Tax challenges of the digitalisation of the economy

OECD © Flickr/Patrick Janicek

The Organisation for Economic Cooperation and Development (OECD) is tasked with developing a consensus-based solution to the tax challenges of the digitalisation of the economy by the end of 2020. Since the proposed reform of the international taxation system cannot be limited to the “digital economy”, the consequences of the proposals must be considered carefully.

Since 2013, the G20 and the participating countries discuss the taxation of the digitalisation of the economy in the “Base Erosion and Profit Shifting” project on OECD-level (Action 1). The discussion centers around the business models of digital companies. According to the OECD/G20, digital business models enable low effective taxation. For this reason, the OECD and the countries involved in the “Inclusive Framework on BEPS”, an association of 137 countries, work on a solution for the tax challenges of the digitalisation of the economy. A final report is due by the end of 2020. Currently two mutually complementary solutions are being developed: Firstly, a reallocation of taxation rights on corporate profits (Pillar 1) and secondly, a global effective minimum taxation of corporate profits (Pillar 2). In November and December 2019, public consultations on critical design features of the proposed measures were held in Paris. Further progress is expected to be made public by the end of January 2020.

Proposals will have significant consequences for all companies

The current proposals aim to reallocate the taxation rights between the countries in which the companies are domiciled and the market countries in which the users of the digital services are located. This would have significant consequences for the entire German industry since the economy as a whole is becoming digital and it is not possible to limit the proposals to the "digital economy".

Global consensus required to avoid unilateral action

The tax challenges of the digitalisation of the economy can only be solved by a comprehensive and globally coordinated approach. Unilateral action, such as already introduced in France and Austria or discussed in Italy, Spain and on EU level, should be avoided since unilateral measures lead to a fragmentation of the international taxation system which further exacerbates differences in tax burdens and tax arbitrage. The global consensus should maintain the fundamental principles of international tax law (such as the permanent establishment principle, taxation at the place of value creation, the arm's length principle) and merely introduce modifications in light of the digitalisation of the economy.

It must be ensured that the global consensus is enacted simultaneously and implemented uniformly in all participating countries. Any reform of the international taxation system must be clearly formulated and legally binding. For this reason, a multilateral treaty without any additional option for the signatories is required ("Super Multilateral Instrument").

Competitiveness of German industry must be secured

The reallocation of taxation rights and the implementation of a global effective minimum taxation of company profit must not lead to double taxation and additional administrative burdens for businesses. Since the OECD proposals may lead to a rise in taxation, it must be ensured that the German industry is not placed at a disadvantage in international competition.

Binding dispute prevention and dispute resolution required

The BEPS measures implemented to date have already led to an increase in international taxation conflicts. If the current OECD proposals are implemented, disputes will be almost impossible to manage without effective procedures. Therefore, the proposals addressing the tax challenges of the digitalisation of the economy must be designed with a focus on dispute prevention and dispute resolution. Measures that ensure binding dispute prevention (e.g. Joint Tax Audits) and dispute resolution (e.g. international mutual agreement procedures) constitute an integral part of any multilateral agreement.

Economic impact must be considered and locational handicaps avoided

The reallocation of taxation rights on corporate profits in favour of the market countries inevitably leads to a weakening of the position of the resident states such as Germany. The reallocation under Pillar1 could lead to a loss of tax revenue which could not be fully compensated by the proposed global minimum tax (Pillar 2). It is imperative that the economic impact of solution agreed on international level does not jeopardise the competitiveness of Germany as a location for business. Any revenue losses must not be compensated by substitute taxes or unilateral measures which go beyond the global consensus.