Capturing the value of the digital economy

Digital technology has undeniably transformed the commercial landscape. Digitization allows businesses to access markets across borders even without establishing a physical presence. Due to territorial absence, and the novelty of digital technology that tax laws then could not have foreseen, for a time, tax authorities found themselves bereft of rights to collect taxes on digital businesses that cross international borders.

In 2015, the challenge of taxing the digital economy was recognized by the Organisation for Economic Co-operation and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) Action Plans. By 2019, the OECD published a Proposal for a Unified Approach under Pillar One, which proposes a new nexus, distinct and separate from the existing concept of the permanent establishment. It would ensure that a company is taxable in a jurisdiction where its sales exceed a certain threshold even if it is not physically present in that market.

In fact, the Bureau of Internal Revenue (BIR) recently issued Revenue Memorandum Circular (RMC) No. 60-2020 to remind all persons earning income through digital means to ensure that their businesses are registered. Voluntary declaration of past transactions and payment of corresponding taxes can be done by 31 July without incurring any penalty.

Unfortunately, the RMC does not seem to cover the digital giants who are mostly non-residents. The net for those bigger fish might be House Bill No. 6765 or the Digital Economy Taxation Act of 2020.

The bill

The bill does not propose a new tax or tax rate. Instead, it proposes to increase income tax and value added tax (VAT) compliance by requiring network orchestrators and electronic commerce platforms to withhold those taxes by appointing them as withholding agents.

A network orchestrator refers to “persons, typically aided by information technology, that create a network of accredited service providers and service consumers, and act as intermediaries that facilitate the matching of a consumer’s services needs with a provider’s available service.” On the other hand, an electronic commerce platform refers to “persons, typically information technology companies that act as intermediaries by connecting sellers and consumers usually through an electronic means of transmission.”

The legislators also propose to expand the coverage of VAT-taxable transactions to include the supply by any resident or non-resident person of digital advertising services, subscription-based services, and services that can be delivered through an information infrastructure such as the internet. This is where streaming services such as Netflix and Spotify would fall.

Pointes to ponder

The bill is still in the very early stages of the legislative process. Hence, we can expect enhancements as it goes through congressional deliberations. To my mind, a number of issues need to be addressed.

For instance, HB No. 6765 is targeting to collect more taxes from subscription-based services including electronic publishing (e-books). The bill appears to adopt the BIR’s stance in a 2012 issuance that the selling of e-books is subject to VAT.

Since the government is applying the same tax rules to both bricks-and-mortar and digital businesses, it stands to reason that the sale, importation and publication of e-books should follow the same VAT treatment as those applied to hard copies, i.e., they should be VAT-exempt. Moreover, with the new norm of online classrooms, it has become more important to make e-books more affordable by recognizing their VAT exemption, so that education is more inclusive.

Another issue that needs clarification is the requirement for non-residents to set up a representative office. In the proposal, a non-resident shall have the privilege to render digital services in the Philippines as a network orchestrator or as an electronic commerce platform exclusively through a representative office, or an agent which shall be a resident corporation in the Philippines. This requirement seeks to address the issue of businesses selling to the Philippine market but not being subject to tax and regulatory requirements due to lack of physical presence.

Under Philippine law, a representative office deals directly with the clients of its parent company but does not derive income from the host country. Fully subsidized by its head office, it undertakes activities such as but not limited to information dissemination, promotion of the company’s products, and quality control. Given that a representative office is technically not allowed to generate revenue in the Philippines, it may not be the appropriate entity to tax network orchestrators and providers of e-commerce platforms, unless it is a different kind of representative office altogether.

Another question is whether digital advertising is a nationalized activity. Under the law, advertising businesses must be at least 70% owned by Filipino citizens. Mass media, on the other hand, must be 100% owned and managed by Filipino citizens.

In 2018, a software development company sought guidance from the Securities and Exchange Commission (SEC) on whether the “marketplace” feature of its online platform could be construed as engaging in the business of advertising and/or mass media, and thus, subject to nationality restrictions. The SEC did not issue a definite opinion or ruling. However, it provided guidelines on when an online or mobile app platform operator is not deemed engaged in advertising or mass media activities.

It appears that the Commission treats digital advertising platforms as similar to conventional print/physical platforms. This would seem to point to nationality restrictions applying, which must be taken into account when refining the digital taxation law.

As with other tax reforms, the introduction of digital taxation is a balancing act that the government must carefully and thoughtfully execute, taking the economy and foreign investment into consideration. It is a difficult task that may be as equally daunting as the pandemic measures that it is proposing to fund.