NewsDeloitte: New Rules for Taxing Digital Companies

On Wednesday 21 March 2018, a proposed reform was presented, enabling member states of the European Union (“EU”) to tax revenues generated by large digital companies in their territories. The proposal should thus eliminate the existing discrepancy between where the revenues are generated and where they are taxed. The proposal was strongly opposed by the United States of America as well some EU member states (such as Ireland and Luxembourg) that attract large firms with low taxes.

The reform is a response to the ongoing digital revolution where the rules for taxing digital companies operating in Europe are highly limited, namely owing to the existing definition of a permanent establishment. The original rules were drawn up in the previous century prior to the introduction of the Internet and were based on the assumption that cross-border trade is based on the physical import and export of goods and services. The existing setup thus makes it impossible for member states to tax digital companies operating in Europe unless they have a sufficiently large physical presence in the EU’s territory.

The proposal works under the assumption that the calculation of the tax base would first be unified, with revenues generated by multinational corporations subsequently divided among all the countries where the company operates. The reform would introduce the legal definition of a “digital presence” of companies in the territories of member states for the purposes of corporate taxation.

Thanks to this, it would be possible to tax companies in the territory of the given state without the company having a physical presence in it and with the company’s digital activities playing the decisive role. Permanent establishments would be set up by the companies that met at least one of the following criteria: annual income from digital services in the given member state in excess of EUR 7 million, over 100 thousand users in the given state during the taxation period, or over 3 thousand contracts for the provision of digital services entered into with other firms during the taxation period.

According to the European Commission, the new rules should also address a fairer allocation of collected revenues among individual states based on the on-line value generated. The criteria could include, for example, the location of the user at the time of using the service. In adopting the proposal, legislators of individual member states will thus have to tackle the task of preventing double taxation. The rules for preventing double taxation are stipulated by double taxation treaties; however, the relevant provisions are outdated. A directive should prevail over international treaties concluded by EU member states; nevertheless, amendments to treaties would need to be negotiated with non-EU countries. As a matter of interest, approximately 60 treaties would need to be revised solely in the Czech Republic’s case.

As the approval of the directive itself is expected to take some time, the EU has come up with a provisional solution whereby certain digital activities would be subject to “interim tax”.

This is a response to the activities of certain states (Italy, Slovakia and others) that have already approved or started to enforce similar measures. Although the proposed tax is classified as income tax, it would, in essence, consist of the indirect taxation of income from the sale of advertising space on the Internet, from digital mediation activities or from the sale of user data.

The measure would apply to companies with a minimal global annual income of EUR 750 million, of which income from the EU should amount to no less than EUR 50 million. The measure would apply to both cross-border and domestic services (to prevent unlawful discrimination). At this point, it should be noted that the introduction of the interim tax could lead to double taxation both at the level of turnover taxation and the level of standard profit taxation.

At the expected rate of 3% of gross revenues (ie excluding costs, if any) from digital services, member states’ annual income is estimated to increase by up to CZK 127 billion following the introduction of the tax.