Taxing the digital economy – are we all on the same page?

The Organisation for Economic Co-operation and Development (OECD) is working towards a multilateral agreement on taxation of the digital economy.  Taxpayers who sell digitally should follow developments closely for impacts to the middle market.

In October 2019, the OECD announced that they are aiming to reach an agreement by 2020. Two years later, the OECD announced that 136 countries, including Canada, agreed on the elements of the landmark two-pillar plan on international tax reform. In February 2023, the OECD General Secretary announced that they are aiming to finalize a new multilateral convention on digital tax by mid-2023, for entry into force in 2024. 

With no multilateral agreement in place, several countries have introduced domestic tax rules to govern the digital economy as they are not willing to lose out on tax revenue while waiting for such an agreement. Even once the agreement comes into force, countries may still impose domestic taxes on the digital economy to close gaps left by the multilateral agreement.

OECD’s Two-Pillar approach to combating tax challenges from the digital economy

The OECD has introduced a Two-Pillar approach to deal with tax challenges from the digital economy. The primary objective of Pillar One is to ensure that large and highly profitable Multinational Enterprises (MNEs), including digital companies, pay Digital Services Tax (DST) wherever they have significant consumer-facing activities and generate their profits. This project is part of wider efforts to restore stability and certainty in the international tax system, address possible overlaps with existing rules, and mitigate the risks of double taxation.

Pillar Two aims to implement a global anti-base erosion rule through the introduction of a global minimum corporate tax rate of 15 per cent that countries can use to protect their tax bases.

Canada’s Approach

Canada has proposed a 3 per cent Digital Services Tax on companies that reach a certain threshold as an interim measure allowing Canada to capture potentially lost tax revenue from the digital economy until it enters into a satisfactory multilateral agreement. The tax will not be imposed any earlier than January 1, 2024, and only if no multilateral agreement is entered into by then. If the tax is imposed, companies would be required to remit tax in respect of revenues earned as of January 1, 2022. As such, companies in the online entertainment sector, e.g., Netflix, Amazon Prime, Spotify, etc., are bracing for a potentially large tax bill in about a year’s time.

EU’s and India’s Approach

While countries in the EU establish their own tax laws, creating laws that uphold the principles of the EU has encouraged a unified approach to digital taxation. However, the EU DST proposal hit a roadblock in 2019. Since then, many EU member nations have implemented or are in the process of implementing a DST at the country level. As of January 2023, Austria, France, Hungary, Italy, Poland, Portugal, Spain, Turkey, and the UK have implemented a DST; while Belgium, the Czech Republic, and Slovakia have published proposals to enact one, and Latvia, Norway, and Slovenia have either officially announced or shown intentions to implement such a tax.

The proposed and implemented DSTs differ significantly in their scope and structure. For example, while Austria and Hungary only tax online advertising revenues, France’s tax base is much broader, including revenues from the provision of a digital interface, targeted advertising, and the transmission of data collected about users for advertising purposes. The tax rates range from 1.5 per cent in Poland to 7.5 per cent in both Hungary and Turkey (although Hungary’s tax rate is temporarily reduced to 0 per cent).

Notwithstanding individual measures undertaken by several EU member nations, a common approach likely will not be discarded especially with the proposal of a single corporate tax rulebook for the EU, Business in Europe: Framework for Income Taxation (BEFIT) in 2021.

Meanwhile, India unilaterally introduced an equalization levy (EL) of 6 per cent in 2016 which applies on non-residents engaged in online advertisement and related activities with Indian customers (Finance Act 2016). India further introduced a 2 per cent equalization levy on amounts received/receivable by a non-resident e-commerce operator from e-commerce supply or services effective April 1, 2020. This new tax applies to all businesses with India source revenue exceeding 20M Indian Rupees (approximately $250,000 US Dollars) unless that e-commerce supply or service effectively relates either to a permanent establishment in India or is subject to the original EL of 6 per cent on advertising services.

Beyond Pillar One

The OECD’s Two-Pillar approach has a fairly limited scope. For example, Pillar One would only apply to multinational enterprises with global turnover above EUR 20 billion and profitability above 10 per cent based on a particular calculation method. There are many companies operating in the digital space providing either goods or services which fall below this threshold. It is unlikely countries would be willing to accept the potential tax revenue lost from these taxpayers. As such, middle market digital companies can expect individual countries to propose and/or implement domestic DST rules that will apply in parallel to the OECD’s Two-Pillar approach.