As digital businesses grow globally, individual countries are seeking to tax either the profits or the turnover generated within their own borders – and that’s where the international tax arguments begin.
By David Walker
Ask yourself this question: what profits qualify for Australian tax?
For almost 100 years, the answer has been relatively clear. Australia’s corporate tax system, like most others, rests on the ideas of source and residence: tax residents of Australia pay income tax on profits sourced in Australia. Australia’s treaties with other nations let them tax the same way, while minimising double taxation.
As the 21st century wears on, however, this definition is breaking down. Highly digitalised businesses don’t necessarily make much Australian-sourced profit. A giant global business such as Google or Airbnb or Uber – or for that matter, a one-person business anywhere from Palo Alto in California to Fuzhou in China – can serve up advertisements or requests or ride locations to Australians. Such a business may have nothing in Australia except customers and bookmarks.
Even if such a business does have assets in Australia, two problems remain. The first is that those Australian assets may not be all that important to generating a profit for an online business. The second is that the company can arrange its affairs so that no profit appears to come from Australia, even if it actually does.
Then again, some would argue that turnover is really the heart of these companies’ businesses. Maybe, for some profitable digital companies, we should just tax that?
The digital problem
This is not a new problem, but it has grown as the internet starts to carry a significant percentage of total global business. It carries special weight in Australia, because almost a quarter of non-GST revenue comes from company tax. In 2018, then Treasurer Scott Morrison declared that “the new economy shouldn’t be some sort of a tax-free environment”.
The Organisation for Economic Cooperation and Development (OECD) has a grand plan to solve this puzzle with a uniform digital tax of some sort. It’s due to report by 2020, and it wants its own approach to carry the day. David Bradbury, the Australian head of the OECD’s tax policy division, says nations risk imposing double taxation if they “go off and do their own thing”.
Paul Drum FCPA, CPA Australia's general manager external affairs, policy and advocacy, says CPA Australia would like to see an Australian system that connects with those of others around the world – that is, an agreed multilateral system. A unilateral policy remains the organisation’s least preferred option.
The OECD’s policy is unlikely to happen in 2020, Drum notes; it’s likely to land “sometime before 2030”. That means Australia – along with New Zealand and many other countries – may need a shorter-term plan for dealing with digital tax.
New Zealand issued a background paper last year, and the Australian Treasury has issued its own discussion paper, The digital economy and Australia’s corporate tax system, looking at the options.
A semi-digital tax system
By its nature, the existing tax system does try to deal with this problem. In particular, as the Australian Treasury document notes, the BEPS (base erosion and profit-shifting) arrangements agreed in 2015 aim to stop multinational tax avoidance. A new diverted profits tax is designed to prevent large multinationals from diverting profits offshore, and the Multinational Anti-Avoidance Law bars those multinationals from using an “operate here, bill overseas” business model.
Tech giants Google and Facebook have reacted to these changes. Google’s Australian “receipts from customers” reached US$3.5 billion in 2017, five times the year before (although it reports under AASB 15, meaning 2017 revenues were a slightly less spectacular US$1.02 billion). Facebook saw revenues jump tenfold in 2016 after it restructured to bring more revenue onshore. Both Google and Facebook are now paying higher income taxes than they used to, even before the impact of the diverted profits tax.
Meanwhile, the US is taking action of its own, with a tax on global intangible low-taxed income (“GILTI”) designed to stop corporate tax avoidance in the US.
Is the current state of affairs still unfair? That may depend at least partly on where you are. If you’re a US citizen, you are likely to think that the vast bulk of profits are properly incurred in the US, where the foundational technologies of these two companies were invented.
Most of the giant digitised businesses are American. Never mind the occasional Xero (New Zealand) or Atlassian (Australia) or Spotify (Sweden); the Americans are making the big new digital profits because they invented most of the technologies that dominate this space.
If you’re an Australian – or a New Zealander, or South African, or French – you are more likely to think that Google and Facebook are making profits out of your country and should pay tax on it in your location, like any other company. You probably don’t fret too much about the precise location of income-generating labour, capital or assets.
New digital taxation?
Various ideas for digital taxes have been floating around the international tax community, using terms such as “virtual PE” and “formulary intangibles”. The countries that have launched their digital taxes, however, have opted to levy a simple share of turnover. The UK plans a 2 per cent turnover tax from 2020, Spain is enacting a 3 per cent turnover tax for companies with revenues of more than €700 million globally and at least €3 million in Spain. France would like to see all European countries move to a 3 per cent turnover tax.
At some point, however, such moves are expected to attract US ire, especially with Donald Trump in the White House. EU economics affairs commissioner Pierre Moscovici calls this “an elephant in the room”, and fears trade reprisals by the Trump administration. The German car industry would be among the first in the firing line.
Meanwhile, the OECD process steams slowly on. In January the organisation unveiled a two-pillar approach, taking aim at the challenges of the digitalised economy while also addressing remaining BEPS issues.
The OECD has acknowledged that it may end up creating new taxing rights where a business activity creates business value “through participation in the user or market jurisdiction”, beyond what’s currently used to tax profits. It’s exploring ideas such as “significant economic presence” that go beyond the current “permanent establishment” threshold for tax.
In essence, this will be a new form of agreed national tax. It should not result in taxing companies that have not made any profit, but it will be levied on something that is probably not quite “profit”, and not necessarily linked to any physical presence. There is to be “a balance between accuracy and simplicity”, the OECD says.
While it will start off aimed at Google and Facebook and their ilk, the OECD itself admits this: over time, the new tax could affect all sorts of businesses.
For Australia, the prospect of a digital tax also poses a question. It’s attractive to Australians partly because no really global-scale digital company has emerged from Australia, with the possible exception of the US$25 billion Atlassian. As CPA Australia’s submission to Treasury asks, why has Australia not managed to do better in the digital race? What can the nation do better to encourage and nurture local digital companies?
The digital loot may look attractive, and Australians may not even want to wait for the OECD to move, but the real digital prize lies not in taxing digital riches, but in generating them.
CPA Australia’s submission to Treasury on the digital economy and Australia’s corporate tax system is available at: cpaaustralia.com.au/economytax
Who's currently taxed?
Businesses that are tax residents of Australia currently pay income tax on profits made in Australia.
Any businesses that are incorporated in Australia, have their central management there, or have their voting power controlled by Australian residents are tax residents.
Profits are made in Australia when they are attributable to income-generating labour, capital or assets located there. Income from business undertaken offshore is generally exempt from Australian tax because it is expected to be taxed overseas.
That way, Australian businesses operating overseas get to play on an even playing field with locals.
Then there are two special classes: the Australian resident with foreign-sourced passive income will find that income is taxable in Australia, with a credit for foreign tax paid. The non-resident business with an Australian permanent establishment is subject to tax only on its Australian sourced income.
BEPS and the global crackdown on multinational tax evasion