David Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Worldwide Tax Daily. Change is inevitable, and adapting to change is one of the most difficult things that we as humans must do. But how does a tax system adapt to fundamental changes in the economy? That is a question now being asked at the Organization for Economic Cooperation and Development and the European Union, among others.
As much of the economy goes digital, how can tax policies developed for an analog world keep up? Joining me in the studio to talk about this is Worldwide Tax Daily senior reporter Stephanie Johnston, who has been following the issue. Stephanie, welcome to the podcast.
Stephanie Johnston: Thanks, good to be here.
David Stewart: Stephanie, lay out for the listener the problem that needs to be addressed.
Stephanie Johnston: So I had a hard time coming up with a short answer to this. There's 99 problems, and a concise explanation is one. The Internet, as we all know, has changed our lives in ways we never thought possible. You can look up anything on Google these days. You can connect with friends on social media like on Facebook and Twitter. You can order books and services through online platforms like Amazon. But with new technologies come new problems, especially for the tax system that relies on outdated tax rules that can't keep up with the pace of change. And this isn't a new problem. The OECD has been thinking about this since the 1990s. But the pressure has really ratcheted up in recent years on the OECD and on governments to come up with some solutions.
David Stewart: What do policymakers mean when they talk about the digital economy?
Stephanie Johnston: It's the economy that's being transformed by advances in information and communications technology. These developments are changing business models and processes and encouraging innovation in all economic sectors, including traditional sectors like retail. And I really see the problem as having two dimensions.
First, there's the technical. So, under current international tax rules, it's a generally accepted fact that a company should be taxed where it's resident, or it should be taxed where it carries out business activities through permanent establishments in other countries. But in an increasingly digital economy, companies can now make profits around the world, but without PEs in other countries. So business models and value chains are evolving, and they're changing the ways in which companies create value. And that value creation is no longer necessarily tied to a company's physical presence in a market. As a result, you're seeing more and more headlines about how major multinationals, like Google, Apple, Facebook, and Amazon, which the Europeans oddly call GAFA, seemingly pay little or no tax in the countries in which they operate.
So that brings me to the second dimension of the problem, which is the political. Governments are under pressure from the public and are becoming increasingly impatient with the status quo, and they're looking for ways to tax the digital economy. And these countries are tired of seeing these MNEs make money in their countries without paying much tax, and now they're looking for answers.
David Stewart: Who is working on a solution to the problem?
Stephanie Johnston: Right now, the tax world is looking to the OECD for answers. And the Task Force on the Digital Economy, they tried to address this issue in action 1 of the OECD base erosion and profit-shifting project. But they really just scratched the surface of the issue and didn't really come up with a short-term or long-term solution. And the task force said it would write a report in 2020 about the outcome of this work related to the digital economy. So that timeline was supposed to give the OECD a nice, long time frame to work on real solutions. But of course, politics is a fickle master.
In February, G-20 finance ministers asked the OECD to come up with an interim report on the way forward on this issue. So now the task force is supposed to submit that to the group in April 2018. That's not a whole lot of time. So the OECD kicked off a consultation in September, and then they did a public consultation on November 1st at the University of California at Berkeley. And that was an interesting choice, I have to say, since most of the OECD's consultations happen in Paris. But it made sense for the OECD to have it near Silicon Valley, given the subject matter.
David Stewart: What are we expecting to see in the interim report?
Stephanie Johnston: I've been trying my hardest to get some concrete details out of the task force on this issue, and they've been fairly tight-lipped on what this might look like, for good reason. But we have heard hints of what it will contain here and there. For example, the OECD, during its latest Tax Talks webcast, they said that the report will likely contain analysis of how digitalization is affecting markets and business models. And they'll also take a look at the impact of BEPS project measures and take a look at measures that countries have already taken. And they’ll also look at interim short-term measures, but also in the context of how to minimize harm. But I think what will be most important for this report is the OECD establishing a clear path for advancing work on long-term solutions and setting up a road map for future work on the issue.
David Stewart: Now while the OECD is working on in this report, I can't imagine that countries are standing still. What are individual countries doing about the taxation of the digital economy?
Stephanie Johnston: Well, countries certainly aren't winning any prizes for patience. Starting in 2015, we saw countries like the U.K. and Australia implement diverted profits taxes. And India introducing an equalization levy on payments for online advertising services. So those are just a few examples of how countries are sort of moving forward ahead on this issue without waiting for the OECD.
After the OECD started work on its interim report, something interesting happened in the EU. A group of 10 finance ministers, led by France, Germany, Italy and Spain, they started pushing for a turnover-based equalization tax and asked the commission to come up with some details on this proposal. So although it might seem like the EU is trying to do its own thing, both the EU and the OECD say they're working closely with each other toward finding solutions.
But then we've also seen the commission basically saying if the OECD doesn't come up with a good plan by April, then the EU will move on its own. So the pressure is certainly on the OECD to deliver a strong report in April 2018 to herd these cats, so to speak, and to move the focus toward sustainable long-term solutions.
David Stewart: If the goal is to find long-term solutions to the taxation of the digital economy, then why is there so much pressure for short-term answers?
Stephanie Johnston: So, many government officials at the Berkeley consultation have said they really do not want to introduce short-term measures, and they do recognize that there are a lot of practical issues related to some of these proposals.
For example, the turnover tax on companies. That would potentially stifle innovation and strangle startups that aren't usually profitable their first few years of life. There's also concern that some of these short-term measures will not be phased out in time and won't really lead to long-term solutions. But many government delegates said at the consultation that they really have to move because there's so much pressure on them, and they really have to show that they're moving and they're taking action to address this issue.
One government official at the consultation put it really well. He compared the situation to letting the air out of a pressure cooker before the food is cooked to prevent it from bursting. So they really are feeling the heat on this.
David Stewart: What does all this work on the digital economy mean for U.S. companies?
Stephanie Johnston: I'm guessing right now, U.S. companies are more worried about U.S. tax reform than about the taxation of the digital economy. But I would think that it's something that they're keeping an eye on still. They're also coming under a lot of pressure from governments, and we're seeing some signs that they're caving in.
You may have heard recently that Facebook announced that it would start recording advertising revenues in countries in which it has offices. And even though the company said it wasn't tax-motivated, many observers have said that the move is in response to the pressures from the BEPS project and the ongoing debate on taxation of digital economy.
But for now, I think the current work will mean that there will be some uncertainty for these companies in the near future. And hopefully, this interim report in April will help get rid of some of that uncertainty.
David Stewart: What work can we expect on the digital economy in the coming months?
Stephanie Johnston: So all eyes are on the OECD now, and I think that the publication of the interim report will be a big deal. The commission is also expected to come up with legislative proposals sometime in early 2018, so that will be another big thing to watch. In the meantime, keep your eyes and ears open for developments around the world.
You know, I'd really be surprised if we didn't see more countries moving ahead with unilateral measures ahead of the OECD's report. It's been pretty fascinating to cover developments in this space because the pace of change in this issue has been intense, it's been very fast. Things are moving quickly, so blink, and you might miss developments. But watch this space closely. I know I'll be.
David Stewart: And I'm sure you'll keep us informed. Stephanie, where can listeners find you online?
Stephanie Johnston: You can find me on Twitter. My handle is @SoongJohnston. That's S-O-O-N-G-J-O-H-N-S-T-O-N. For updates on this and other international tax developments, and the occasional animal video.
David Stewart: Excellent, thank you for being here.
Stephanie Johnston: Thanks for having me.
David Stewart: That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or would like to suggest a topic for a future episode, you can email us at podcast@taxanalysts.org. Be sure to subscribe on iTunes or Google Play to make sure you get the next episode of Tax Notes Talk.
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