A Tax Playbook for the Digitalised Economy (Part 2)

A Tax Playbook for the Digitalised Economy (Part 2)

Wed 03 Feb 2021

In a series of articles aimed at promoting debate on the evolution of international tax regimes, Michael Lennard, Chief of International Tax Cooperation and Trade in the Financing for Sustainable Development Office (FSDO) of the United Nations, discusses the tax-related challenges governments, professionals and practitioners face. Following on from the first article on this topic, in this second part, Mr Lennard continues to outline, from a personal perspective, some ideas on tackling barriers to transforming tax regimes as we adapt to an increasingly digitalised economy.

While there is great value in taking a positive approach to the challenges we face in transforming tax regimes to factor in the digitalised economy, if we are to avoid creating a spaghetti bowl of regulation, it’s also essential to address some of the significant barriers to achieving change. So what are these barriers, and how can they be addressed? Again, devising a playbook that focuses on the bigger picture can help break down barriers and visualise a more manageable way forward in tackling the challenges ahead.

1. Improve “Tax Certainty”

We currently have a plethora of unilateral, bilateral and multilateral tax agreements in place around the world. At their heart, they seek to address an approach to taxing international companies based on protocols and agreements that, in many cases, do not fully take account of new business models. Bilateral treaties are built on domestic law, and an instrument such as the OECD MLI is in turn built upon those treaties.

As sustainability both from an economic and business perspective gains political importance, there is the issue of how to develop tax treaties between developed and developing countries that offer a consistent approach and a level of tax certainty across all business models. While collaboration between governments, practitioners and companies is not an issue, complex negotiations can often result in years of stasis and a barrier to change. It will be years before any multilateral agreement brings money into budgets, which by the way, means countries are unlikely to want to withdraw their unilateral tax measures when consensus is reached (the OECD is aiming for mid-2021).  They are more likely to wait some years until the treaty has entered into force internationally and domestically, and possibly in relation to fellow treaty adherents.

Yet, as we have seen with the global COVID-19 pandemic, changes to tax, albeit temporary, can be quickly effected when required. Multilateralism is not just about “big bang” treaties but about multilateralised, multi-stakeholder, encouragement of coherent and consistent domestic law and treaty approaches, especially as interim or emergency  measures, or when deeper consensus is currently lacking.  It is not necessarily a stark choice between the luminosity of big bang multilateralism or the Stygian darkness of “uncoordinated unilateral” approaches (which by the way current multilateral processes have happily drawn upon). 

Countries in effect see unilateral measures as in effect creating more certainty for their budgets over as shorter time frame, and for public confidence that those profiting from the economy will bear the certainty of taxes – they do not see “tax certainty” as purely about taxpayer certainty though that is an important component, And with their singeing experience of investment treaties, developing  countries generally see mandatory binding arbitration as an instrument of uncertainty (for regulation) than certainty. Improving dispute avoidance and settlement without such a mechanism requires creative thinking.

So let’s use this background and mindset to create an improved level of tax certainty – either in parallel to or by amending existing treaties – that recognises digitalised and bricks and mortar models in a way that is fair to taxpayers and the needs of governments alike.

2. A Place for Simplicity

Clarity and consistency in any tax regime based on profits is a significant challenge. Much will depend on the economic needs that individual governments face, which can often result in widely different interpretations. Developing countries, in particular, also face issues of a lack of technical expertise and administrative infrastructure that can result in a barrier to much-needed tax collection. A less complicated tax measure such as withholding taxes, while not universally popular, can appeal to governments with limited resources and capabilities as giving a fair return for engagement in an economy without relying upon concepts such as “value creation” that are shapeshifters and tend to shift away from the developing world. Plus, if not set too high, and administered in business-friendly ways, withholding taxes offer a simple, admittedly imperfect,  solution to a wide range of business models, including digital.

The imperfection is apparent, but we should not kid ourselves that PE and profit-based approaches are simple, entirely coherent or consistently applied. So while the international tax community can often get bogged down in applying the complexities of tax, there is a place for the introduction and application of simple tax measures as a complement to a profits-based regime – this helps preserve the country and citizen confidence in the system – important for business partnerships with countries over time.  The cost of the inevitable imperfections should be minimised and fairly shared, and the “tax certainty” we seek should be a high level, but viewed not only from the (important to country development) perspectives of business planning and confidence but also from a perspective of greater certainty of government budgets and the legitimate interests of the citizenry.

3. The Right Sort of Engagement

One of the fundamental changes brought about by digitalised business models is the instant removal of borders. It is, therefore, more important than ever that the international tax community places increased importance on how we communicate and engage on complex issues involved in such a transformational period. Engaging with a broader range of experts including professionals and academics from vertical disciplines such as sustainability and economic development can often give a different perspective and remove the inevitable industry bias that can build up when interests are too aligned. Appointing a wider range of people in key decision influencing and making roles can help to recognise different styles and needs both from a government and taxpayer perspective and build something that will stand the test of time. We need to develop capabilities for both “rapid response” and a “vaccine” for international tax ills at present and as they emerge, but also to engineer better early warning systems in future, an architecture for international tax norm-setting that is inclusive and principles-based, and a set of norms that may have variable geometries and differentiated responsibilities, and needs the flexibility to deal with both the known and unknown unknowns, but gives the clarity needed for confident planning by both businesses and governments.

Digitalised business model update

“Recent papers from the OECD with respect to digitalized business models used in the FS industry suggest that, while there is some strong support to exclude the more regulated FS business from these discussions and new principles, it is also obvious that most likely the less or unregulated business within FS such as asset management and Fintech operations will be affected by the new principles and potentially new laws. It is definitely something to follow and be aware of for many of our clients.”

Erik Stroeve, Mazars Financial Services Tax Leader

By looking at fresh ways to tackle the barriers that currently exist in transforming tax regimes as we deal with an increasingly digitalised economy, we become better equipped for the inevitable challenges that the international tax community faces going forward. Emphasis on the commonalities in these challenges and the sustainable development dimension will help this process.  As we look to transform global tax to meet the needs of digitalised business models, having a continual multi-stakeholder and multi-disciplinary dialogue on new ideas will help the international tax community to evolve and thrive so it can meet the needs of all and not just a few – leaving no one and no country behind.