A Long-Term Policy Solution for Taxing Digitalized Business Models Should the Permanent Establishment (PE) Definition be Modified or Should the Focus be on a Shared Taxing Rights Mechanism? Dr. Vikram Chand 1

Agenda The current Tax Treaty Policy framework The International Tax Policy Issue at stake Existing options to solve the issue at stake Core of the discussion: A critique of the long term option The future direction: Shared Taxing Rights Mechanism; or Rethinking nexus and profit allocation rules

Article 7: Taxation of Business Profits under the current Tax Treaty Policy framework Residence State Source State Enterprise (Company R) Business Profits

Article 5: Concept of Permanent Establishment under the current Tax Treaty Policy framework Residence State Source State Enterprise (Company R) Permanent Establishment (PE) Business Profits Article 5(1), 5(2) & 5(3): Fixed Place PE – eg. Office Article 5(5) & 5(6): Agency PE – eg. Employees Article 5(4): Exclusions to PE concept – eg. Preparatory activities

The International Tax Policy Issue Residence State Source or Market State Traditional Businesses Tangible presence PE Digital presence Highly Digitalized Businesses No PE

Highly Digitalized businesses that may operate without physical presence – Illustrations Businesses providing an online marketplace for goods or services Businesses providing online services Businesses providing online solutions Businesses selling digital products through an online platform Businesses in all verticals

Key Features of Highly Digitalized Businesses Reliance on users and data Ability to commercialize without physical nexus Intangibles Policy question: How do we tax such highly digitalized businesses?

I. Turnover Taxes on selected digitalized businesses Residence State Source or Market State Selected Highly Digitalized Businesses Advertising Services Clients Sales Turnover Double taxation Do such taxes fall under the scope of tax treaties? Within the EU: Do they conflict with EU primary law? Do they conflict with trade obligations? Do they conflict with constitutional principles of certain States? E.g. principle of Neutrality in Switzerland Key issues if introduced unilaterally

II. Introducing a Digital PE in Tax Treaties Residence State Source or Market State Highly Digitalized Businesses Digital PE (new paragraph) Article 5(1), 5(2) & 5(3): Fixed Place PE Article 5(5) & 5(6): Agency PE Article 5(4): Exclusions to PE concept

Policy question Does the introduction of a Digital PE concept for highly digitalized businesses make sense? Prior to that lets look at lessons that we can learn from BEPS Action 7 What happended in the pre BEPS world? What is BEPS? What is BEPS Action 7? Article 5(4) – Amazon and warehouse Article 5(5) – Agents - P&G – Commissionaires

Lessons from implementation of BEPS Action 7 through the Multilateral Tax Convention Exceptions to PE were narrowed Implemented in only 277 Tax Treaties Article 5 Post BEPS Action 7 Art. 5(4) Art. 5(5) & Art. 5(6) Agency PE definition was broadened Implemented in only 206 Tax Treaties Lesson 1: Non-uniform adoption of the PE concept by States. States do not like to change the PE definition

Profit Attribution to a Permanent Establishment Principles Authorized OECD approach (AOA): Attribution of profits depends on significant people functions in the PE* Formulary approaches such as percentage of sales Lesson 2: Attribution of profits depends on the wording of the tax treaty. Uniform attribution rules do not exist among States * The AOA focuses on functions, assets and risks and is similar to the Article 9 arm’s length approach

Key issue under the OECD AOA approach for profit attribution to a post BEPS agency PE Residence State Source or Market State Question: Are there are significant people functions in the Agency PE? Co A Online Service provider Agency PE Clients Business income – USD 1000 Arm’s length remuneration for services under Art. 9 Co B Sales services Lesson 3: Attribution of profits under current framework is unsettled and therefore tax uncertainty exists for businesses. This would lead to significant tax disputes

Summary: Key Lessons Lesson 1: Non-uniform adoption of the PE concept by States. States do not like to change PE definition Lesson 2: Attribution of profits depends on the wording of the tax treaty. Uniform attribution rules do not exist among States Lesson 3: Attribution of profits under current framework is unsettled and therefore tax uncertainty exists for businesses. This would lead to significant tax disputes Recap the key lessons

Digital PE Proposal: EU Commission and Academics Nexus Selected digital businesses that exceed either: Revenue threshold User threshold Number of online contracts Profit Attribution Formulary approach: Upfront profit allocation of 30% of profits to the Digital PE; or Amending the current AOA framework which is already unsettled by introducing additional fictions The breach of a few key Ottawa Principles of Taxation Neutrality: Different rules for digital businesses in comparison to traditional businesses Certainty: Tax uncertainty for businesses Recap the key lessons

Shared Taxing Rights Mechanism

A new distributive rule in Tax Treaties Scope (Illustrative list) Digitalized businesses providing an online marketplace (goods and/or services) Digitalized businesses providing online services and online solutions Digitalized businesses selling digitalized products through an online platform Taxable Basis Sources State may tax if the income exceeds a certain revenue threshold; Charged tax  the lower of either a certain percentage of gross revenues or profits taxed under a net basis mechanism Residence State to provide relief Takeaway: Easier to implement and tax certainty for businesses Status of research: Paper to be finalized end of August and will be submitted for peer review

The way forward: Rethinking nexus and profit allocation rules

Equality between Traditional and Digitalized Businesses Profit Attribution Full formulary approaches should be rejected A more balanced approach: The transition from a functions, assets and risks to a Functions, Assets, Risks and Market (FARM) analysis Nexus All businesses that exceed either a: Revenue based threshold User based threshold Compliance with Key Ottawa Principles of Taxation Fairness Neutrality Certainty Flexible Status of research: Detailed paper that will be submitted for peer review