I am excited. I don’t get to say that often with regard to the international tax system, but things are changing for the better. The OECD’s digital tax roadmap has now been accepted by the G20 and a series of working groups have been organised to address the technical issues. At first glance, the plan seems clear. The OECD is seeking to develop a global tax policy where the total profits of a company’s global footprint are considered and allocated according to where the economic profit is generated. Simple?
But the business leaders I have spoken to are confused about what these policies mean and how they will be impacted by them. Make no mistake, the impacts will be far reaching, but we should welcome them.
Where we are
The current landscape has emerged chaotically without an overarching strategy. Individual countries have created their own proposals in no particular order and with limited international coordination. A range of jurisdictions including France, Britain and Italy, have either introduced or are creating new taxes intended to tackle digital companies that sell products and provide services locally, but are headquartered in lower-tax countries.
I believe that these taxes were designed, not so much to solve the issue of digital taxation, but to protect their own tax base and to spur the OECD into action. In this, at least, they have been successful, but the OECD’s first job is now to unpick the tangled web of measures already introduced. The digital services taxes introduced thus far are generally based on turnover and one of the challenges now facing the OECD is how to align these disparate policies and eliminate the threat of double taxation. With no effective mechanism for tax relief between countries for these kinds of digital services taxes (DST), double taxation would quickly become a costly reality, that could affect businesses around the world.
Overall, the current system is difficult for companies to navigate. There are different structures in place, with little cohesion internationally, and that introduces a layer of unnecessary complexity for any business looking to operate globally. There is a growing consensus that the tax system needs to be simplified and standardised, and we are seeing the first steps towards that change.
Where we are heading
The next step is for the 129 countries who agreed that change was necessary to agree on a political direction, and for the OECD to begin the analysis that will lead to their recommendations. The current outline does give us some idea of what to expect.
- Presence vs activity: The physical presence of a company, where it is headquartered, will be replaced by the economic activity of a company as the appropriate way to measure where its taxing point should be, and how much should be taxed in that location.
- Raising the minimum rate of tax: Currently, countries are free to set their rates of company tax to any level they feel is economically appropriate and choose higher or lower rates depending on their economic strategy. It is likely we will see the introduction of a minimum rate of tax globally, but we currently do not know where this level will be.
- Recognition that all businesses are becoming digital: The new policies will apply to all businesses, not just ‘digital’ firms that have been targeted by DSTs. This is a crucial recognition that it is increasingly impossible to separate the digital from the physical or allocate value to each.
While I will have to wait to see what the final proposal contains, these seem like a sensible starting point and one that businesses should welcome. A focused approach on the “giants” might seem like a good idea now, but in a few years’ time new business models will have developed and the specific design of today’s tax policies will be superseded. Fundamentally, all businesses should be subject to the same tax system, because business models continually change, and innovation should be encouraged, not hindered, by the tax system.
In future, it is likely that administration and reporting systems will become increasingly important. The key to making these proposals work will be in finding a balance and creating a system that makes it easier for both business and government to report and collect tax across borders.
The impact on you
The new tax rules need to be appropriate for not only existing digital business but those which are only just starting, and those which have not yet emerged. That is not an easy ask. For business leaders, it is crucial that they are aware of what these changes might mean.
One example that shows just how far reaching the changes will be is the toll road industry. At first glance this appears to be an infrastructure business: building and financing roads and deriving toll revenue from users. However, the industry uses data to optimise traffic flows, plan future road usage, and anticipate driverless cars. Additionally, the volumes of user data that can be acquired has many further applications that can lead to additional services and generate value. The toll road can’t be relocated but if the relevant IP is located offshore, what profit is attributable to the IP?
Beyond the immediate tax implications, there are economic implications that businesses will need to consider. This is about both about where a business is currently based, and where they want to operate in the future. Currently, countries can set their tax rate where they please and this has been a fundamental part of their ability to attract investment. However, if a minimum rate is set at, say, 15%, then there is little incentive for countries to introduce a lower rate as there will be a catch-up tax payment due in a company’s ‘home country’.
Ireland is currently the European home of many of the world’s largest technology companies, and there are thousands of businesses who are dependent on the economic stimulus this headquartering provides. Ireland’s tax rate is currently 12.5%. Would those companies stay if that tax rate was ratcheted up to 15%?
Economic hubs and supply chains will likely shift and rebalance as the OECDs changes come into effect, but that will not happen overnight. It is crucial that business leaders are aware of the tax environment in which they operate, but also that they have on eye on the future.
Change is never easy, but the OECD roadmap sets out a plan for change that business should welcome. The current system is disjointed and makes global ambitions a maze of regulation that businesses will be better without. By introducing one clear set of rules, the OECD is giving business a clear direction that unexpected tax bills won’t derail their plans for international growth.
The real key is going to be keeping one eye on the horizon. Nothing changes yet, but if a global format is agreed its implications are going to be far reaching indeed.