In March, the European Union (EU) took aggressive measures to ensure the governments of member states capture their fair share of tax revenue for transactions conducted over the internet, by proposing a 5% tax on digital companies. Shortly thereafter, the US Supreme Court’s decision in South Dakota v. Wayfair overturned 26 years of precedent to require online retailers to collect state sales tax no matter where a buyer is located.
These two very different approaches to taxing the digital economy will cause a seismic shift in the way online retailers around the world do business, and have created a host of pitfalls that these businesses will have to navigate.
The EU changes the game
Under current EU regulations, businesses are only required to pay corporate tax to a municipality when they have a physical presence in that location. That means that online retailers, large and small, who are able to reach customers virtually anywhere on the planet, are not bound to the same tax structure as brick-and-mortar stores.
In a bid to create a stronger link between where users are based and where profits are recorded, the EU has proposed an interim tax of up to 5% on companies that are part of the digital economy. The charge will apply to companies with total annual worldwide revenues of more than €750 million and EU revenues of more than €50 million.
The EU also plans to reform its corporate tax rules for digital activities by introducing the concept of a virtual permanent establishment, or taxable digital presence. This would kick in if an organisation:
1) Exceeds a threshold of €7 million in annual revenues in a member state;
2) Has more than 100,000 users in a member state in a taxable year; or
3) Has more than 3,000 business contracts for digital services created between the company and business users in a taxable year.
The financial thresholds suggest that US companies are the main targets of both proposals, though the European Commission denies it. But it unquestionably complicates matters for US multinationals, which are dealing with a heightened layer of tax complexity on their own shores as well.
US wrestles with sales tax
On June 21, the US Supreme Court overturned Quill Corporation v. North Dakota, a 1992 decision that exempted companies from the burden of collecting sales taxes in states where they have no physical presence.
That decision, made before the widespread acceptance and adoption of the internet, was a black cloud that loomed over states. When a customer in a state bought from an online retailer, the retailer would usually not have to collect that tax, and as a result, could elect not pay into that state’s tax coffer. As a result, according to some estimates, states missed out on roughly $17 billion in sales tax revenue each year.
Changing this law may sound like an easy fix, but there are 15,000 different taxing jurisdictions in the US, including city, county, and state sales tax authorities. Some large firms are set up with sophisticated tax software that can account for all these different variables – for example, if a buyer in New York purchased something from an online retailer in California, it would have to pay the applicable sales taxes in each qualifying jurisdiction. But it will severely challenge small-to-mid-sized firms. At Thomson Reuters, we estimate that just 8% of mid-sized US companies are set up to collect taxes at this highly localised level.
Taxing ‘big data’?
If this wasn’t enough to make a chief financial officer’s head spin, more digital tax questions continue to create potential landmines for multinationals around the globe. As part of BEPS initiative, the OECD has been wrestling with a variety of issues. One that has been on the its agenda for the better part of the last two years is companies’ use of the troves of data they collect about their users, and whether or not it is reasonable to tax it.
The EU estimates that the value of its data economy will be $739 billion, or 4% of the region’s GDP, by 2020, and that means the stakes are high for those that can profit from this information. Data in and of itself, without structure or context, may not have much value. However, when that data is layered with context about consumer purchase patterns and behavioural influences, in the way that companies such as Facebook, Apple, Amazon, Netflix, Google, Alibaba, Baidu and Tencent are doing, one has to wonder if that data itself is a taxable product.
The road ahead
As these issues are pushed to the forefront, it’s clear that multinationals are swimming unchartered waters that are infested with uncertainty. The tools used to combat and adapt will have to be just as cutting edge, and, at times, just as unprecedented as the challenges these firms face.
The emerging applications of artificial intelligence (AI) throughout the tax landscape seem to represent the most logical way to make inroads against problems we have yet to even imagine. It’s true that AI has emerged as the catch-all buzzword to solve the business problems of the future, but when we look at its use from practical applications across all business sectors – whether it’s uncovering supply chain inefficiencies or curbing wasteful spending – the road ahead begins to come into focus.
That’s not to say AI will take over the role of accountants or CFOs. Instead, this technology can be utilised to connect issues that were once too complex to draw any insights from; to find patterns in the uncertainty ahead and anticipate the unforeseen. When businesses – small-to-medium-sized retailers and huge multinationals alike – begin to deal with reconciling disparate tax rates, or taxing the tangible equivalent of air in the form of data, they will need as many of these insights as possible.
New challenges require new solutions, and with a global economy staring down a brave new world of digital taxation, business leaders will have to find a way to push beyond their boundaries more than ever before. For those who have the stomach to handle the risk, the reward should be twice as sweet.
This article was prepared by Brian Peccarelli, chief operating officer of customer markets at Thomson Reuters
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