Digitisation of the economy has presented numerous challenges to global governance. One such challenge is the framework to address tax challenges pursuant to increased digitalisation. The Organisation for Economic Co-operation and Development (OECD) is working on a multilateral effort towards drafting a framework for addressing tax challenges that were created pursuant to digitalisation, which is at present being supported by 139 countries.
Amid the ongoing deliberations at OECD and G20, the United Nations Committee of Experts on tax matters has approved the recommendation to add Article 12B to the existing UN Model Convention. Article 12B seeks to tax “automated digital services” through bilaterally negotiated tax treaties.
At the outset, the experts committee must be appreciated for its efforts in coming up with a simple solution to this issue. Though, it may be argued that the proposal does not preclude itself from some technical and policy challenges that could come in the implementation process.
Article 12B proposes two alternate options to tax the income from automated digital services, i.e., on gross basis or net basis. Gross basis method is an imposition of withholding tax by the source country, rate of which is to be agreed through bilateral negotiation.
Meanwhile, net basis taxation is subjecting qualified profits to the applicable domestic tax rate. Qualified profit is to be considered as 30 per cent of the amount resulting from the profitability ratio to the gross annual revenue from automated digital services derived from the source jurisdiction. Gross based taxation may cast significant and disproportionate tax burden on the MNEs compared to the profits they make from the source countries. This might also result in passing these tax burdens to the end users which might prove to be counter-productive.
It is worth noting, net basis taxation requires computing qualified profits in accordance with laws of each country, this could raise administrative difficulties and significant compliance costs for an MNE operating in several countries. Additionally, a formulary apportionment of 30 per cent of the profits departs from widely accepted transfer pricing rules (in India and Internationally) and is not backed by any research.
Further, Article 12B limits itself to only automated digital services. Therefore, it gives countries a chance to unilaterally impose tax measures on the businesses that are outside the current scope of Article 12B. The provision does not contain any express prohibition on imposition of unilateral measures which means that countries can operate two systems of digital taxes concurrently.
For example, theoretically, if Article 12B comes into any of India’s tax treaty, it may co-exist along with Equalisation levy (which is wider in scope) and create uncertainties for the industry. Further, a global tax reform including only specific business models will prove too limited conceptually to result in a system fit to accommodate the possibilities of increasing digitalisation of the global economy.
On the policy front, enforcing this proposal is going to be an uphill task given that it would require amendments in thousands of tax treaties operating around the world through re-negotiation, which would require significant effort from each country. Further, it seems highly unlikely that countries who are working towards achieving a multilateral solution will accept this framework.
With rapid globalisation, this issue requires a global solution with a uniform mechanism as it could also be detrimental for the companies of source countries to then operate under a non-uniform tax structure. With evolving business models in the increasingly globalised world, it’s better to have a mechanism where changes are accepted through a stroke of pen rather than renegotiation of treaties. It is not only cumbersome but also puts a significant compliance burden on the entities operating in multiple countries. Multilateral approach further provides consistency and uniformity through a global consensus which keeps every country on an equal pedestal.
For what appears to be a simple solution to the global tax complexities, the devil lies in the details. The fact that the committee members do not necessarily represent the views of their government makes this solution a little tricky. Further, a large minority of the committee members were not in full agreement with the details and the commentary recognises that a number of countries may not include Article 12B.
While the governments are negotiating at the OECD where India is part of the steering committee, the bilateral nature of this solution puts cumbersome obligations on the governments and entities alike. Long and lengthy process of negotiations with each country and further amendments in case of any addition or omission will take a significant amount of time. A multilateral effort will significantly reduce this time consuming process and will avoid the creation of any imbalances that might occur during the negotiation process. Therefore, Article 12B needs to be revisited and reassessed on the grounds of technical challenges it presents and whether a bilateral process is needed to solve a global conundrum.
Kazim Rizvi is the founding director of The Dialogue and Ayush Tripathi is a research associate at The Dialogue
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