Future of Digital Tax – a step closer?

The prospect of an EU wide “digital tax” raised its head again this month following recent developments at the OECD. 

Are we now closer to implementation of a digital tax across all member states?  What impact would this have on Ireland’s offering?

Background

The EU agreed last year to park its digital tax proposals in order to allow global consensus be reached through the OCED digital tax discussions. 

Broadly, both the EU and OCED proposals aim to allocate a portion of profits based on the location of consumers, reflecting the increasing value that businesses place on consumer data.

The withdrawal of the US from the OCED’s digital tax discussions increases the likelihood that the EU will now again push ahead with its own proposals. 

While things may change again depending on the outcome of the US elections, as noted by Pascal Saint-Amans this week, for the moment the OECD digital tax work is on hold.

In the short term, the impasse at OCED level is also likely to see other countries push ahead with unilateral digital tax proposals.  Indeed many EU countries have now either implemented or proposed their own digital tax proposals.

Very broadly, the EU’s original digital tax proposals envisaged a simple 3% turnover based tax as an interim measure subject to reaching agreement on a means of allocating profits based on digital activity.  Given the complexities involved in arriving at such a means, the risk is that any interim “quick fix”, such as a flat turnover based tax, could potentially become permanent.

While countries are free to introduce their own digital tax measures, as several have done, implementation of an EU wide digital tax regime would require unanimity across all EU member states.  Unanimity could make it difficult to implement as certain countries, including Ireland, are not in favour of the existing EU digital tax proposals.

However, the EU is looking to replace unanimity over tax decisions with a form of “Qualified Majority Voting”.  While any such change itself requires unanimity, political factors could lead to the removal of unanimity in the future, potentially paving the way for easier implementation of EU wide tax changes.

While the removal of the requirement for unanimity on significant EU tax decisions is some years away, in practice countries are often reluctant to use a veto to block EU tax proposals.  Hence the possibility of an EU wide digital tax in the short to medium term is real.

COVID-19 is also likely to drive countries to look for additional tax revenues to fund spending, with digital tax from large multinationals likely seen as an easy target.

What does it mean for Ireland?

In recent years, many multinational companies (“MNCs”) with substantial operations in Ireland have moved their valuable Intellectual Property (IP) here.  Over time, this would be expected to increase corporation tax revenues in Ireland,.  

A simple 3% tax on the “digital” revenues of large multinationals would increase the effective tax rate of these companies and thus dilute the benefit of our 12.5% corporate tax rate.  Low margin businesses would be impacted most.

From a pure tax perspective, it would make it less attractive to operate from Ireland.

Thus while the movement of IP to Ireland should see an increase in our corporation tax revenues, a new EU wide digital tax could see a pull the other way if it caused some groups to reconsider their Irish presence.

However, even if our tax regime becomes relatively less attractive, our 12.5% tax rate may still make Ireland the most compelling location in Europe in which to do business, which should help us retain key employers.

The EU acknowledges that a 3% turnover based tax is a blunt instrument and that a more refined taxation of digital activity is the end goal. 

The OCED had been considering other options, which would involve looking at the level of activities in the selling country in determining an appropriate allocation between the selling country and the market jurisdiction.  However it is acknowledged that this is a difficult exercise, potentially involving a rewriting of transfer pricing principles, hence the EU proposal to start with a straightforward 3% turnover based tax.

Ideally, there would be agreement at EU level on a more sophisticated, and accurate, means of profit allocation rather than simply jumping into a turnover based tax regime.  While this might take some time to develop, it could be part of negotiations at EU level given that unanimity is required in order to implement any digital tax proposals (although countries would remain free to continue to develop their own digital tax regimes, which is a far from ideal scenario).

A longer term solution that reflects the value added activities taking place in the selling jurisdiction, not simply market jurisdiction factors, would be better for Ireland, as well as encouraging more knowledge based activities to locate here.     

If the price of any negotiating on the digital tax proposals is that unanimity over tax decisions is removed, then there is the longer term vista of other EU proposals being pushed through, including the dreaded CCCTB, which would again look to rewrite the rules in terms of the allocation of a group’s profits. 

Such moves would be bad for a small open economy such as Ireland, with significant profits diverted to larger market jurisdictions again diluting the benefit of our 12.5% tax rate.

Once again, we are at a critical juncture in terms of global tax rule changes.  Developments to date have generally been positive for Ireland.  However, it would be dangerous to think that this will continue to be the case.

While in practice our options are limited in terms of influencing the direction of travel, in any future scenario the location of high value-add activities should continue to play a key role in the allocation of a group’s profits.

One thing that is not good for Ireland is uncertainty.  Groups cannot make robust plans in an environment of uncertainty.  The sooner that there is clarity on digital tax changes, the better from Ireland’s perspective.

Ongoing robust corporate tax receipts evidence the generally positive impact that global tax changes have had in Ireland to date, with a movement away from tax havens to jurisdictions with substance.

If Ireland can continue to maintain a regime that both encourages and rewards innovation, we will be in the best possible place to emerge relatively unscathed from the latest round of changes.