In their search for ways to tap into the value generated by today’s increasingly digital business environments, tax authorities are exploring some novel channels – and reevaluating old ones. Tax leaders looking for a quick guide to the current state of play should check out an article in which PwC Deputy Global Tax Policy Leader Will Morris categorizes three variations of digital taxation currently being proposed and briefly examines their potential impacts:
Turnover tax (i.e., equalization taxes): This strategy focuses on sales rather than profits, and that could be problematic for certain types of business. If you have a supply chain that passes ownership of goods from one company to another, a turnover tax could apply at each transfer of ownership. Businesses that depend on high volume at low margin would be hit harder than those with high turnover and low margins. And businesses running at a loss, which can’t be taxed on profit, would still be taxed on sales. For these reasons, Morris points out, turnover taxes were abandoned in the sixties, “and the intervening 50 years … have not made the idea any better.”
Digital permanent establishment (PE): A PE arises, Morris notes, when “activity in another country contributes so much to the profit of the company that the second country gets the right to tax, not just the sale, but some of the profit as well.” PE rules work relatively well, but proposals to extend them to cover digital activities – for example by looking at the number of users in a country, the length of operation of websites or even cookies installed on computers – face serious difficulties and may increase the likelihood of disputes.
Formulary apportionment: In this approach, jurisdictions divide profits according to a formula based on factors linked to profit creation. U.S. states, for example, use a variant of formulary apportionment based on payroll, property owned and sales within the state. The EU is considering a formulary apportionment system, and the European Parliament has proposed using the collection and use of personal data as a factor in the formula. But the idea raises some prickly issues, Morris notes. There’s no straightforward connection between data and value. And if data does generate value, when does that happen – when it’s collected, when it’s analyzed, when it’s linked to a product?
Digital taxation is coming, no question, but its details are still far from clear and the topic warrants input from stakeholders. As Morris concludes, “It’s time to start thinking – carefully, thoughtfully and with an eye to growth – about what a tax system for the digital age might look like. And businesses need to get involved.”
Please remember that the Tax Matters provides information for educational purposes, not specific tax or legal advice. Always consult a qualified tax or legal advisor before taking any action based on this information.
Michael Bernard is the Chief Tax Officer of Transaction Tax. In his role, he provides insight and thought leadership around tax department operations, U.S. indirect tax, tax risk management, and tax policy, as well as emerging tax trends. He is an executive-level tax attorney with a diverse portfolio of experience in corporate tax, administration, and finance, including a substantive knowledge of U.S. and international tax laws.
Prior to joining Vertex, Michael was in various tax leadership roles at Microsoft Corporation for 28 years, the most recent being Senior Director – Tax Counsel. Michael led teams in the following functional areas: direct and indirect tax controversy, sales and use, business license, property, tax IT, SOX, and telecommunications. He also co-led a corporate taxpayer advocacy group with the Washington Department of Revenue and was a Director on the Board of the Washington Research Council. Michael has also testified before administrative and lawmakers at both the federal and state level.
Michael earned both a J.D. and a Bachelor of Science in Business Administration from Creighton University. He is a part-time lecturer of Law in the LLM program at the University of Washington School of Law. Michael also served on the board of directors, executive committee, and chaired committees for The Tax Executives Institute (TEI) for nearly 25 years.