Tax policy analysts may have missed an important incidence analysis in the OECD/G20 BEPS Action 1 Report: Addressing the Tax Challenges of the Digital Economy. Appendix E. Economic incidence of the options to address the broader direct tax challenges of the digital economy, p. 275-285. The analysis examines the expected economic incidence of three different taxes designed to impose uniform taxes on both remote and domestic sellers of digital goods and services. The analysis highlights the importance of the market structure of the goods and services in countries in which foreign companies compete without taxable status and the potential response of affected foreign companies to the specific tax policies.
The Action 1 report concluded that “it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purposes.” It also noted that key features of the digital economy may exacerbate BEPS risks, many of which could be addressed by proposed BEPS changes in the permanent establishment (PE), transfer pricing, and controlled foreign corporation (CFC) tax rules. The digital economy also raises broader challenges in the areas of nexus, data and characterization for direct taxes (and also challenges for value added tax collections, which will be discussed in a future blog).
The Action 1 report analyzed, but did not recommend, three potential options: (i) a new corporate income tax nexus in the form of a significant economic presence for remote sellers, (ii) a withholding tax on certain types of digital transactions, and (iii) an equalization levy. Countries could introduce any of these three options in their domestic laws as additional safeguards against BEPS, provided they respect existing treaty obligations, or in their bilateral tax treaties.
In the first half of 2016, Israel and Turkey proposed changes to their permanent establishment rules affecting some companies with "significant digital presence" or with an "electronic place of business", respectively. India enacted a 6% Equalization Levy chargeable on the gross payment for specified digital services and facilities received by a nonresident who does not have a PE in India. (See EY Tax Alert)
Given countries’ consideration of digital economy tax options, the economic incidence analysis of the options is worth highlighting. The analysis considers the expected economic incidence in open-border economies, but with particular attention paid to the fact that the options represent tax changes only for foreign providers without a permanent establishment (PE) making remote sales of digital goods and services to in-country customers.
“The tax change options are:
· a corporate income tax on the net income generated from remote sales of digital goods and services to in-country customers by a foreign producer without a PE to which such income is attributed under current law
· an equalisation levy (“excise tax”) imposed on the remote sales of digital goods and services to in-country customers by the same providers, and
· a withholding tax on the gross receipts from the remote sale of digital goods and services to in-country customers by the same providers.”
The key policy finding is, given the assumptions, the expected economic incidence of the three tax options for taxing the activities of affected remote sellers related to the sales of digital goods and services by foreign suppliers without a PE would be the same. In other words, the form of the tax options does not alter the incidence of the new taxes.
· “In the case of a perfectly competitive market for digital goods and services, the incidence of the corporate income tax increase is likely to be borne by labour in the affected foreign suppliers’ production country and consumers in market countries, depending on the importance of the affected suppliers in the particular market and the availability of replacement suppliers with similar cost structures and the availability of alternative goods and services.
· If the market is imperfectly competitive, the corporate income tax increase is likely to be borne principally by the equity owners of the affected foreign suppliers.
It should be noted that there will be a difference in the geographic distributions of the tax burdens borne by capital owners, labour and consumers. Any portion of a CIT increase that would be borne by reductions in the income of equity shareholders of foreign suppliers without a PE will occur in countries where the shareholders are located. The distribution of the burden on labour will reflect the geographic distribution of production by the affected suppliers. In contrast, any portion of the tax burden borne by consumers will be spread over market countries where the foreign producers without a PE have market power in setting the domestic price of particular digital goods and services. Therefore, the share of the total worldwide increase in tax burdens borne by consumers, workers and capital owners will vary from country-to-country.
As a final point, further analysis of the economic characteristics of the affected remote producers and the market for particular digital goods and services would need to be analysed to determine whether perfect competition or imperfect competition, in the short and medium term, is the most accurate to use in the incidence analysis. The analysis also does not provide any insights into the distribution of tax burdens by household income levels. In addition, the incidence results for the three tax policy options depend heavily upon the key assumptions about the responsiveness of foreign suppliers of digital goods and services without a PE that will become subject to the alternative tax options.”
Thus, depending on market conditions for the specific services on which the Indian Equalization Levy is imposed, the burden could be borne by Indian consumers in higher prices, IT workers in other countries in lower wages or reduced jobs, and/or global shareholders in lower capital returns.
Bob Cline and Tom Neubig