DIGITAL ECONOMY – Value generation, taxing powers and proposal for the Income Tax Collection
We intend to analyze the tax aspects of the digital economy based on the principle embodied in Action 1 of BEPS, concerning the digital economy, to achieve ” … a better alignment between the localization of taxable profits and the localization of economic activities and the creation of value”. In other words, it seeks to ensure “… that profits are taxed where economic activities take place and value is added”.
In short, we can define the digital economy as the production of intangible goods and services based on ICT Technology, Information and software, and their consequent transaction between different types of users. Examples of goods and services produced by the digital economy and supplied through the internet are software, digital storage service, sale of tangible goods, provision of television services or entertainment, a medical consulting, or the sale of an e-book.
To analyze the generation of value in the digital economy, we perform the following classification of its goods and services:
Primary digital goods are those that allow the provision of digital services, the procurement of traditional services or the conduct of transactions relating to physical (tangible) or secondary digital goods (which we will define below). Examples: the digital platform that provides the Language Teaching Service over the internet, the one that allows buying tickets or hotel services, rent a car, buy a machine or “download” a software for graphic designs on a PC.
Primary digital goods have value with their existence alone combined with potential demand. Example: for a digital language teaching platform to have value, its existence and potential demand are necessary. By potential demand, we mean users who are potentially willing to demand the use of the digital platform. With these two aspects combined, the digital platform acquires value and can be transferred at a certain price by its creators. If this potential demand did not exist, the digital platform would have no value.
Secondary digital goods are intangible goods produced from a primary digital good. Examples: an e-book or a copy of a movie or software “downloaded” by the particular consumer.
Digital services are those that are provided through digital platforms, such as the service that is provided to rent a hotel room, the one that is provided to when a language course is being conducted online, or the one for which you buy a physical asset via internet.
Both for the existence of a secondary digital good and a digital service, the prior existence of a primary digital good is necessary, through a software that allows, for example, accessing content (movies, software) or download them from the network (e-book).
Likewise, in the case of a secondary digital good and a digital service, in order for them to come into existence, and their valuation, their effective demand is necessary. That is, in these cases, even if there is a potential demand, neither the good nor the service exists and therefore neither their value without an effective demand. That is, they can have a potential demand, but they do not take on existence and, logically, their value will not be generated, if that concrete potential demand is not verified. Therefore, unlike a primary digital good, potential demand is not sufficient, but the existence of real, concrete demand is essential.
As for the creation and generation of a value of a secondary digital good and a digital service, both share the same characteristic as a service of the traditional economy. Example: the service of a dentist is not generated, and therefore its value, until an actual demand for it appears. In other words, the dentist has the ability to provide the service, given his knowledge and tools available to him or her, but his or her services (and their value) do not exist until the specific, real patient appears, demanding them.
Once we have characterized how the value of the various goods and services of the digital economy is generated, it is necessary to determine which state, or states, have authority to tax the profit derived from the transaction of that value.
In this regard, it is worth quoting Giuliani Fonrouge, who mentioned that in referring to the tax power, we are referring to the cause of the tax. In this regard, the author cites the Italian School of Taxation, whose main representatives are Ranelletti, Griziotti and Vanoli. Quoting the first of these tax experts, Giuliani Fonrouge stresses that he considers that “… “…a service, as generally understood, provided by the State to the society, is the first and mediate cause of the tax (Giuliani Fonrouge 1997).
Then, given the jurisdictional Nexus pursued by Action 1 BEPS, which is the generation of value and where the activity is developed, the state or states with tax power to tax the income of the digital economy will be the state or states that allow the generation of value and in whose jurisdiction the activity is developed.
Attentive to the previous analysis of how value is generated in the digital economy, we can identify:
In the case of the transfer of ownership of the primary digital good, aware that the existence of the primary digital good is due exclusively to the digital State, it is the digital state that has exclusive power over the income derived from such transfer.
In the case of the transfer or lease of secondary digital goods and digital services, since their existence and value are derived from the interaction of the primary digital good and the demand thereof, both the digital State and the market state have tax power over the income generated by the transfer or lease.
In the case of profits derived from sales or leases of secondary digital goods or digital services, a double taxation arises when the digital State is different from the market state
In the case of internationally traded services of the traditional economy, the existence and value of which arise in the same way as that of secondary goods and digital services, there is also double taxation, but the difference is that it occurs through the application of two different jurisdictional nexus (usually residence and source). On the other hand, in the case of secondary goods and digital services, based on the aforementioned criterion established in Action 1 of BEPS, the double taxation is verified on the basis of the same jurisdictional nexus, the generation of value and the place where the activity takes place.
While both the digital State and the market state contribute through their interaction to generating value, and the income in question, it is very difficult to determine to what extent each state contributed to generating that value. That is, it would be an arduous and debatable task to determine how much of the value and income originates in the existence of the digital good and how much in its demand. In addition, that proportion is likely to vary according to the particular primary and secondary digital good and digital service. To the difficulty of determining the extent to which each jurisdiction contributes to the generation of the value in question, one can add the cost and time it would cost both states and taxpayers.
In view of the foregoing paragraph, it is understood that a practical solution, that is, easy to understand, low-cost and easy to implement, would be to agree internationally on a percentage distribution of the tax base (income) between the two states. This agreed percentage distribution could even be revised with a certain predetermined periodicity in order to consider new parameters of analysis that may arise.
In this way, a percentage of the tax base is attributed to the digital State and the remaining to the market state, applying each of these states the tax rate that each of them decides in exercise of their fiscal sovereignty.
We should keep in mind that there is likely to be more than one market jurisdiction, and even that the digital jurisdiction may also at the same time be a market jurisdiction. In this case, the share of the tax base corresponding to the market jurisdictions could be distributed among them on the percentage share of each in the amount of sales.
As for the value of the tax base (income), it can be determined based on the accounting statements of the holder of the primary digital asset, prepared in accordance with international accounting standards (example: IFRS).
With regard to the collection of the tax, since the entity that is the owner of the primary digital asset, and therefore calculates the revenues and costs related to it, is located outside the market jurisdiction, the task of determining the tax base and collecting the corresponding tax is difficult for said market jurisdiction. (collecting directly the tax to the holder of the digital good parent is appropriate, because, as was already discussed in this same space,[1] the collection at the source can lead to a grossing-up, that would imply that the burden of the tax falls upon the consumer, hurting the economy of the market state, coupled with the fact that there is already a consumption tax on the income of the digital economy, in fact this would verify two consumption taxes).
Then, in order to correct the circumstances described above, the digital State could collaborate, either by providing information on the amount of taxable benefits, or, without prejudice to this exchange of information, by collecting the corresponding tax which will then be sent to the market state (a fee could even be agreed upon to be paid to the digital State for the provision of this service).
In conclusion, it should be noted that without prejudice to the solution adopted to tax the revenues of the digital economy, whatever the modality adopted, it should not only be fair to individual states, but also not be complex, neither in its interpretation nor application, in such a way as to facilitate the task of tax administrations and taxpayers, while avoiding excessive costs for both parties.
For further details of these concepts, please consult the following link:
[1] Economía Digital – Impuesto a los beneficios en las transacciones internacionales. Necesidad de aguardar una coordinación global – 3 diciembre, 2018
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