Netflix is seeing the good, the bad and possibly the ugly of doing business in the EU. The streaming company benefits from the single market, namely being able to provide its subscription services to customers throughout Europe via one company, albeit being subject to different tax rules and charges in each European country it operates.
This has been highlighted in recent months with news stories regarding its tax liability in Italy and the UK, while it is subject to yet another different tax treatment in France. If this were a TV show, these events would just be the pilot episode.
Countries normally tax non-residents who have enough of a presence in the given country to be a permanent establishment (PE). If the presence in a country does not rise to the level of a PE, that country does not normally have the ability to tax the profits of the company (there are exceptions, such as the UK).
To level the playing field, many countries enter into double taxation agreements (DTAs) and these are usually based upon the OECD's model tax convention. This model convention defines what a PE is and if the relevant entity does not meet that definition, the DTA stops the host country from taxing the non-resident's profits. This does apply to the UK and hence a non-resident normally needs a UK PE to be taxable here, despite the domestic legislation.
To help with interpreting what a PE is under a DTA, the OECD also publishes commentaries to its model and many countries, this time including the UK, are then able to use those commentaries when applying DTAs.
The definition of a PE is set out in Article 5 of the OECD model and the commentary to Article 5 covers e-commerce. The commentary sets out that, where a non-resident has servers available to it in the source country, these can be a taxable PE, i.e. it has its own servers, or possibly dedicated servers in a third-party server farm and not just renting server space that could be anywhere.
Therefore, under international law, or at least the accepted application of DTAs based upon the OECD model, if a country can tax a non-resident that has a PE in its borders, the relevant DTA will not stop it. The key here is that the country must have the domestic legislation to raise the charge. DTAs divide taxing rights between the signatories, they do not create taxing rights, otherwise most of the UK's DTAs would allow it to levy withholding tax upon dividends despite the lack of any domestic law.
This must be causing Netflix some confusion. Media reports are asserting that Netflix has not filed a tax return in Italy (and presumably underpaid tax as a result) because it has enough servers and cables in Italy to be considered to have a PE and, therefore, should have filed a return. However, cables are outside of the definition of a PE, according to the OECD, and it's not as if Netflix owns the cables used to take their content to people's TVs. It's also the case that Italy's domestic legislation specifically exempts some e-commerce businesses:
"computers and auxiliary equipment for the collection of information and the transmission of data for the sale of goods or services do not by themselves constitute a permanent establishment;"
This seems to describe Netflix quite nicely. You pay your money to Netflix for the right to view their programmes, and the servers and cables are used to transmit that data in respect of the sale of that service. It would be interesting to understand the basis on which the Italian authorities are arguing that Netflix has a PE there and how they are interpreting both their domestic legislation and the OECD's commentary to Article 5.
As well as Italy, Netflix has been in the news in the UK, both because it has not paid enough tax according to some unknown yardstick and has had the temerity to obtain a tax refund. These reports seem to be remarkably uninformed.
The UK has two tax breaks that are of use to Netflix. The first break is the UK's creative industry reliefs. These reliefs could be described as a flagship policy of the UK. Since starting out as an incentive for the UK film industry in the last century (that actually did lead to widespread tax avoidance), it was relaunched from January 2007 and since then has been expanded from films to also cover high end and children's TV, animation, video games and theatre productions.
The reliefs allow a production company to boost its tax deductible expenses, and if this boost leads to a loss, surrender of those losses for a repayment. Given the level of the boost (up to 100%) and that each film or TV series is treated as a separate trade, is it any wonder that companies like Netflix can (and do) claim a repayment?
The British Film Institute is in favour of this break because it brings many high paid jobs to the UK, including 25,000 jobs from Netflix alone, as must be the Treasury and HMRC, given how often their headquarters at 100 Parliament Street appears in Hollywood blockbusters – the open air club scene in Fast and Furious 6 was shot in the so-called 'drum' at the centre of the building. However, bringing jobs and investment to the UK is something that can be conveniently ignored when seeking a headline.
Creative reliefs are not the only tax reliefs that Netflix are able to take advantage of in pursuit of complying with UK policy. As discussed above, the UK has very wide-ranging domestic legislation when it comes to taxing non-residents. Anyone carrying on any part of a trade in the UK is subject to income tax. However, the UK also has one of the widest DTA networks in the world and this limits the taxation of non-residents to those carrying on a trade in the UK via a PE.
Given the noises the government has made about the perfidious digital giants using sneaky tactics to avoid paying tax in the UK, you would expect the UK to gleefully take advantage of the OECD's wording on treating servers as a PE for e-commerce. However, the UK is the only country to specifically disagree with the OECD on this issue and HMRC has stated that servers do not create a PE. Netflix is, therefore, not taxable in the UK upon the income generated through these servers.
France, being France, ploughs its own furrow. Rather than use a tax break to encourage investment in their film industry, the French went for a levy on video and DVD rental businesses, which was extended to streaming services like Netflix and YouTube from 2017. As an aside, it would be interesting to see how many films are now shot in London and how many in Paris as a rough comparison showing which method works: A levy upon producers or an incentive?
This levy of 2% does appear to have kept Netflix out of the French digital services tax, and as that is 3% it has even given them a saving. There are no reports of France seeking to tax Netflix because it has a PE in the country, but it would be unwise to bet against the French authorities carrying out one of their signature raids in the not too distant future.
Sensationalist headlines about corporate tax could become a thing of the past. The OECD is seeking to move the goalposts of international tax and has suggested that multinationals should now allocate more profits to the country where their customers are.
The OECD proposal has been made to stop the international tax system from breaking apart due to the imposition of individual digital taxes, such as the service tax in France and the diverted profits tax in the UK. The proposal is rather complex and needs a review all of its own, but, if successful, it could cut down the number of screaming headlines about Netflix not paying their 'fair share'
Andrew Parkes is an international tax specialist and serves as national technical director at Andersen Tax.www.andersentax.co.uk
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