This article first appeared in Forum, The Edge Malaysia Weekly on October 23, 2017 - October 29, 2017
Technology companies continue to dominate the headlines. From the generous valuations for start-ups to record highs for the Nasdaq, it may seem to some observers that the tech industry can do no wrong.
However, the industry has its fair share of issues with senior executives having to deal with legal concerns such as patent disputes and regulatory challenges to unique business models such as ride-sharing and accommodation sharing. These executives will now have to add “managing the tax man” to their agendas because tax authorities around the world are focusing on the digital economy like never before.
The challenges of taxing digital transactions are well documented. Corporate tax laws that were designed to tax companies based on physical presence (the so-called “bricks-and-mortar” businesses) cannot cope with online trading across borders, where business value is driven by intangible assets and data.
Traditional indirect tax rules, which generally tax the physical movement of goods or provision of services, are simply not able to deal with services and e-goods (such as music and books) provided digitally. As more and more businesses move into the digital space, tax authorities cannot afford to maintain the status quo.
So, what does the future hold for the taxation of digital businesses? The Organisation for Economic Cooperation and Development started the ball rolling by making “Addressing the Tax Challenges of the Digital Economy” the very first action item in its 15-plan “Base Erosion and Profit Shifting” (BEPS) initiative, formulated to address aggressive cross-border tax planning.
Countries around the world have subsequently taken action to plug perceived gaps in legislation. Technology companies will have to accept that they will need to contend with significantly different tax systems and issues in the various countries they transact with.
Geographically, Europe is at the forefront of change and it appears that the European Commission will not shy away from developing innovative means of taxing digital transactions. In a recent communication, the EC discussed measures such as a so-called “equalisation tax” to be applied on the turnover of digital companies, withholding tax on digital transactions and separate levies on revenues.
Whilst no conclusions have yet been reached, Europe appears committed to establishing coordinated measures to tax the digital economy. The EC is concerned that divergent approaches by EU member states may lead to greater uncertainty and the unintended consequence of creating new loopholes.
In Asia, in the short term, countries are likely to continue to focus on the Value Added Tax (VAT) and the Goods and Services Tax (GST) as a means of extracting a fair share of tax from digital transactions. India, Japan, China and South Korea, to name but a few, have made sweeping changes to their indirect tax laws to tax digital supplies of goods and services. Australia and New Zealand have done the same.
The general concept here is to compel the supplier of digital products/services to register for indirect tax purposes (and charge VAT/GST as appropriate) in the country in which the customer resides, as opposed to only in the country in which the supplier is located (where there may be no indirect tax or where indirect tax may not apply to exports).
Interestingly, the US, home of Silicon Valley, does not appear to have focused on the taxation of the digital economy at a federal level. Instead, it is likely that digital taxation will first be addressed at the state level with the Marketplace Fairness Act proposed earlier this year to allow states to collect Sales and Use Tax from online retailers based elsewhere.
Microsoft co-founder Bill Gates, in the meantime, has jumped into the fray by suggesting a “robot tax”, where companies replacing human labour with technology will pay a tax, which is then used for re-training and upskilling displaced workers. Incidentally, earlier this year, the European Parliament decided against such a tax.
In Malaysia, Budget 2018 may address the taxation of the digital economy, possibly in the form of changes to GST rules to collect taxes from foreign companies making sales to Malaysian customers electronically — similar to the concept discussed above.
Ironically, technology will play a crucial role in the tax authorities’ efforts to tax digital players. For example, tax authorities will increasingly rely on data analytics, using the large amount of information that will become available to them under the disclosure rules laid out in the BEPS initiative, to detect tax leakages. Meanwhile, the Inland Revenue Authority of Singapore has approached ride-sharing firms to ask that they electronically disclose the amounts paid to their drivers, which will prevent drivers from under-declaring income earned through ride-sharing apps.
Overall, the challenge for regulators will be to ensure that the tax rules they propose are fair, easy to understand and relatively simple to administer and enforce — no easy task. Upfront consultation with relevant stakeholders will be crucial.
Digital businesses, meanwhile, need to understand that tax laws are changing very rapidly. They will need to ensure that they remain updated and fully understand the impact of changes in tax laws on their business models, profits and tax compliance obligations. Failure to react appropriately could result in financial and/or reputational impact. It looks like this is just the beginning of a long road.
Anil Kumar Puri is a partner at Ernst & Young Tax Consultants Sdn Bhd. The views in this article are his own and do not necessarily reflect those of the global EY organisation or its member firms.
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