International tax law principles deal with the allocation to various jurisdictions of taxing rights in respect of the business profits of a multi-national company. The basic idea is that the country of residence of a company (ie whether a company is incorporated or where its board of directors make their decisions) can tax all the business profits of the multi-national company.
However, if the multi-national company operates through a “permanent establishment”, ie a “bricks and mortar” office in another jurisdiction, then such other jurisdiction (the source state) has primary taxing rights in respect of the business profits relating to that office. The country of residence must then either exempt these profits from tax or provide a tax credit in respect of the tax imposed by the source state.
If the multi-national company does not operate through a ‘bricks and mortar’ office then only the state of residence has taxing rights over its business profits.
The problem is obvious in the context of the digital economy. The likes of Google, Apple, Facebook and Amazon do not need to have a ‘bricks and mortar’ office in a jurisdiction in order to derive significant profits from that country. And in the absence of this office only the USA as the country of residence has taxing rights in respect of business profits arising for these global tech giants. The issue is, of course, much wider than these tech giants and involves all multi-nationals operating in the digital economy.
The international tax rules have simply not kept pace with the developments in the digital economy and so in July 2019 the French took matters into their own hands and imposed a digital service tax on certain digital service revenues at the rate of 3% on the gross revenues derived from such digital activities.
The French took the view that the relevant issue is where value is created as opposed to where a physical office is located and pointed out that significant value is created by the collection and selling of data in the jurisdiction where the users or subscribers are based.
France stated that as soon as the international tax authorities (ie the OECD) amend the relevant international tax rules they would withdraw this tax, but as long as there is no international solution it intends to continue to impose this tax.
The US threatened unprecedented legal action against France and accused the French of singling out successful US tech firms and breaching existing principles of international taxation. President Trump threatened to impose tariffs on French wine and pointed out that, in his view, US wine was superior to the French varieties.
Whilst the French have been the only country brave enough to stick their heads above the parapet and incur the wrath of the USA by imposing this tax on a unilateral basis, many other European jurisdictions have draft laws along the lines implemented by the French and are also considering implementing such taxes on a unilateral basis in the absence of appropriate amendments to international tax principles by the OECD.
The OECD is now under significant pressure to provide a multilateral solution that moves away from the old “bricks and mortar” concept in order to allow the market or user jurisdiction to tax certain of the profits of, amongst others, the tech giants.
Instead of requiring a physical office, a new nexus is being considered by the OECD which is unconstrained by a physical presence. One of the potential approaches of the OECD would be to allocate a portion of the non-routine profit of a tech company to the market jurisdiction, ie, where the user or subscriber is based. The nexus could be based on revenue thresholds, certain marketing activities and digital engagement in that market jurisdiction.
This is a politically sensitive topic since, under the current rules, the right to tax all the business profits of the tech giants is allocated to the USA in which these companies have their tax residence. The new approach would allocate taxing rights to the market jurisdictions with the USA essentially losing the tax revenue allocated to these other jurisdictions.
The question arises how South Africa should respond. It is no secret that our tax revenues are lagging behind budget. Earlier this year SARS reported revenue shortfalls for the 2018/19 year of R57.4 billion. Is this an appropriate time to at least consider a unilateral approach such as that taken by the French or should we continue to wait until the OECD introduces a multilateral solution through the amendment of international tax rules? The potential tax revenues in this regard of course extend way beyond the scope of the USA tech giants and include all aspects of the digital economy. Interestingly, the French have anticipated that they will raise approximately EUR400 million from this tax in 2019.