The European Council’s Expert Group on the Taxation of the Digital Economy, which was set up with the task of examining key tax issues relevant to the digital economy (“DE”), issued its final report to the EC on 28 May 2014.
The main conclusions are as follows:
- A separate tax regime for the DE is specifically ruled out.
- The report advocates that the current VAT exemption for small consignments from non-EU countries be removed to ensure tax neutrality (in the UK this exemption has already been removed for imports from the Channel Islands, following intensive lobbying from UK retailers). This is to be further supported by the VAT One Stop Shop (“OSS”) initiative which is being implemented in 2015 as well as a proposed fast track customs procedure.
- The report sets out that a destination-based VAT system for digital services i.e. taxation at the place of consumption, along with the anticipated tax simplification benefits arising from OSS and its possible extension to smaller entities will help simplify and reduce ‘red tape’ costs associated with the current tax system. It also suggests that there could be a possible extension of the OSS to all goods and services in Business to Customer (“B2C”) transactions in the future.
- The report identifies that the G20/OECD Base Erosion and Profit Shifting project (“BEPS”) will be instrumental in tacking tax avoidance and aggressive tax planning globally and it advocates that Europe should play a central role in promoting BEPS. The report highlights priority BEPS areas including countering harmful tax competition, revising transfer pricing rules and reviewing the concepts for defining and applying taxable presence in the DE.
- Particular emphasis is drawn to what the report identifies as an EU opportunity to influence new developments in international tax standards such as the movement towards an increased use of profit split methods for transfer pricing purposes. The report lists the EU initiative on drawing up a Common Consolidated Corporate Tax Base (“CCCTB”) as a key example.
- Finally, the report leaves open the possibility introducing more radical reforms of the tax system, including a “destination-based cash flow tax” in the longer term.
What is the likely impact of the report on European tech firms?
The report is generally good news for in-bound investors in the European tech markets in that it is a very strong signal in support of broadly maintaining the current tax system as it is. The adverse public reaction to the often exaggerated media reports on the taxation of digital companies meant that this report was prepared against a backdrop of unprecedented public pressure that could have resulted in the recommendation of reactionary measures. As it stands the report reveals a measured response to what it sees as the very real problem of aggressive tax avoidance. It advocates that the EU should seek to build international consensus on tax matters through working with international bodies such as the G20 and the OECD and supporting reforms that are more likely to be widely adopted.
The two areas of EU taxation that will likely experience changes are VAT (where changes are already underway in the form of the introduction of a destination based VAT system) and transfer pricing where changes to transfer pricing rules pertaining to the pricing of IP are likely to be adopted by 2015. Both of these areas will be of concern to tech companies and many will undoubtedly want to carefully consider how best to structure their European businesses so they can adapt to the changes with minimal impact on commercial arrangements. Some tech companies may find that some business models may no longer be appropriate following some of the changes. For example, the abolition of the VAT exemption for small consignments from outside the EU may change the way some digital and physical format companies sell content in the future, as it will level the playing field as between digital content and physical DVDs / CDs being imported from outside the EU. Another example is that the way IP revenue is booked and recognised may need to be reviewed as a result of the changes to the transfer pricing rules with the result that effectively only the true IP investor with the demonstrable capacity to innovate and develop IP will be able to book IP revenue for tax purposes.
The report is an interesting development, but should not be viewed in isolation. The BEPS project and the statements being made by individual governments across Europe will need to be carefully followed and examined in the coming months as they are an integral part of the changes to the European tax system.