You’re the CFO of a large manufacturing company with operations in several countries. Or the CFO of a Financial Services business. Or of a Pharma company. Or a household supplies company. You hear the phrase “taxation of the digital economy,” but you tune it out. The digital economy only applies to technology, and you don’t have time to think about that with US tax reform being implemented, right?
Wrong. Very wrong.
Just as digital is quickly becoming everything in business; the taxation of digital, if not handled properly, could dramatically affect your business’s growth. And, in fact, some of the tax reform provisions relating to foreign income and IP only heighten this impact.
Consider manufacturing. Almost all your products either do, or soon will, contain digital components, and the impact of the internet of things will continue to transform your industry. Financial services is now all about Fintech and the provision of electronic platforms for trading, selling, or reaching consumers. For Pharma it’s about global teams cooperating virtually — not to mention digitized supply chains. For a household goods company it’s about collecting and using marketing data, about online advertising, about new channels in social media. So, no, the digital economy is not just tech companies. It’s about every business. The digital economy is the wholeeconomy.
But the digital changes — as we all know — are also disruptive. They are disrupting industry sectors, jobs, and, as it turns out, the base on which governments compute and then collect tax. These changes disrupt tax bases in part because business models and patterns of where value is added and profits are made are changing; and in part because they make it much easier to sell goods and services without being physically present in a country, without having a factory, or a storefront — the traditional way that governments taxed corporations.
This has led to claims that large multinational companies that can access local markets without a physical presence are not paying their “fair” share, and are squeezing out local competitors — usually smaller — in part because of the tax advantage. This, in turn, has led to much recent activity, especially in Europe, to examine, and perhaps implement, new taxes on certain digital activity (especially around the collection and monetization of personal data).
There are currently three major proposals for new ways to tax the digital economy. The first is for a turnover or “equalization” tax. This could be levied on turnover (i.e., gross revenues, not profits) of “digital” businesses or on certain types of digital income. A second idea is to allow a “digital permanent establishment”. Cutting through the technicalities, this would allow a country to say that the level of digital activity in that country was such — even without any physical presence by the business — that the country now had the right to tax the activity. And third, there would a type of apportionment similar to that used by US states, except that one of the apportionment factors would be collection and use of personal data (alongside property, payroll and sales).
These ideas all come with significant downsides (we’ll look at those in a future blog), but, again, what business people need to know is that a number of significant European countries (and possibly others) could well enact these measures, soon, possibly even in the next few months. The UK has set the ball rolling and others may well follow.
But what should the tax answer be? I firmly believe that we need to start with traditional concepts of value creation. As companies rethink their tax strategies based on US tax reform, business people need to make sure they have a clear understanding of exactly what it is in their business that creates value. It’s the cutting edge R&D; it’s assuming financial risk; it’s providing working capital; it’s making key decisions; it’s providing legal protection for intellectual property; it’s devising marketing strategies — and many more.
But we also need to recognize in applying those principles that the world is changing — digital is becoming everything. So, we will need, for example, to consider whether or not data and users create value in certain business models. Perhaps even more importantly we will also need to try to figure out how business models may continue to change.
That’s hard, but it’s really important for businesses to engage. Because, make no mistake, taxation of the digital economy will change the way your business is taxed. Decisions are currently being made in this area by the EU, by the OECD, and by other organizations. Business needs to be involved in this, advocating with, explaining to, and educating national governments and international organizations. This will move ahead with or without you — and if you don’t tell your own story, I guarantee that someone else will tell it for you.
Tax Services, Washington National Tax Services, Tax Reform, Tax Technology, Private Company Services, PwC US
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