On 24 March 2014, the Organization for Economic Cooperation and Development (OECD) published a discussion draft relating to addressing the tax challenges of the digital economy. This is Action 1 of the Action Plan on Base Erosion and Profit Shifting (BEPS). The discussion draft entitled “BEPS Action 1: Address the Tax Challenges of the Digital Economy,” sets out a discussion of the main features and the principal business models in a digital economy, the opportunities for profit shifting that can be offered by the digital economy, and some possible choices that can be made to deal with the tax challenges arising from the digital economy.

There are situations where a business can artificially segregate taxable income from the activities that generate that income, thereby shifting profits from one jurisdiction to another or keeping some profits out of taxation altogether. A digital business could avoid a taxable presence in a particular country, avoid withholding taxes, ensure low taxation on the recipient of funds, for example by using low tax jurisdictions,

Some characteristics of the digital economy may increase opportunities for base erosion in indirect taxation, through remote digital supplies to exempt businesses or by remote digital supplies to a multi-location entity.

Tackling the challenges of the digital economy involves adapting the tax laws to deal with the characteristics of digital businesses. The importance of intangibles in the digital economy and the mobility of intangibles under current tax rules give opportunities for profit shifting by digital businesses. The mobility of digital businesses and their users gives opportunities for avoiding indirect taxes. Taxation needs to be more aligned with the location where economic activities take place. The action plan on base erosion and profit shifting will aim to increase tax transparency and information exchange, risk assessment processes by tax administrations, and mandatory disclosure of aggressive tax planning arrangements.

Policy challenges raised by the digital economy include those involving nexus – the reduced need for a physical presence in a particular country. Attribution of value created from the generation of date through digital products is another perceived problem. New methods of delivering services and new digital products raise problems of characterization of income. In the realm of indirect taxation there is a problem of how to collect the indirect tax due from a digital transaction.

This publication is part of a number of discussion drafts that the OECD will be issuing in relation to the BEPS Action Plan with an invitation for comments to be sent in by interested parties. It is expected that the final report on Action 1 will look at several different choices, including those included in the current Discussion Draft and other possibilities that may be identified from the response to the Discussion Draft.