EC digital economy taxation report calls for adaptation of rules

The report makes recommendations ranging from simplifying tax laws to a fundamental review of transfer pricing rules.

EC President José Manuel Barroso said: “A strong and fast-growing digital sector is good for our economy, but we must also think about how best to adapt our tax systems to the online world.”

“I welcome the report by Vítor Gaspar and the expert group, which the Commission will now study with interest,” he added.

The report, co-authored by the seven members of the High Level Expert Group on Taxation of the Digital Economy and chaired by Vítor Gaspar, special adviser to the Banco de Portugal, was released on May 28.

The group responsible for the report believes that digitalisation is not just a challenge for tax systems, but an opportunity to move towards a better tax administration and less burdensome tax compliance rules.

“Complex, uncoordinated and fragmented tax regulations make it extremely burdensome, particularly for small companies and start-ups to operate throughout the EU and create a barrier for innovative technologies to spread rapidly,” said the 78-page report.

“The group believes that the most valuable contribution from a tax policy perspective would be a drastic simplification of rules and procedures to cut down red tape and allow entrepreneurs to focus on business rather than administrative compliance.”

EU Digital Commissioner, Neelie Kroes, echoed this point: "This is no longer about a digital sector, it's about an entire economy that's going digital. It is about creating the conditions for growth and jobs.

“I also welcome that the group is not just seeing digital as a challenge from a tax perspective, but also as a solution for simplification, transparency and innovation in the taxation area."

The report asserts that articles 8, 9 and 10 – the articles which concern transfer pricing – of the G20/OECD BEPS project are crucial to the success or failure of the initiative.

It singles out profit allocation to intangibles, namely intellectual property (IP) and profit allocation to business risks as particularly important in the context of the digital economy.

“The importance of IP, especially in the digital economy means that transfer pricing rules also allow a significant part of the aggregate profits of digital enterprises to be allocated to the underlying IP,” said the report.

“The Group considers it vital that transfer pricing rules consider the economic relevance and purpose of an intercompany IP transfer.

“The Group recommends the Commission and the Council to undertake a review of transfer pricing standards to enable tax administrations to ignore intercompany transfers of IP in extreme circumstances where there is a lack of economic substance and the creation of a tax benefit is the main purpose.”

The report also underlines concerns about current rules on profit allocation to business risks, which it says leave opportunities for businesses to arrange for risk to be borne mainly by one entity rather than another.

This then allows businesses to attribute financial consequences by tax characteristics of the companies in the group, rather than by economic realities.

“The fundamental review of transfer pricing standards mentioned above should also examine the feasibility of disregarding contractual allocation of risks and related attribution of profits amongst group entities if the risks are actually borne by the group as a whole and the actual allocation lacks economic substance,” said the report.

The report was well-received by EU Tax Commissioner Algirdas Šemeta: "A united EU approach to tackling tax evasion and a more favourable tax environment for businesses – digital and otherwise - have been our overarching goals in recent years,” he said. “I am pleased that the High Level Group very much confirms that this is where our energy and efforts must be focused in EU tax policy”.