On 13 April 2021 the IMF and World Bank tax conference on Minimum and Digital Taxation: Consensus or Divide discussed aspects of unilateral digital service taxes. The discussions covered the scope of the taxes, tax treaty issues and challenges for developing countries.
Unilateral approaches to taxing foreign digital services include:
• VAT/GST – taxation of digital users as customers;
• Income tax – tax on digital companies as suppliers;
• Withholding tax on payments.
There can also be a tax on digital access or toll tax which taxes the digital companies as customers.
Income within the scope of the unilateral DSTs varies greatly from one country to another. The scope of a unilateral DST often covers digital services such as sale of data derived from the users; revenue from advertising; activities of intermediaries; and sale of digital content.
An important issue is whether the tax falls within the scope of a tax treaty. This can be a problem because some DSTs are presumptive taxes based on a percentage of turnover.
Coordination between unilateral DSTs
Some countries will coordinate their unilateral DSTs with those of other countries. There is an issue as to how will they identify a foreign tax as a DST, because the scope and structure of unilateral DSTs varies.
Coordination of unilateral and multilateral DST
Some countries such as the UK have announced that their unilateral DST will be discontinued when an international consensus is reached on taxation of the digital economy (under Pillar One). It is not clear at what point the unilateral DST would be abolished or phased out. This could be when international agreement is reached; when the international provisions come into effect; or when the tax revenue starts to flow.
Some DSTs are enacted by extending the already existing consumption tax to cover imported services. These rules would not be overridden by a multilateral agreement on a DST as they are a part of the domestic consumption tax.
Issues for developing countries
One issue for developing countries is identification and registration of taxpayers. Simplified registration regimes are being introduced to lower compliance costs. The tax administration needs to identify the level of online traffic and the number of users. The domestic law must define the scope of the tax including the items to be covered, and there must be a way of defining the amount of digital service revenues subject to the tax.
MNEs are already challenging amounts due, under the relevant tax treaties. Developing countries must overcome the challenge of treaty disputes.
UN Model Treaty – Article 12B
The proposed Article 12B (Income from automated digital services) of the UN Model has resulted from input from developing countries, responding to concerns about the current PE rule which does not suit modern ways of doing business. Under Article 12B the source state would be able to impose tax up to 30% on the deemed net income derived from automated digital services.
The taxing right is given under domestic law and the tax treaty preserves that taxing right at international level. The treaty does not create the taxing right so countries will need domestic legislation as a basis for the tax. Article 12B and its commentary also give guidance on domestic legislation.
Withholding tax is important for developing countries because it is cheap to administer; and is less subject to abuse than profit-based taxation. There is however an option included in Article 12B for a profit-based alternative, although profit-based taxes are often abused by MNEs through profit shifting.
