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| April 5, 2018

Tax (r)evolution in digital economy

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Within the area of digital economy, the problem is no longer tax evasion but the question what should global taxation of digital economy businesses look like. Rules stemming from traditional economy cannot provide optimal results in these cases. Business often generate significant revenues abroad without having to be physically present in said countries. The rules of traditional economy, focused mainly on the physical presence, omit the fact that a large portion of the value of digital businesses comes from other forms of non-physical/intangible presence abroad, e.g. social network of users. Thus, the digital revolution toppled economies of countries and shook the ways in which businesses create revenue nowadays.  

Even though taxation of digital economy is a global challenge, the European Commission has decided to bring forth a draft of a solution for Europe. With the Fair Taxation of the Digital Economy initiative from March 21st, 2018, the Commission brought forth a set of new regulations which should lead to a more just and sustainable way of taxation of the digital economy within the European Union.  

One of the reasons the European Union is focusing on taxation of digital economy businesses is the fact that, according to the data of the EU, the effective tax rate imposed on digital companies is 9,5% on average, whereas for traditional companies the rate is 23,2%. The new draft of the European Commission aims to set tax regulations for digital businesses which would be more fitting for the way of business of our age; and this should result in retention of profit in states where the revenue was created. This proposal does not concern only the U.S. technology giants such as Google, Apple, or Facebook. 

The EU based the proposal on the internationally accepted basis that revenue should be taxed where it is created. However, what happens today is that the place where the revenue was created is not the place of profit taxation. Because the setting of new rules will take a long time, the European Commission proposed a temporary solution: digital tax of 3%, which shall apply to gross revenue. However, this tax would not apply to smaller companies, only companies with a global revenue higher than 750 million euros, out of which at least 50 million come from the EU.  

One of the most important ideas in the proposal is to re-structure taxation of legal persons so that the taxable revenue is divided among relevant jurisdictions, based on the scale of the added value. For this reason, the European Commission introduced a set of rules for the permanent establishment, so called digital permanent establishment. According to the proposed rules, a permanent establishment should be created if: 

  • a company reaches revenue in the value of 7 million EUR from providing digital services in the territory of a given state, 
  • surpasses the limit of 100 000 digital service users in the territory of a member state, 
  • surpasses the limit of 3 000 contracts concluded in the territory of a member state.  

The implementation of said draft into legislation (and practice, as well) will most likely be accompanied by several issues because to be able to implement tax regulations concerning the whole of the EU, it is necessary to have a unanimous approval. And there is no such thing in sight for now. We can only speculate whether countries like Ireland or Luxembourg, famous for their low-tax philosophy, would agree to such a change. The proposal has already been criticised by these countries. Critical voices have been heard from the United States as well, since they would also be affected negatively by the new rules. 

Since the proposal has been met with a wave of displeasure and some critique and since one needs a unanimous agreement to implement a change in the field of taxation, it is safe to assume that adoption of these new rules will take a long time.  

We will provide more information concerning this proposal in the following issues of our newsletter. 


Veronika Novotná & Štěpán Osička