BEPS widening to capture VAT on e-commerce

THE EU has led the world in collecting VAT on all online sales, adopting a mechanism which is now part of the OECD’s Base Erosion Profit Sharing (BEPS) project. The OECD’s Raffaele Russo explains how regulators are moving to capture profits hidden in borderless trade . . . 

THE EUROPEAN UNION has introduced a mechanism to collect value added tax (VAT) on all online sales in its first move to claw back some of the so-called stateless income that has eluded its tax net.

Since it was introduced in January this year, the EU has collected more than 3 billion in VAT, and some 18,000 e-merchants from around the world have signed up to the new EU registration system.

The EU is the first region in the world to implement the mechanism, which is now part of the Base Erosion Profit Sharing (BEPS) project at the Paris-based OECD (Organisation of Economic Development), under a work programme for the G-20 (Group of 20) to deal with the rising problem of stateless income.

 Rapid growth in the digital economy has
exacerbated the problem of stateless income. Until now, countries did not have a mechanism to collect these taxes. “There is now an agreement that consumption tax on online sales should be levied in the market country where the customers reside,” says Raffaele Russo, Head of the OECD’s BEPS project.

 The OECD has set out rules to allow non-resident providers to register and to remit VAT in the destination country.

 Russo says South Africa has implemented a system similar to the EU and has had ‘equally positive’ results.  Australia and Japan are moving down the same path. “There will be more uptake of the work that we are doing in this space,” Russo told ATI.

 Stateless income is a much broader problem that covers multinational companies and companies dealing with intangible assets, such as intellectual property rights.

 For cash-strapped governments, the rise of stateless income has become the scourge of the digital world. No one knows for certain the amount of tax revenue lost to governments, but OECD estimates presented in October suggest a conservative figure of between US$100
million and US$240 million.

Anecdotally, says Russo, growth in stateless income is occurring on an important scale.

He says the digital economy has exacerbated the BEPS problem because of the mobility that characterises the digital economy. “And when I talk about mobility I refer to the mobility of
assets, because obviously these players rely heavily on intellectual property, which is an
intangible asset — as well as the mobility of users and of employees themselves.”

He says the work his team has been doing is to identify those areas which have to take into account the specificity of the digital economy.

The OECD is looking at changing the treatment of sales income of a foreign company in the context of the digital world. Companies can currently transact with customers over the Internet and choose to make a foreign affiliate the counterparty of the sale, located in a country with the lowest tax burden. 

Existing rules enable countries to protect tax erosion by requiring that incomes of foreign subsidiaries of domestic companies are taxed onshore and not stashed in offshore jurisdictions to avoid tax. But the income covered by those rules is often narrow enough that companies can circumvent those rules where sales income is derived over the Internet. Further, the advent of 3D printing (which changes the role of manufacturing) robotics, and the Internet of Things are changes bringing with them big challenges for tax authorities.

The digital economy has required an evaluation of the meaning of ‘a permanent establishment’, Russo says. 

The existing definition, drafted a long time ago, excludes certain activities carried out through a fixed place of business where these activities are deemed to be of a proprietary or auxiliary nature. A warehouse is considered a preparatory or auxiliary activity. 

Yet in certain new business models, having a warehouse close to the customer is key to the operation. Part of the work at the OECD is to change the definition of permanent establishments to take into account the changing nature of the business environment.

The digital economy has thrown up many more questions. Russo says that in today’s world increasingly, consumers are becoming a cog in the value chain of companies. Social media companies or search engines leverage on the fact that they provide a free service — in exchange for data on their users. 

They can then monetise the data, either via increasing sales or selling the data, for example, to insurance companies or companies interested in advertising their products to a targetted Internet audience.

The question arises which countries should tax the income from such activities. Is it the country where the consumer is located or in the countries where the activities are carried out to produce the income? 

Russo says tax authorities have anticipated problems arising from the shift to the digital economy in the next five to 10 years, and have been trying to develop potential solutions to be ready to protect their tax base in case this is needed. However, getting up to speed on digital commerce is different from the challenge facing governments over the issue of stateless income. 

More than loss of revenue, the challenge has much to do with level playing fields. 

“Assume that a company needs to finance its debt, and that another company within the group provides the loan, says Russo. 

“The borrower pays the interest on the loan, which should be tax deductible to the borrower but taxable for the provider of the loan. This is what happens if the transaction is done within one country.”

But when two countries are involved, he says, the financing can be structured in a way that one company benefits from a tax deduction while the other claims exemptions on dividends when the loan is structured as either a convertible loan or preferred equity.

Of late, governments have honed in on the level of tax paid by multinational corporations (MNCs) in their countries of operation, to make political capital out of the issue.

Russo says the argument is about fairness of the tax system. Citizens see their individual income tax and consumption tax increasing and they are told that MNCs don’t pay what they are supposed to pay in tax. 

Transfer pricing is another issue, and the OECD has issued new guidance on inter alia intellectual property rights. 

“Why? Because it is often difficult to value IPR, so the BEPS report will come up with rules that provide tax administrations with tools to resolve ambiguity between the taxpayer and the tax administration.”

But transfer pricing per se is an issue of the old as much as the new economy.

Russo says: “We work on transfer pricing with a number of developing countries. They tell us that transfer mispricing is one single issue that is most important to them, in particular regarding commodities. They have not been happy with companies exploiting their resources and then, instead of selling them to their customers, selling them to an empty shell company in a favourable tax jurisdiction before reselling to customers.”

Russo says these developing countries, as well as developed ones, agree that something has to be done to stop companies from doing this.  The OECD will publish a final report with guidance on commodity transactions as part of the full package of BEPS measures. 

Asked if the private sector supports the work of the BEPS project, Russo says: “Some representatives of the private sector are very aware of the need for change in the current system. This group has provided very useful input, which we have taken on board.”

“A second group may have always assumed that the BEPS initiative was going to fail
because it is too ambitious, but they will soon realise that they are wrong, and that the BEPS project has drawn up a comprehensive package of measures to tackle the problem — two years after starting the project, which is record time for an endeavour like this.”

Russo describes a third group as “the deniers” who do not accept that there is aggressive tax minimisation. They may regard BEPS as “just propaganda for cash-strapped socialist governments that want to extract more money from taxpayers”. 

This group is politically and philosophically opposed to tax. But, says Russo, even this group is starting to realise that there is so much political pressure to act that they will have to adapt to the new environment. 

Even though the BEPS project is the work of the OECD and G20, Russo says developing countries and all stakeholders — businesses, tax advisers and academics — have played a role in a transparent process.

“Countries, including from Asia, are pretty happy with the results, because when we talk about BEPS we are not talking about developed countries ‘win’ and developing countries ‘lose’. If BEPS is not addressed, everyone loses. 

“We have collected more than 12,400 pages of comment and more than 1,000 submissions from stakeholders. And there is strong interest from around the world.”

Russo recalls a discussion with the OECD web team about doing a webcast. The expectation was that perhaps no more than100 people would participate. As it transpired, there were 40,000 worldwide viewers.

He says there is political impetus behind BEPS because of public anger of perceived tax avoidance by transnational companies, because of the need to ensure that the system is, and is perceived to be, fair, and because there is a need to level the playing field between companies that operate only domestically and multinationals. 

“Overall, the BEPS project has been an extremely demanding exercise, but it is worth it because we have come up with rules that are going to address the issues. Governments can now address the BEPS problem without creating collateral damage.” 

Does this mean that stateless income will soon be State-owned income?

“Indeed, the level of scrutiny is such that you cannot declare victory unless you have really won the fight against BEPS, and for this reason we are working on designing an inclusive framework to support and monitor implementation,” says Russo.

So the work is not over. In addition, Russo says, the world has to rethink the optimum
approach to tax collection in a constantly interconnected world – should it be from income tax, consumption tax, or a new type of tax?

“Probably,” he muses, “the world needs to start thinking about a new tax system more suited to the third millennium.”