In an era of rapid technological advancement, digitalization is reshaping how taxes are managed, presenting both challenges and opportunities for businesses worldwide.
Digital profit taxation – tax authorities need to adapt
The way taxes are handled is at a turning point as a result of rapidly advancing technology and digitalization. The methods and rules for taxing profits are undergoing significant changes due to the rise of digital economies. This shift challenges traditional approaches, and tax authorities worldwide are grappling with the need to adapt to a constantly evolving business landscape.
Anticipated changes regarding profit taxation ahead
The tax system in our fast-digitizing economy is a hot topic in both national and international discussions. The relevance of existing rules and concepts is questioned, while tax authorities and judicial bodies must adjust to the ever-advancing digitalization. The traditional methods of taxing profits are about to see substantial changes. Historically, countries used fundamental principles like residence, main income, and nationality to determine their tax jurisdictions. The choice of residence or establishment, i.e., the geographical location of income or taxpayer, aligns logically with the benefit principle. This principle states that anyone benefiting from collective services should contribute to their funding through taxes.
Digital presence
However, with the rise of digital and technological developments, entrepreneurs often operate in a market without physical presence. The essential question, both nationally and internationally, is whether 'digital presence' can be a criterion for tax liability. Concepts like 'significant digital presence,' 'digital permanent establishment,' and 'economic nexus' come to the forefront. Besides figuring out when digital presence leads to tax liability, assigning profits to this digital presence presents a significant challenge.
Tax Challenges; OECD's response to digitalization: BEPS 2.0 initiative
The OECD's 'Task Force on the Digital Economy' initiated discussions in 2018, followed by the G20/OECD Inclusive Framework on BEPS, suggesting fundamental adjustments to national profit taxation systems. These adjustments aim to provide a global solution to the impact of digitalization on profit taxation.
Since 2019, the OECD has presented additional ideas under the BEPS 2.0 initiative as part of BEPS Action 1: Tax Challenges due to Digitalization. A work program published in May 2019 includes possible measures to address fiscal challenges in a digitizing economy. BEPS 2.0 comprises two pillars.
Pillar One: Revising profit taxation
The first pillar, 'Pillar One,' seeks a balanced distribution of tax rights among states concerning corporate profits. The OECD aims for a common approach. Three models have been developed to involve multinationals providing services without physical presence in taxation.
The traditional methods of taxing profits are about to see substantial changes.
These models result in a greater allocation of profit to user or market countries. Pillar One revises the profit taxation system and its allocation. This impacts multinationals with an annual turnover of over 20 billion euros and profitability of at least 10%. According to new rules, profit is allocated to market countries where products and services are used. Work on this is still ongoing within the OECD.
Pillar Two: Global minimum tax rate
The second pillar, 'Global Anti-Base Erosion Proposal' (GloBE) or 'Pillar Two,' advocates for a global minimum tax rate of 15%. States retain their fiscal sovereignty, with a minimum rate as the lower limit. If the primary taxing country does not levy, other source countries have the right to tax up to this minimum rate. Pillar Two proposes a global effective minimum profit tax of 15% for multinationals with an annual turnover of at least 750 million euros.
EU directive implementation: The Netherlands' response
In December 2022, EU member states reached an agreement on implementing Pillar Two. The Netherlands implements the EU directive through the 'Minimum Tax Act 2024,' featuring domestic additional taxation (QDMTT), income inclusion (IIR), and under-taxed profit additional taxation (UTPR). This new tax is not part of the regular Dutch corporate tax but constitutes a separate self-assessment levy.
Combating abuse
A caveat to consider is whether this directive aligns with current European rules, especially the existing concept of abuse within the EU. A few years ago, the European Court of Justice provided a notably limited interpretation of the term 'abuse.' According to the Court, combating abuse is justified only when the scheme relates to "fully artificial or fictitious constructions set up solely to avoid taxation." Market-conforming conditions, such as at arm's length/prices, appear to exclude tax avoidance.
The way taxes are handled is at a turning point
This view is also followed by the EEA Court, specifically the Court of Justice of the European Free Trade Association (EFTA). They noted: "It must be established that transactions entered into at market-conforming conditions, and thus not fully artificial or fictitious constructions solely designed to avoid taxation normally due on profits from activities within the national territory (...)." This development raises questions about the application of existing national anti-abuse provisions and casts doubts on the sustainability of Pillar Two.
This era of tax reforms calls for a balance between digital realities and fiscal justice. The debate on digital taxation is complex and rapidly evolving, with profound implications for national and international economies. Shaping a new tax landscape that aligns with digital transformation is a challenge.
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