European Commission’s Proposition on Digital Economy Taxation leaving out Block Chain Related Matters

Digital Economy Taxation in the European Union — European Commission Proposition on Digital Economy Taxation leaving out Block Chain Technology

This article written by Tilmar W. Goos, LL.M, Ph.D. researcher in the field of International Fiscal Law and the representative of the World Block Chain Organization to the United Nations in Geneva (Switzerland) and Director General of Europe addresses the key aspects of the European Commission (EC) proposal on digital economy taxation.

(1) Highlighting the main concepts of the most recent report by the EC;

(2) Analysing the interim solutions

(3) Propose measures to improve current developments

(1) Highlighting the main concepts of the most recent report by the EC

On 21st March 2018, the EC proposed two Council Directives addressing the taxation of the digital economy. Not only the EC moves forward in this regard, also the OECD developed proposition regarding the taxation of the digital economy. The OECD describes in its BEPS Action Plan in particular Action Point 1: Tax on Digital Economy the first approach highlighting the tax challenges of the digitalising economy. Action Point 1 exhibits the difficulties and expected changes not only on a social level but also on an economic level. The OECD is the preferred forum for those who wish to preserve a global level playing field with its ultimate aim to relocate the profits with the location of the business activity.

The EC proposal came shortly after the OECD published an interim report on 16th March 2018. As known among tax experts reaching consensus seems to be rather difficult. This is due to the fact that interim solutions proposed in these reports do not find unanimity across the Member States. The proposition of a Digital Service Tax (herein after referred to as DST) as an interim solution is considered to be contentious and some countries consider that no action is required as the BEPS recommendations are implemented. Others, in particular the US expressed strong opposition against taxation of internet companies on a gross basis, which would be the case under the DST. The author believes this is due to the fact that the major digital goods and services providers are in fact American (Google, Amazon, Facebook, Uber, etc.). Furthermore, it is the one out of several results of the Trump Tax Plan (See my Article on the Trump Tax Plan) which aims towards a more protectionist economy with its ultimate aim to benefit US companies. Nonetheless, this proposal will be challenging for a number of reasons. (i) The proposed reforms would reallocate taxing rights from (often smaller) EU Member States that host the European headquarters of large digital economy companies to larger EU Member States with large user bases. Such headquarter countries generally seem to seek a solution that is globally supported. The EC and EU Member States support the current initiatives in place and hope for a swift approval and the related subsequent ratification in domestic law by 31st December 2019. In this way such rules would become effective as from 1st January 2020. However, on the contrary the OECD observed a lack in global consensus whereas the US being the opposition within this movement could jeopardise the success of the initiatives.

DST — the interim solution?

The proposed DST is a 3% tax that target digital service providers with an annual worldwide revenues exceeding EUR 750 mil. and revenues from the provision of digital services in the European Union (EU) exceeding EUR 50 mil. Consequently, only a limited number of companies are likely to be affected. The DST covers the following digital services (i) valorising user data by placing (online) ads targeting users of the digital interface; (ii) transmitting user data generated from their activities on digital interfaces, or (iii) making available a digital interface for users to supply amongst themselves goods and services (i.e. online market places). However, the supply of IT solutions, digital products including online retail activities and intragroup digital services would not be considered under the DST.

Digital PE — the long term solution?

The EC work on finding a long term solution, orientates itself on the current focus of the ongoing work by the OECD. Both consider the adaption of the permanent establishment concept (PE) to the digital economy. This means that certain digital services provider would be taxed in the countries where they have a significant digital footprint and generate value from technology users’ interaction and or users’ data. This concept of a Digital PE then triggers the need to establish such taxable presence, new profit allocation as well as the need to ratify those rules in domestic law and tax treaties. The Digital PE option does not apply to enterprises which are resident in a non-EU country that has a tax treaty with the EU Member State where these companies have a significant digital presence. Therefore, the EC issued a recommendation to amend these tax treaties. Moreover, this concept of a Digital PE will also propose corresponding amendments to the Common Consolidated Tax Base proposal (CCCTB).

(2) Analysing the DST Interim Solution

The DST focuses on the major player in the digital goods and services economy which generate world wide revenues exceeding EUR 750 mil. or revenues exceeding EUR 50 mil. within the EU. Therefore, only a limited number of the market participants will be affected by this provision. This means that smaller market players can continue operating underneath the radar and will not be caught by the DST provision. The DST furthermore focuses only on three key areas in the digital economy stated previously.

Consequently, this proposal does not include any provision regarding Block Chain technology in particular the taxation of crypto generated profits or regulation provisions regarding Initial Coin Offerings (ICO) which are more than ever necessary in the fast paced development of this industry. Block Chain based companies demand regulations in order to be able to operate their businesses with more certainty. Additionally, regulations also contribute to the quality of the projects as they are legally inspected and supervised. Customers on the other hand require regulations to ensure a fair level playing field and to prevent fraud, which is currently one of the major issues in this industry world wide.

It can be said regulations are not per se bad. They provide the operators with more certainty, result in higher project reliability and customers are able to participate in a fraud free market. The author believes that IT development in the field of Block Chain simply moves too fast for legislators to implement effective rules and regulations. Therefore, governments are advised to work closely with experts of this technology in order to provide rules which are principle based and do not create unnecessary regulatory obstacles to innovative business models, are technology-neutral, transparent, clear and provide zero tolerance for criminal behaviour. No response to the demand of the stakeholders is not an option as it would create unnecessary uncertainty and most likely drives businesses and their income potentials to other jurisdictions.

The Swiss Financial Authorities (FINMA) are at the forefront to develop effective guidelines for Block Chain based projects. See my article on FINMA regulations guide on ICOs. The FINMA is both a credential supervisor which ensures that firms are financially sound and a conduct supervisor with regard to the behaviour of firms and persons to adhere to current regulations.

No other European authority move as quick as the FINMA does which is the result of the beneficial tax legislation in regard to Swiss based foundations. Swiss foundations are often used to ensure the ongoing development and success of Block Chain projects. Thus the FINMA is somewhat forced to be a first mover in this industry as the is currently a major influx of Block Chain based projects into Switzerland. The ongoing success of their regulations is a direct result out of a series of roundtable discussion in various cities in order to be in contact with the experts of the industry.

(3) Propose measures to improve current developments

The IT industry, the taxation of digital goods and assets and the fast pace development of this industry leads to a bright future with legislative obstacles to overcome. Not only in the field of tax law but also regarding general regulations to ensure the success of the projects and ultimately the industry. Block Chain Technology as a new industry has the potential to change the current world as it is. Therefore, it is utterly necessary to respond to the industry in order to ensure a business environment which is regulated, secure and free of criminal behaviour.

The Swiss financial authorities are at the forefront of developing concepts in this regard and can be considered as a first mover. Even though there is no general recognized or even legal defined classification of the terms, what we see here are guidelines and categorization for parliaments to take example from. It is necessary to define regulations and legal classifications otherwise terminology cannot be discussed at any level.

The authorities of the EU Member States are advised to develop concepts which:

(i) do not represent unnecessary obstacles to innovative business models

(ii) are principle-based, technology-neutral, competition-neutral

(iii) transparent and legally clear

(iv) provide zero tolerance for criminal behaviour.

Not responding to the industry is not an option. My article on the absence of effective legislation of crypto generated profits highlights the key issues when no regulation is developed.

Furthermore, it is ever more important to closely collaborate with experts of the industry. This is to ensure the prolonging success of this technology, its industry but furthermore its economic potential and the resulting revenue for the respected government. Becoming a late adapter may result in governmental loss in this industry as businesses move to other jurisdictions.

If you have questions regarding an effective legal strategy regarding the taxation of crypto currency, regulation or how to set up and ICO do not hesitate to contact me. My team and I are on the forefront of this topic and assist our clients throughout the start of an ICO, buying, investing and trading crypto currencies. We also assist during the incorporation process of Swiss business entities, business plan and white paper review, road shows at the most important conferences and events here in Switzerland as well as in Crypto Valley.

by Tilmar W. Goos, LL.M, Ph.D. Researcher published 4th May 2018, San Francisco, Silicon Valley, United States. © All rights reserved