On 19 October 2018 the OECD issued a policy note on tax and digitalization. The policy note looks at the challenges to tax systems arising from the digital economy and the opportunities and risks presented. A review of the international tax rules to assess the impact of digitalization will be a significant task going forward. The tax policy implications are now central to the global debate on whether the international tax rules are fit for purpose.

Digitalisation and the international tax rules

Tax planning by multinational enterprises (MNEs) takes advantage of gaps in the interaction of tax systems to reduce taxable income or shift profits to low tax jurisdictions. The BEPS project included action 1 on addressing the challenges of the digital economy, which considered the challenges of digitalization to both direct and indirect taxation. Although progress has been made on dealing with profit shifting, the Tax Force on the Digital Economy (TFDE) has been consulting with business and the academic world to identify key issues and possible solutions.

In March 2018 the Inclusive Framework on BEPS issued the “Interim Report on the Tax Challenges Arising from Digitalisation” for the G20, analyzing value creation across various digitalized business models and describing the main characteristics of digital markets. Three characteristics are common to certain highly digitalized business models, these being scale without mass; reliance on intangible assets; and data and user contributions. These are likely to become more common as digitalization continues.

Reviewing foundational concepts in international tax policy

The interim report looked at the issues raised for allocation of taxing rights between jurisdictions (nexus rules) and the share of MNE profits that is subject to tax in each jurisdiction (profit allocation). The existing nexus rules may be outdated as an enterprise can be heavily involved in the economic life of a country but with a presence that attracts minimal or no taxing rights for that jurisdiction.

The profit allocation rules focus on functions, assets and risks of each entity. There is an issue as to whether the existing rules still produce appropriate results, even where all three characteristics are present.

In assessing digital transformation the Interim Report agreed that the first two characteristics of new business models (scale without mass and reliance on intangible assets) exist and are relevant for tax purposes, although they are also found in traditional business models. There is no consensus on whether the third characteristic, data and user contributions and their synergies with IP, should be considered as contributing to a firm’s value creation. Some countries consider that no action is need but some want action to take into account user contributions, while others consider that any changes should apply more broadly to the economy.

The Inclusive Framework through the TFDE has commenced the next phase of work to reach a consensus-based global solution by 2020, with an update to be provided to the G20 in 2019.

Other impacts of digitalization on taxation

The OECD is also looking at other elements of modern tax systems resulting from the effects of digitalization. Elements affected include the design of the tax system; tax administration; the rise of business models facilitating the growth of the gig and sharing economies; an increase in other peer-to-peer (P2P) transactions; the development of technologies such as blockchain; and growing data collection and matching capacities.

There are opportunities to improve the effective taxation of online platforms by improving taxpayer education and self-reporting; and to obtain tax data about transactions facilitated online by platforms. As technological innovation is continuing to develop tax administrations will need to closely follow the developments to identify new risks, challenges and opportunities raised by emerging technologies including distributed ledger technology such as blockchain. Tax administrations can therefore use digital tools to enhance the effectiveness of tax compliance activities and improve taxpayer services.