Deadlines for agreement on international measures to “address the tax challenges arising from the digitalisation of the economy” have been missed more than once, yet the world may be closer to solving digital tax than ever before.
The announcement on October 8 of final agreement among 136 of the 140 members of the Inclusive Framework marks a very significant step in addressing the international tax challenges arising from the digitalisation of the economy and has again proved wrong those cynics who did not believe that consensus was achievable.
The OECD statement includes a reference to the future of DSTs:
“The Multilateral Convention (MLC) will require all parties to remove all Digital Services Taxes and other relevant similar measures with respect to all companies, and to commit not to introduce such measures in the future. No newly enacted DST or other similar measures will be imposed on any company from 8 October 2021 and until the earlier of 31 December 2023 or the coming into force of the MLC…”
The statement appears equivocal: there is a requirement that all existing DST and equivalent taxes must be removed by all countries that sign and implement the MLC. But that is immediately followed by a commitment that no DST or similar tax will be imposed, not in perpetuity, but during a 27-month window.
Does this mean that all countries are free to implement in 2024 a new DST that does not target the 100 global MNEs to which pillar one applies? Or that any country that for whatever reason does not ratify the MLC can continue to impose existing DSTs and implement new ones?
There was evidence before the October 8 statement that there was continued support for DSTs in some countries: as an example, it was reported on August 31, that the EU Budget Commissioner Johannes Hahn said the Commission would put forward a proposal for an EU digital levy after the October meeting of the G-20/OECD inclusive framework on base erosion and profit-shifting “no matter if there’s agreement or if there’s not agreement”.
The G24 Group of lower income countries, responding on September 19, to an earlier OECD statement urged that “withdrawal of unilateral measures should be gradual and progressive alongside the implementation of Amount A, and that if the developing countries are expected to withdraw unilateral measures due to agreement on Pillars One and Two, then there should sufficient revenue under Pillar One and a broader subject to tax rule”.
It remains to be seen if all DSTs will be repealed in line with the International Framework agreement reported in the October 8 statement, which will depend on all of the 136 IF members signing and ratifying the proposed MLC, and the position on future DSTs whether or not a county ratifies the MLC is also uncertain.
It is therefore at least possible that DSTs are not going away in all jurisdictions immediately and new DSTs may be proposed and implemented from 2024.
In that case it is reasonable to ask what actions could be taken to mitigate the impact of these new taxes on business activities if an organisation is present in any country which has enacted or may in the future be considering implementing digital levies or taxes.
As these are politically sensitive taxes, mitigation strategies should be assessed not only from commercial and technical perspectives but also in relation to stakeholder reactions and perceptions.
At least three approaches to mitigation are possible.
Three approaches to DST mitigation
Revenue offset
The existing and proposed DSTs are not profit taxes but are typically gross taxes on certain categories of revenues and operate more like excise taxes than direct or indirect taxes.
As a tax on gross revenues and not an income or withholding tax covered by bilateral tax conventions, credit for DSTs against other taxes is not certain and the US have indicated that they will not be regarded as a creditable income tax.
Mitigation through credit or exemption double tax relief is unlikely, but commercial offset of the cost directly or indirectly is an alternative.
Other MNEs are reported to have also directly passed the cost of DSTs to customers. Such an approach could be followed for future taxes. However, the ability to raise prices in this way does depend on market dominance, and in highly competitive markets, full and effective mitigation by price increases may not be possible.
Political and stakeholder reaction to price increases directly related to the introduction of DSTs was strongly negative in the past and similar reaction could be expected if companies seek to directly pass on any DST costs to customers.
Local management of mitigation
If the principal mitigation strategy is not direct revenue offsets, other options could well be affected by where enterprise responsibility for the DSTs lie. As an indirect tax, this may not be wholly or partly with the tax department but with territory or business sector management.
This could result in mitigation actions being considered or executed at a local level where the special levy directly affects net revenues, profits and other critical metrics and ratios.
Specific mitigation actions would be affected by the particular services subject to the tax, detailed definitions of revenues and services, and access to data on service users and their location.
Experience suggests that local actions to mitigate the incidence of taxes and duties may not always be in line with enterprise tax strategy, transfer pricing policies and other legal and regulatory requirements. They can be based on limited understanding of the tax, incomplete information on enterprise costs and value chains and poor communication and relationships with tax administrations.
There could also be limited central visibility or control over mitigation actions, increasing risks of negative stakeholder and public reactions to those actions and damage to the enterprise relationship with the tax authority.
Tax Department accountability
Some immediate media and public reaction to the October 8 announcement made assumptions that MNE responses to the implementation of different tax rules would be that the lead would be taken by tax departments and the focus would be on inappropriately minimising liabilities.
This reflects the low level of public understanding of international tax policy and is linked to the level of public trust in tax professionals being even lower.
Some expectations were that profits and revenues would be reallocated to locations or entities where the incidence of effective taxation would remain low or non-existent. To illustrate the level of understanding, The Times recently referred to “so-called transfer pricing, an arrangement which involves moving money between group companies in order to pay lower local taxes on profits that might arise from sales in higher tax jurisdictions, including the UK. This is a common and legal tax avoidance strategy that has often been deployed by multinational technology companies but costs countries billions of pounds every year.”
Enterprise senior management may consider that management as a commercial cost through pricing strategies, or through sector or local responsibility for mitigation is the most appropriate model. This might be the case even for novel levies that are politically and media sensitive, where the central tax department may have no role to play in decision-making.
There are nonetheless benefits from tax department involvement, including the treatment of DST as a tax to be managed rather than a commercial cost. Mitigation strategies should be based on a detailed understanding of the proposed changes in laws and processes. This includes assessing and quantifying the potential effect of the legislative changes on the business activities of the enterprise in the relevant territories.
Based on this estimated impact assessment, internal and/or external advisors would consider and evaluate options for process or business change that would likely reduce or eliminate the effect of the new laws.
That process could result in a decision on, or recommendation of mitigating actions intended to limit the effect of the new laws on the enterprise through minimisation of their economic and fiscal effects.
While business changes should not be the responsibility of the tax organisation, their input on the tax effects of changes should always be a key part of decision making. It would be prudent for the tax team to ensure that accountability for management, mitigation and compliance of DST is clearly defined, establishing the role, responsibility, and resourcing of the tax team in relation to existing and future DSTs, including potential mitigation of their effects.
Whoever has sole or joint accountability for DST, careful evaluation is required. This starts with the key question of whether the business activities of the enterprise meet the criteria or thresholds that create the liability to the special levy in each of the jurisdictions that the enterprise does business, whether or not there is any physical presence in the jurisdiction.
That requires sufficient knowledge of the rules in each jurisdiction where a liability potentially arises and sufficient knowledge of business activities to be able to identify whether the laws will or could apply.
The tax team or its advisors could be the safe source of that knowledge, but that role should not be taken on by default or through business managers making an unjustified assumption that tax has the responsibility.
It could be the case that with a special levy targeted at particular activities that the enterprise undertakes in a particular territory, the best mitigation of negative consequences for the enterprise, including stakeholder and public reaction.
This is to ensure that the collection and payment of the levy is efficient, and that costs are built into business plans, and stakeholders are made aware that the enterprise is, as a good corporate citizen, complying in full with the changing fiscal obligations.
The optics of an MNE carefully planning to avoid a new tax targeted at the revenues or profits that the MNE earns within a territory are not good and would probably be contrary to any ESG commitments that the MNE board have affirmed.
And finally, a critical mitigation of the impact of any DST on a business is to ensure that there are robust systems and processes in place to collect relevant data to calculate tax liabilities. This includes maintaining adequate digital and physical records, ensuring timely payments to tax authorities and maintaining good relationships with those authorities.
The tax department should at the very least ensure that those systems and processes are in place, even if it does not have ownership or accountability for them.
