Government Europa attended this year’s Masters of Digital event, where Pierre Moscovici set out the tax challenges of the digital economy and society ahead of the launch of the digital taxation package.
There is no doubt that the burgeoning digital economy and society opens up huge economic opportunities in the EU – but if its full potential is to be unlocked, new, modern and digital taxation rules, which ensure legal certainty and enable all companies to compete fairly on a level playing field, will be necessary.
Masters of Digital 2018, DIGITALEUROPE’s flagship yearly event, provided a valuable platform for businesses and policymakers alike to discuss this issue and more, among them the European commissioner for economic and financial affairs, taxation and customs, who took to the stage in February shortly before the European Commission unveiled its digital taxation package at the end of March.
Pierre Moscovici began his address by acknowledging the importance of welcoming digitisation if Europe is to remain economically competitive on the world stage.
“Let me be very clear,” he said, “digitisation has had a major transformative effect on economic fundamentals and is highly beneficial to our economy. Europe must embrace this opportunity and work with the digital companies that are spearheading this profound transformation. We see a strong digital single market as the key to maintaining Europe’s position as one of the world’s most important economies. Our continent has a very competitive industrial base and is a global leader in key sectors. The digitisation of its economy is crucial to maintaining this leadership.”
Is the digital economy all good news?
Moscovici acknowledged that fostering growth and successfully building a digital single market is not without its challenges – especially given the European Commission’s resolve to “preserve a level-playing field, to promote Europe’s general interest and to ensure fairness”.
Among these challenges is the fact that “digital companies are growing faster than the economy as a whole,” Moscovici said. Average annual revenue growth for the top digital businesses over the past seven years stood at roughly 14%. In comparison, revenue growth in IT & telecoms was just 3%, while for other multinationals it was a mere 0.2%.
At the same time, technology companies are commanding an ever-larger share of market capitalisation – increasing from 7% of the 20 largest stakeholders in 2006 to 55% in 2017.
“Do not get me wrong,” Moscovici said, “this is good news. I want the digital economy to reach its full potential in Europe. But these positive developments have also made some issues more salient and have exposed the outdated nature of some of our regulatory frameworks.”
What is taxation in the digital age?
The commissioner highlighted corporate tax frameworks as one example. “They were conceived in a pre-internet age and are confounded by today’s mobile, globalised and digital companies,” he explained. “They rely heavily on the concept of physical presence and are underpinned by the simple principle that profits should be taxed where value is created.
“Digitalisation has shaken this principle to its core. In a digitalised world, it can be difficult to pin down the value that has been created, how it has been created, and where it should be taxed.”
The result is digital profits being generated in one place and being taxed – if at all – in another, Moscovici said, noting that one social media company – which he did not name – “generates today well above half of its revenues from its international business; it offers services to consumers abroad and uses their data to further improve its services; it concludes contracts in foreign jurisdictions, taking full advantage of the infrastructure and rule of law institutions available there – yet only 5% of the taxes paid by this company accrue to these jurisdictions”.
Why is this a problem? For Moscovici, it comes down to an issue of fairness. The EU Single Market operates according to the principle that all companies, no matter their size or type, pay tax where they make their profits, but digitalisation naturally favours the digital. Traditional business models are subject to an effective tax rate of 21% – more than double that of domestic digitalised business models (9%).
This tax conundrum is also impacting on economic recovery. “As the digital economy overtakes the traditional economy in terms of market presence, member states face shrunken tax bases and dried up revenues… One of the lingering legacies of the crisis is high debt levels in many member states. To reverse that development, governments have to secure their tax bases.”
How to proceed?
The solution, according to Moscovici, is a “fundamental overhaul of our corporate tax systems” and, in March, the European Commission announced just that.
The digital taxation package, which comprises two separate legislative proposals, arrives among a growing frustration among member states at their “inability to tax the high volumes of digital activity within their borders” and, at the same time, a reluctance “amongst key global players to find concrete solutions”.
It has therefore been designed to “give impetus to the international debate and help push our global partners to act, while resolving the tensions in our Single Market,” Moscovici explained.
What do the proposals comprise?
Proposal 1: A common reform of the EU’s corporate tax rules for digital activities
The first proposal, which represents the commission’s preferred long-term solution, aims to ensure that online businesses contribute to public finances at the same level as traditional companies by reforming corporate tax rules so that profits are registered and taxed where businesses have significant interaction with users through digital channels.
Digital businesses will be deemed as having a taxable ‘digital presence’ or a virtual permanent establishment in a member state if they fulfil one of the following criteria:
- They exceed a threshold of €7m in annual revenues in a member state;
- They have more than 100,000 users in a member state in a taxable year; and
- They create over 3,000 business contracts for digital services with users in a taxable year.
The proposal is also expected to change how profits are allocated to member states so as to better reflect how companies can create value online, the ultimate aim being to establish a real link between where digital profits are made and where they are taxed.
Proposal 2: An interim tax on certain revenue from digital activities
A second, interim, measure has been designed to ensure that activities which are not effectively taxed now can begin to generate immediate revenues for member states.
It is also intended to discourage member states from adopting their own national approaches and avoiding associated risks, as Moscovici elaborated at Masters of Digital 2018.
“The aim of any targeted measure should be to address the most serious voids in our corporate tax systems when it comes to digital taxation, and to prevent unnecessary burdens for companies through a patchwork of national measures in our Single Market – especially SMEs,” he said.
“A combination of fragmented, un-co-ordinated national ‘patches’ and solutions would negatively affect the single market, raise compliance costs, and ultimately undermine competitiveness: that is the disorderly outcome we would very much like to avoid.”
This temporary solution will therefore apply only until comprehensive reform has been implemented and has inbuilt mechanisms to alleviate the possibility of double taxation.
It covers revenues created from activities where users play a major role in value creation and which are the hardest to capture under current tax rules. These include:
- Revenues created from selling online advertising space;
- Revenues created from digital intermediary activities that let users interact with each other and facilitate the sale of goods and services between them; and
- Revenues created from the sale of data generated from user-provided information.
The proposal allows tax revenues to be collected by the member states where the users are located and is applicable only to companies with total annual worldwide revenues of €750m and EU revenues of €50m. In this way, smaller start-ups and scale-ups should not be affected.
According to the commission, some €5bn in revenues could be generated for member states every year if the tax is applied at a rate of 3%.
Where next?
As Moscovici acknowledged at Masters of Digital 2018, the questions surrounding digital taxation are numerous and complex, and finding practical solutions that work for everyone will demand input from a range of stakeholders. The digital taxation package is a crucial and long-awaited step in this process, and one which the commissioner is confident will make a lasting contribution to the digital economy and society.
“With our proposal on the table, the EU will fully assume its leadership role: an EU that is united, ready to propose ambitious solutions at an international level.”
