European Commission Mulls over Proposal for Withholding Tax on Online Sales in Framework of the ‘Digital Economy’
06 October 2017
On 21 September 2017, the European Commission launched a new agenda on the taxation of the digital economy. A key concern is to ensure that companies with a significant digital presence pay an effective tax rate similar to traditional companies. It is likely that online retailers will be affected by the proposals, although the final form of the new taxation regime is not yet clear.
The Commission has noted that the current tax framework does not ‘fit with modern realities’, especially when many companies operate across borders and have business models which increasingly rely on new technologies and new platforms for consumer choice.
Hong Kong and mainland Chinese traders will appreciate that digitalisation changes the nature of exchange by blurring the lines between goods and services, transforming products to their digital representation, such as e-books, or using the least material possible, for example 3D printing. As the global economy becomes increasingly digitalised, so existing business models will need to adapt to this new reality as new and innovative business models emerge.
The main characteristics of these new business models include the ability to conduct activity remotely, volatility in the market, an occasional tendency towards monopoly or oligopoly, and network effects.
Consumer behaviour is also changing. New generations of consumers favour instant access over ownership, as is seen in the large growth of online sales. Asset-light digital platforms connect spare capacity and demand, and facilitate huge amounts of collaborative transactions, which are forecast to grow by 35% per year over the next decade. It is likely that Hong Kong and mainland China-based businesses are expected to be key growth areas of economic activity in the EU in this regard.
The Commission observes that businesses of all kinds now derive much of their value from intangible assets, information and data. There is no single defining feature of new ways of doing business in the digital space and the different aspects are often combined together in a single business. From a taxation point of view, this diversity will require substantial work on the scoping of the various types of digital activities and services to be covered by any potential solution.
In this context, the Commission calls for long-term solutions at EU and international level, but also proposes short-term measures. The long-term solutions include progressing the establishment of a Common Consolidated Corporate Tax Base (‘CCCTB’) throughout the EU and further cooperation through the OECD and G20 to combat Base Erosion and Profit Shifting (BEPS). These are likely to raise difficult legal and political issues, including compatibility with double-taxation treaties, free trade agreements and WTO obligations.
Short-term proposals include a levy on revenues generated from the provision of digital services or online advertising, and an equalisation tax on the turnover of digitalised companies. These proposals would primarily affect internet-based businesses such as social networks and advertisers.
Of particular relevance to retailers, however, is the Commission’s proposal for a withholding tax on digital transactions. In broad terms, the Commission proposes a stand-alone gross-basis final withholding tax on certain payments made to non-EU resident providers of goods and services ordered online. Retailers who are resident in Hong Kong and mainland China and who sell to EU-based customers through online channels would therefore likely be affected.
While these proposals are at an early stage, they highlight the EU’s increased interest in addressing the fiscal challenges of digital trade on a pan-European basis. The Commission emphasises that the growing challenge of ensuring that the digital economy is taxed fairly has still not been adequately addressed, primarily due to a lack of international consensus and the multidimensional nature of the challenge. Its response is to begin with these proposals for short-term solutions while working on longer-term solutions in a more global framework.
An approach at European level may streamline taxation for businesses seeking to operate in the EU without establishing a physical presence there, but it may also increase the regulatory burden. An OECD interim report on taxation of the digital economy will be presented to the G20 in the spring of 2018, and it is expected that the Commission will set out its final proposal shortly afterwards.
Please click on the following for the full text of the Commission’s Communication.