Taxman cometh for the digital economy
Since the financial crisis of 2008 and 2009, the tax authorities worldwide have had their work cut out for them, growing national coffers to fund the rebuilding of their economies.
This job has been made tougher by the explosion of the digital economy over the same period, as global tax rules were traditionally made for the bricks-and-mortar world.
Digitalisation has led to the emergence of new business models and increased cross-border flow of goods and services, while removing the need for a company to have a physical presence in a particular country to conduct business with its residents. These trends complicate the work of figuring out who should pay taxes, where and how much.
The problem has become so pressing that the Organisation for Economic Cooperation and Development (OECD) has several working groups studying the different ways that the world’s tax rules could and should be tweaked in the face of a growing digital economy.
TAXING THE SHARING ECONOMY
Perhaps nowhere is the conundrum more stark than in the sharing economy. Companies such as Uber and Airbnb do not need a physical presence or employees in a particular country before offering their services there.
Uber, a ride-sharing platform, manages its overseas operations in the Netherlands. So when someone in Singapore takes an Uber ride, Uber’s cut of about 20 per cent of the fare is sent to a network of Dutch offshore companies. No income is recorded here. After deducting operational expenses, that 20 per cent revenue is then sent to a Bermuda-registered offshore company that holds the licence to Uber’s intellectual property. The money is sent as royalty payment, which under Dutch law is not taxable.
A European Parliament report on tax challenges in the digital economy said that Airbnb has a similar tax structure which helps it pay very little in taxes in the United States and elsewhere. It said: “Airbnb takes a 13 per cent commission for each rental of spare rooms advertised on its website. As Airbnb uses the complex tax systems in Ireland and offshore tax havens like Jersey, it avoids paying taxes in the US or elsewhere.
“It manages to do so by assigning its software IP to a subsidiary in Jersey and shifting profits to the tax haven by royalty payments from its Irish unit.”
Ernst & Young Solutions’ tax services partner, Mr Chai Wai Fook, noted that these companies can rightly argue that they are compliant with existing tax rules.
“The current tax rules have not kept pace with the rapid developments in technology and the digital economy.”
Take ride-sharing apps platforms for example. The real economic activity being conducted is by the drivers who are bringing in the revenue, so getting the drivers to pay income tax is one part of the equation.
The Inland Revenue Authority of Singapore (Iras) is certainly looking closely at this – a Sunday Times report earlier this month reported that Iras had approached two ride-hailing firms, Uber and Grab, to work out an arrangement for their drivers to file tax returns automatically to ensure they are not under-declared.
But the more difficult part is the fact that ride-sharing platforms also take a cut from these drivers, but that particular activity is not covered by the tax rules.
The OECD is working on these questions, and Mr Chai is hopeful that it will come up with guidelines that will not only deliver a fair and equitable basis of taxation, but also provide certainty to businesses while embracing the disruption that technology would bring.
TAXING THE DATA COMPANIES
Another business model that has taken on a grand scale in the digital economy is the monetisation of personal data.
As the European Parliament report noted, the value generated by using personal data in online digital giants such as Google and Facebook is hugely profitable.
These two companies capture data on their users to better target ads at them. As a result, Facebook has 16 per cent of all global digital ad revenue, while Google has 33 per cent.
However, it is a challenge to calculate the value created and therefore how much to tax these firms in each country where their websites are accessible – how do you attribute value to data created by users free of charge?
It also does not help that Google, Facebook and the like also have complex tax structures, much like the ones Airbnb and Uber have.
Some countries have begun coming up with solutions. Last year, India introduced an equalisation levy on online advertising revenue by non-resident e-commerce companies earned in India.
Under the rules, a 6 per cent levy is deducted from the amount paid to a non-resident who does not have a permanent establishment in India, for services such as online advertisement, any provision for digital advertising space, or any other facility or service for the purpose of online advertisement.
France, meanwhile, is considering taxing revenues of tech giants such as Google and Facebook based on their bandwidth, rather than on the basis of their reported profits in France. France has also suggested attributing profits to jurisdictions where the users of social media services are located.
There are concerns among tax experts that if each country begins implementing its own set of tax laws on such digital activities, things could become chaotic.
“We don’t want a situation where companies end up being double or triple taxed for the same economic activity, so there needs to be global coordination, which the OECD is attempting,” said PwC Singapore digital tax leader Tan Ching Ne.
“We do grapple with this in Singapore too. How do we update our legislation while being competitive and continue being an attractive place for companies to do business?”
The rise of e-commerce has certainly been a boon to deal hunters, but has not been such a blessing to the tax authorities, who traditionally have collected goods and services tax (GST) only from locally-registered businesses.
A Singapore resident who downloads software from an American provider or buys a coffee table from Taobao in China, for example, does not pay GST on those purchases.
This might soon be addressed. In this year’s Budget, Finance Minister Heng Swee Keat said Singapore is studying how it can implement the GST on foreign companies that sell goods and services to Singapore residents over the Internet.
A Deloitte report from December noted that the issue is not just one of lost revenue, but has wider economic repercussions, as it has also created an uneven
playing field between domestic GST-registered suppliers and overseas suppliers who are not registered for GST.
“At the same time, it has presented incentives to taxpayers to structure their business arrangements by shifting offshore to take advantage of this uneven level playing field. By doing so, it could also mean more job losses in the domestic retail industry.”
PwC’s Mr Koh said the Government may be studying how to bring overseas online vendors within the tax net by making them register for GST in Singapore if they sell to Singapore consumers.
“Making the overseas vendor account for GST on their business-to-consumer sales of music, movies and subscriptions is an effective way for the Government to collect the tax rather than to try collecting it from the consumer.
“At the same time, we also understand that the Government is studying the taxation of cross-border business-to-business services that are received by financial institutions such as banks and insurance companies.”
This would be done under what is known as a “reverse charge mechanism”, which, according to a report by law firm Dentons Rodyk, works by allowing (or sometimes requiring) the customer to account for the tax on supplies received from foreign suppliers.
Countries such as Japan, South Korea, New Zealand and Australia have begun levying GST on foreign companies that conduct online transactions with their residents.
So foreign companies, regardless of where they are physically located, must register with the tax authorities in these countries and pay GST or value added tax (VAT) accordingly, if they want to sell goods and services to the residents there.
South Korea, a leader in all things digital, imposed the VAT on physical and digital goods and services bought over the Internet from July 2015.
Australia has taken a more gradual approach, implementing a first step in July this year, when the GST was applied to the sales of imported services and digital products – streaming movies, legal services – to Australian consumers. From July next year, GST will also apply to sales of physical goods worth A$1,000 (S$1,072) or less that are imported by consumers into Australia.
PwC’s Asia-Pacific indirect tax leader, Mr Koh Soo How, said: “I think the approach that Singapore would adopt is the 80-20 rule. If we can get the 20 per cent of online retailers that make up 80 per cent of sales to register with Iras, that would be good enough, as we can’t possibly get every single overseas vendor to register.”
One could argue that the past decade or so has been something of a free pass for digital players, who have been able to take advantage of legal loopholes to pay very little tax on their extremely lucrative businesses. But as the saying goes, there are only two certainties in life – death and taxes – and it is only a matter of time before the taxman catches up.