECD BEPS project in 2013 and has engaged with the OECD and the EU Commission, as well as with the UK Government since then. 1.3 As an educational charity, our primary purpose is to promote education in taxation. One of the key aims of the CIOT is to work for a better, more efficient, tax system for all affected by it taxpayers, their advisers and the authorities. Our comments and recommendations on tax issues are made solely in order to achieve this aim; we are a non-party-political organisation. 1.4 In our view, objectives for the tax system should include rules which translate policy intentions into law accurately and effectively, without unintended consequences. The tax system should aim to provide simplicity and clarity, so people can understand how much tax they should be paying and why, and also to provide certainty so that businesses and individuals can plan ahead with confidence. 2 Policy articulating the issue 2.1 We welcome the clarity in the government s position paper around the issues and the problem that is to be addressed, as well as the explanations of what is not intended to be within the scope. It is clear that the increasing and pervasive nature of digitalisation across the majority of businesses and, therefore, the economy presents unique and

2 new challenges for tax policy makers in seeking to address the perceived imbalances that arise. 2.2 We also welcome the commitment to the existing principles of the international tax framework and, in particular, the principle that a multinational group s profits should be taxed in the countries in which it undertakes its value-generating activities. 2.3 There are many difficult and fundamental questions which have to be addressed when considering how to tackle the challenges arising from the digitalised economy and whether, as the position paper notes, the current international tax framework is able to take account of the differences in how certain digital business models operate and generate value. 2.4 Conceptually, we can see the case that in certain and limited circumstances, new value indicators, may have been created by digital innovation, and user participation on platforms where such participation is central to the business model could be such a circumstance. However, we take the view that even in these cases, the overwhelming bulk of value creation would be represented by the long term investment in the platforms themselves, and this is where the vast majority of profit and taxing rights should be allocated; the attribution of profit to user participation will always be small, and once divided between all jurisdictions where users participate, it will not represent a major source of income for governments in those territories. 2.5 We also take the view that defining what should give rise to such profit, and attributing profit is a complex exercise, and there are no easy metrics, such as data usage or revenue. 2.6 The CIOT considers it is important to arrive at a long term multilateral solution to this issue. The challenges should not be underestimated, and many of these are identified in the position paper particularly around identifying the businesses which are to be within the scope of any changes. Time should be taken now to investigate and consider the difficult and complex questions to help ensure that unintended consequences are avoided. 3 Multilateral action 3.1 It is our view that multilateral action across the globe is essential. It is unfortunate that a number of countries have already introduced unilateral and uncoordinated domestic measures aimed at tackling the digitalised economy. We understand that different countries have different aims and objectives in relation to the digitalised economy, but this is inevitably leading to less alignment of tax bases globally. Unilateral actions by countries inevitably lead to double taxation and a significant compliance burden for businesses and, consequently, stifle economic growth and innovation. There is also a negative impact on the perceived competitiveness of countries introducing such measures. 3.2 Consequently, we strongly encourage the UK government to seek greater and early consensus at an international level that the problem to which a solution is sought is along the lines of that set out in the position paper and to seek a commitment that these issues will be tackled globally. 3.3 In addition, it must be noted that the current international taxation framework is undergoing significant change as the BEPS minimum standards and P/tech/subsfinal/CT/2018 2

3 recommendations are implemented across the globe. Whilst these aim to encourage consistency, it remains to be seen how this will turn out in practice. However, we expect that the BEPS actions being implemented will go a long way towards mitigating the effect of mismatches and missing elements of the international tax system that some highly digitalised businesses may have been able to take advantage of. We suggest that these changes should be given time to be fully implemented and take effect throughout the international tax system before conclusions are reached in relation to any further changes that may be required to address the digitalised economy specifically. 3.4 In addition, ongoing consideration of the issues should include an analysis as to what form of tax is most appropriate to tackle the digitalised economy, with a balance needing to be struck between tax on corporate profits and consumer taxes. The question of how profits may need to be attributed amongst different enterprises will also need to be considered and we note that the OECD s thinking in this area is also something that continues to develop. 4 Value of user participation 4.1 As noted above, we agree that the international tax system should focus on value creation. We note the approach in the position paper of identifying activities user participation as being a new key identifier of the value creation that is being targeted. Conceptually, we understand that argument, and can see that it can be distinguished from factors such as size of market which are not seen as value indicators requiring profit attribution. However, given the range of different business models and the changing economy we think it will be extremely difficult (if not impossible) to design the rules so that they capture the intended targets without also drawing in businesses that are not intended to be effected. In our meeting we discussed that there are probably a very limited range of businesses where users (as opposed to customers) lead to value creation possibly the only examples being those identified in paragraph 5.5 of the position paper? 4.2 We also continue to believe that the fundamental question to ask is where value is created, and not have value ascribed automatically to metrics such as data, its creation and exploitation. We are concerned that many of the digitalised economy proposals could represent a potential change in direction. The concept of widely attributing profits to the point of sale or market or customer base for a product would be a fundamental shift in approach to the taxation of profits which would undermine the Transfer Pricing Guidelines, and could negatively impact the countries supporting growth and value creation. 4.3 As we discussed at our meeting, it will be exceptionally difficult to devise rules or guidelines to ascertain the value that is created by user participation. In considering how this might be achieved, there are a number of points that should be borne in mind: (i) (ii) (iii) (iv) There should be a transaction that monetises the value, otherwise it is debatable whether value is ever created; The transaction might not be in the ordinary course of the business; it might, for example, be a disposal of the entity or business; If the rules do not wait for a profit to arise, any tax charge will be a dry tax charge; If it is accepted that a profit must arise, then either explicitly or implicitly what is being taxed is an allocation of that profit; P/tech/subsfinal/CT/2018 3

4 (v) Profit allocation is already dealt with on an international level, and consequently any changes to it should also be done at an international level, which is why a multilateral solution should be pursued. 4.4 In addition, at our meeting we discussed that we were sceptical of the extent to which value is really created by users, as opposed to, say, the writers of the algorithm analysing the use. 4.5 It cannot be assumed that wherever users provide content/data that it has value. In many cases the raw data does not. Even where it has some value that is often minimal until that data is analysed. At this point, the data is likely to become a more conventional IP asset such as a brand or a client list or know-how. If user value is to be used as a distinct factor in profit apportionment, will it need to be disaggregated from the value it adds to, say, a trademark, name or image rights? 4.6 It is clear that valuing any user input is going to be very difficult and result in considerable controversy. The position paper suggests that it might be possible to use a simple proxy for value generation such as monthly active users. We do not think that this would result in a fair assessment of value because the value of each user s contribution is going to vary considerably between businesses and even within the same business over time. In addition, there are a number of other factors which feed into the number of users. In particular, value generated by user participation will only arises after what are typically long term, continuous and very substantial investments in new and innovative technologies and use of technology. Without continuing investment, numbers of users will rapidly fall. This investment is where the overwhelming bulk of value is created, and this is where profit and taxing rights should be primarily allocated; any amount allocated to user participation will always be a small fraction of the total. 5 Scope of rule 5.1 The position paper says that the new provision is intended to apply where user participation is central to the success of the business. We suggest that it will be very difficult to determine what is the business for these purposes. We understand that this is intended to look at the relevant digitalised business models to which the user participation is relevant. Paragraph 5.5 of the position paper provides a helpful summary of some possible key features of business models to which this may be applicable. However, applying these concepts to identify specific entities and/or groups within the wide variety of legal constructs of a multinational groups, overlaid with the different possible business models will make this very difficult. It will be necessary to consider business models which combine multiple elements: for example a small social media element which is part of a much wider business; what about conglomerates? 5.2 It will also be very difficult to define the scope of the rules so that it only includes the intended businesses and does not inadvertently catch other businesses. A rule that is too wide in scope will impede growth and adversely impact competitiveness. To what extent is user participation required for a business to be within the rules. For example, if an engineering business collects data from its customers and uses this two-way interaction with its customers to improve its product, is that sufficient user participation which is generating value? Nearly every business seeks customer feedback and to an extent this is valuable provided that the business uses the information wisely to improve its product and, therefore, generate increased profits going forward. P/tech/subsfinal/CT/2018 4

5 5.3 We remain of the view that it will be very difficult, if not impossible, to identify digitalised businesses to which any new rules should apply because of the pervasive nature of digitalisation within the majority of businesses. The undesirable effect is likely to be rules that apply to many more businesses than the intended targets and those most adversely effected will not be the largest digitalised businesses whom the measure is aimed at, but smaller businesses; these businesses will have to spend time and money ascertaining whether or not they are in the rules and incurring compliance costs for relatively low taxable amounts. Tax authorities will, of course, face similar costs. 5.4 It is important to recognise that digitalisation is a main driver of innovation and growth and this should be encouraged. Changes to taxation should seek to ensure that this innovation and growth is not discouraged or inhibited by double taxation, or the fear of double taxation, and seeking to prevent double taxation should continue to be a fundamental aim of work in this area. 6 Interim measures 6.1 We are very sceptical about the wisdom of interim measures. Firstly, we would be concerned that any such measures, although intended to be for the short term would, in the end, stay for the longer term. In this regard we would note that a short term measure is likely to be a blunter tool than a fuller developed long term solution and therefore catch more than it should. Unfortunately, it is likely that countries would not want to give up these interim measures, even when a better targeted longer term solution is agreed. Therefore we would strongly encourage the UK government to focus its efforts on a longer term solution. 6.2 In any event, the shorter term measures suggested in the position paper raise significant concerns in their own right. Many of these concerns are highlighted in the position paper but the challenges of these should not be under-estimated. In addition, short term solutions would only add to uncertainty for taxpayers and create administrative burdens for businesses and tax authorities especially in light of the ongoing work on BEPS. 6.3 At our meeting we also discussed the proposed royalties withholding tax measure which was announced at the Autumn Budget and is the subject of a separate consultation document. We will be responding more fully to that consultation document in due course. At this stage we would simply reiterate what we said at the meeting around whether, following the US tax reforms which occurred after this measure was announced, the proposals are necessary or worthwhile. It is not clear to us that, following the US tax reforms, these measures will raise any significant revenue for the Exchequer, but will result in significant costs for HMRC (as well as taxpayers) in terms of compliance, in addition to the significant Parliamentary drafting time that will be required. The expected revenue that may be raised should also be weighed against the negative impact on the UK competitiveness at this sensitive economic time. 7 Other considerations 7.1 The position paper contemplates more pragmatic approaches including the splitting of taxable income between market jurisdictions. With regard to this we note that the BEPS project began by considering such a global profit split approach, but rejected this in favour of an entity based approach based on the existing international tax P/tech/subsfinal/CT/2018 5

6 framework. Whilst it may merit some further exploration, we would envisage that any approach involving the splitting of taxable income would quickly run into the same difficulties as arose in relation to the discussions on the BEPS action points and also in relation to CCCTB. 7.2 A concept involving something akin to a permanent establishment that is something, an entity, to tax would ensure that it is profits rather than income that are being brought into account and so reduce the risks of double taxation. However, it would also be a significant compliance challenge for tax authorities and taxpayers if the result were to be multiple PEs in all countries where there are users. We suggest that if these proposals develop along these lines, including de minimis provisions should be kept at the forefront of policy developers minds to minimise the compliance burden on tax authorities and taxpayers. 7.3 In this context we also note that the position paper highlights the government s aim for the UK to be a global digital hub. An informative way of considering this issue may be to work from the position of a significant UK company which is a global digital hub, and operating some or all of the digitalised businesses of the type that the government considers should be in scope of any new rules. What allocation of its profits could/should properly be made to the jurisdictions in which its users are based? 7.4 The UK government could consider how unilateral measures of other countries might impact such a UK company in terms of how it would fall to be taxed in the UK and in those other jurisdictions. It would be useful to consider both unilateral measures that are currently in force, and also the effect if other countries were to adopt measures similar to those that have already been adopted by some countries (including the UK), for example, other countries have adopted rules similar to the UK s diverted profits tax. What would the UK government s approach to double taxation be if there were further proliferation of unilateral measures? Would the Exchequer be a net winner or loser? 7.5 In addition, one practical suggestion which the UK government could explore would be that of the UK and its treaty partners devising a new form of multilateral APA to resolve the taxation position of such a UK company operating a global digitalised business: this APA would be the result of transparent proposals put forward by the company based on their user interface and particular circumstances. The potential outcomes of such an exercise may be informative and help to clarify thinking around how the challenges may resolve themselves in practice. For example, clearly there are significant user bases in, say, India and China: would this result in a significant reallocation of profits to those jurisdictions from the UK? 8 Acknowledgement of submission 8.1 We would be grateful if you could acknowledge safe receipt of this submission, and ensure that the Chartered Institute of Taxation is included in the List of Respondents when any outcome of the consultation is published. 9 The Chartered Institute of Taxation 9.1 The Chartered Institute of Taxation (CIOT) is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of P/tech/subsfinal/CT/2018 6

7 our key aims is to work for a better, more efficient, tax system for all affected by it taxpayers, their advisers and the authorities. The CIOT s work covers all aspects of taxation, including direct and indirect taxes and duties. Through our Low Incomes Tax Reform Group (LITRG), the CIOT has a particular focus on improving the tax system, including tax credits and benefits, for the unrepresented taxpayer. The CIOT draws on our members experience in private practice, commerce and industry, government and academia to improve tax administration and propose and explain how tax policy objectives can most effectively be achieved. We also link to, and draw on, similar leading professional tax bodies in other countries. The CIOT s comments and recommendations on tax issues are made in line with our charitable objectives: we are politically neutral in our work. The CIOT s 18,000 members have the practising title of Chartered Tax Adviser and the designatory letters CTA, to represent the leading tax qualification. The Chartered Institute of Taxation 2 February 2018 P/tech/subsfinal/CT/2018 7

Royalties Withholding Tax Response by the Chartered Institute of Taxation

Royalties Withholding Tax Response by the Chartered Institute of Taxation 1 Introduction 1.1 We refer to consultation document on Royalties Withholding Tax published on 1 December 2017. We welcome the