Multilateral provisions against tax avoidance in digital business

Universidade do Minho Escola de Direito Thiago Barisson de Mello Oliveira junho de 2020 Multilateral provisions against tax avoidance in digital business Thiago Barisson de Mello Oliveira UMinho|2020 Multilateral provisions against tax avoidance in digital business Thiago Barisson de Mello Oliveira junho de 2020 Multilateral provisions against tax avoidance in digital business Trabalho efetuado sob a orientação do Professor Doutor João Sérgio Ribeiro Dissertação de Mestrado Mestrado em Direito dos Negócios Europeu e Transnacional Universidade do Minho Escola de Direito ii DIREITOS DE AUTOR E CONDIÇÕES DE UTILIZAÇÃO DO TRABALHO POR TERCEIROS Este é um trabalho académico que pode ser utilizado por terceiros desde que respeitadas as regras e boas práticas internacionalmente aceites, no que concerne aos direitos de autor e direitos conexos. Assim, o presente trabalho pode ser utilizado nos termos previstos na licença abaixo indicada. Caso o utilizador necessite de permissão para poder fazer um uso do trabalho em condições não previstas no licenciamento indicado, deverá contatar o autor, através do RepositóriUM da Universidade do Minho. Licença concedida aos utilizadores deste trabalho Atribuição CC BY https://creativecommons.org/licenses/by/4.0/ iii ACKNOWLEDGEMENTS I would like to express my gratitude to my supervisor, Professor Dr. João Sérgio Ribeiro, who guided me throughout this project, with patience and care. Any mistake is my only fault. Thank you also for the Professors of School of Law University Minho, by sharing their knowledge with me. I wish to acknowledge the help provided by the technical and support staff in the School of Law University Minho. They kindly helped me in many occasions. I would like to thank Robyn Freiheit, for the final grammatical revision made from the perspective of a native speaker. Thank you to my classmates, whose friendship and enthusiastic debates offered me deep insight into the study. Finally, I could not engage in this endeavour without the unconditional support of my family, Patrícia and Saulo. Their love allowed me to do my best in this research. iv STATEMENT OF INTEGRITY I hereby declare having conducted this academic work with integrity. I confirm that I have not used plagiarism or any form of undue use of information or falsification of results along the process leading to its elaboration. I further declare that I have fully acknowledged the Code of Ethical Conduct of the University of Minho. v Multilateral provisions against tax avoidance in digital business ABSTRACT Digitalisation of the economy is an extremely important issue. It generates reflexes in several fields of law, with tax law being one of the most affected. With the prevalence of intangible assets, the physical presence of a business is often no longer essential. This makes the traditional criteria of stable establishment no longer effective. In light of this, the OECD and other international organisations have been discussing ways to reform the general international taxation rules to cover new businesses. The present work aims to analyse the main points of failure in tax legislation, tax avoidance practices via the digital economy and the central aspects of the OECD and European Union proposals to reverse the erosion of the tax base. Keywords: Digital Economy; Digital Service Tax; Digital Taxation; International Tax Law. vi Provisões Multilaterais contra Elisão Fiscal em Negócios Digitais RESUMO A digitalização da economia é um tema de suma importância. Ela gera reflexos em vários campos do direito, sendo o direito tributário um dos mais afetados. Com a prevalência de ativos intangíveis, a presença física de um negócio muitas vezes deixa de ser essencial. Isso faz com que os critérios tradicionais de estabelecimento estável não sejam mais efetivos. Diante disso, a OCDE e outros organismos internacionais vêm discutindo formas de reformar as regras gerais de tributação internacionais abarcando os novos negócios. O presente trabalho visa analisar os principais pontos de falha na legislação tributária, as práticas de elisão fiscal via economia digital e os aspectos centrais das propostas da OCDE e da União Europeia para reverter a erosão da base tributária. Palavras-chave: Direito Tributário Internacional; Economia digital; Imposto de Serviço Digital; Tributação digital. vii TABLE OF CONTENTS Abstract..................................................................................................................................... v Resumo.................................................................................................................................... vi List of Abbreviations ................................................................................................................. ix INTRODUCTION ........................................................................................................................ 1 CHAPTER I – DELIMITATION OF OPERATIVE NOTIONS IN INTERNATIONAL TAX LAW ................ 7 1 TAX AVOIDANCE DEFINITION ................................................................................................. 8 2 RESIDENCE AND PERMANENT ESTABLISHMENT ................................................................ 13 3 SOURCE INCOME ................................................................................................................ 15 4 PRINCIPLES APPLICABLE TO DIGITAL TAXATION ................................................................ 17 4.1 PROFIT ALLOCATION PRINCIPLES ................................................................................... 17 4.2 NEXUS PRINCIPLES ......................................................................................................... 19 4.3 PROCEDURAL PRINCIPLES .............................................................................................. 21 CHAPTER II – BASE PROBLEMS ............................................................................................. 24 1 DIGITAL BUSINESSES CHARACTERISTICS ........................................................................... 24 2 PRACTICAL PROBLEMS ....................................................................................................... 27 2.1 MODEL CASE ................................................................................................................... 28 2.2 CASE LAW ON DIGITAL TAXATION .................................................................................... 31 2.3 BASE EROSION ON DIGITAL ECONOMY ............................................................................ 33 2.4 NEW VALUABLE RESOURCES IN SCALE MARKET ............................................................. 36 2.5 INTERNATIONAL LACK OF CONSENSUS ON TAXING DIGITAL BUSINESSES ..................... 38 3 THE GENERAL CONCERN REGARDING TERRITORIALITY ...................................................... 40 3.1 RULES FOR ATTRIBUTION OF PROFITS TO A PE CONTROL .............................................. 43 3.2 THE PROBLEM OF PERMANENT ESTABLISHMENT FOR DIGITAL BUSINESS ..................... 44 4 VALUE CREATION WITHOUT PHYSICAL PRESENCE ............................................................. 49 5 DIAGNOSIS OF THE BLEMISH OF PRINCIPLES .................................................................... 51 1 OECD’S RECENT DEVELOPMENTS IN DIGITAL TAXATION .................................................... 53 1.1 OECD 2015 ACTION PLANS ADDRESSING DIGITAL ECONOMY ......................................... 55 1.2 OECD’S OTHER ACTION PLANS IN CONNECTION WITH DIGITAL CONCERNS ................... 57 1.3 INTERIM REPORT OF 2018 .............................................................................................. 60 1.4 INCLUSIVE FRAMEWORK OF 2019 ................................................................................... 62 viii 2 THE PROGRAMME OF WORK AND RECENT DEVELOPMENTS .............................................. 63 3 PILLAR I – ALLOCATION OF TAXING RIGHTS ....................................................................... 63 3.1 USER PARTICIPATION PROPOSAL .................................................................................... 64 3.2 SIGNIFICANT ECONOMIC PRESENCE PROPOSAL ............................................................. 66 3.3 THE “UNIFIED APPROACH” ............................................................................................. 69 4 PILLAR II – GLOBAL ANTI-BASE EROSION PROPOSAL ......................................................... 72 5 OTHER INITIATIVES TOWARDS DIGITAL ECONOMY ............................................................. 75 5.1 EUROPEAN DEVELOPMENTS ........................................................................................... 76 5.1.1 DIRECTIVE PROPOSAL 2018/0072 ............................................................................... 78 5.1.2 DIRECTIVE PROPOSAL 2018/0073 ............................................................................... 80 5.2 UNILATERAL TAX POLICIES .............................................................................................. 86 CHAPTER IV – CRITICS TO THE MEASURES TAKEN ............................................................... 91 1 MULTILATERAL MEASURES ................................................................................................ 91 1.1 REFORMS ADDRESSING PERMANENT ESTABLISHMENT .................................................. 92 1.2 THE TWO PILLARS PROPOSAL ......................................................................................... 96 1.3 OMISSION ON M2M TAXATION ........................................................................................ 97 2 DIGITAL SERVICE TAX AS A STRAIGHTFORWARD RESPONSE .............................................. 98 3 PASSIVE STANCE REGARDING DIGITAL TAXATION .............................................................. 99 4 BALANCING PRINCIPLES .................................................................................................... 99 5 ECONOMIC CONCERNS .................................................................................................... 101 6 OVERCOMING THE BILATERAL BIAS IN TAX TREATIES ...................................................... 103 6.1 UNITARY TAXATION AS A POLICY DRIVEN TO DIGITAL TAXATION ................................... 105 6.2 LIMITS OF LAW ENFORCEMENT IN TRANSNATIONAL BUSINESS.................................... 106 7 POINTING SOLUTIONS FOR THE MATTER ......................................................................... 108 CONCLUDING REMARKS ...................................................................................................... 111 REFERENCES ....................................................................................................................... 117 5 the so-called BEPS Project. The project events can be listed as follows. In October 2015, the final report of Action Plan 1 was published under the heading Addressing the Tax Challenges of the Digital Economy . In April 2017, the OECD Releases International VAT/GST Guidelines was also published. In March 2018, the Tax Challenges Arising from Digitalisation - Interim Report 2018 was released. In January 2019, the International Community Makes Important Progress on Tax Challenges of Digitalisation was released. In February 2019, the OECD Invites Public Input on Possible Solutions to the Tax Challenges of Digitalisation was released. In May and June 2019, the Consolidation and Meeting of G20 Finance Ministers was released. In November 2019, the Public Consultation - Secretariat Proposal for a "Unified Approach" under Pillar One was released. In December 2019, Public Consultation - Global Anti-Base Erosion (GloBE) Proposal under Pillar Two was released. And in January 2020, the Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy was released. The work is still ongoing, and there is no definitive resolution so far. Yet, in short, the explicit object of the OECD is to achieve multilateral consensus for a long-term solution by 2020, despite the slow advancement in terms of international deals. Nevertheless, the OECD BEPS Reports recognises that the digital economy is a challenge for international taxation. New concepts such as the significant economic presence, withholding taxes on digital assets and the digital equalisation tax are on the implementation agenda. The aim is to protect international tax treaties against unilateral digital economy measures by countries, while increasing the taxation of consumer markets. Although there is no significant implementation addressed to digital economy, some states are reacting by themselves by implementing national legislation in order to tax transactions operated inland. Unilateral measures represent a response to the OECD's delay in establishing effective policies in this respect, but lead to a pernicious tax race between countries. This stance creates an environment of uncertainty, which for the economy is a negative symptom of how the market is behaving. Nevertheless, any measure taken must not constrain R&D, otherwise economic development may be harmed. As a result, the fact this new ways of doing business generates the reallocation of essential business functions along with a different distribution of the tax burden on wealth generators. It is crucial to closely examine how businesses in the digital economy add value and make a profit, so that it is possible to determine whether and to what extent current tax rules need to be adapted to meet these specific characteristics, avoiding erosion of the tax base. 6 The intent of this work is to consider the impacts of tax avoidance practices, addressed to direct taxation concerns in digital economy, considering mainly multilateral policies. The indirect taxation is mostly harmonised and eventual concerns in such area are here postponed for further investigation. Nevertheless, it has been chosen to focus the issues of direct taxation because – in the context of EU law and international tax law – this area is the most peculiar and continuously evolving branch of law. Direct taxation also has a more significant impact in tax avoidance practices, being so the main target in multilateral discussions. As the objective of this thesis is to analyse tax avoidance in digital economy, the first necessary step is to beacon well-accepted concepts of tax evasion, tax avoidance and tax planning. Other basic concepts of tax law that are relevant for the matter will be examined, especially those territoriality legal concepts, derived from international tax law, namely residence , source and PE . Some consideration will appear in terms of moving to a different tax allocation system, and overcoming the territorial approach in one of the BEPS proposals. Considering the innovation in the proposal, it is paramount to point out law principles that are relevant to the matter, clearly highlighting principles orbiting the nexus rules and profit allocation. In this sense, the first chapter presents a list of fundamental tax law principles in the environment of digital taxation. Indeed, not all tax law principles are relevant here; therefore the comparison will encompass the following principles: principle of equality, neutrality, principle of proportionality, ability to pay, home state taxation, simplicity, efficiency, cost minimisation arm's length, value creation and good faith. These principles are all relevant to international taxation, within the scope of digital economy. Following, in Chapter II there will be an analysis of the ongoing problem of base erosion – in a broad sense –, exposing practical cases of manoeuvres that lead to tax avoidance which are the failing tax law concepts and how tax administrators traditionally deal with them. In the Chapter III, there will be a summarised description of the main solutions proposed by OECD, taking into account the current stage of the reports, as they still have no final conclusions. In the final part of this thesis, a critical analysis is made by the researcher, considering the commitment with tax law principles, while also providing predictions for digital taxation for the upcoming years. The last chapter presents some critiques to the proposals, taking in account that there are still no consensus in how to tax digital assets. Some considerations are made regarding the possible scenarios in which a multilateral measure is adopted or not to mitigate the effects of the ongoing fiscal war. 7 CHAPTER I – DELIMITATION OF OPERATIVE NOTIONS IN INTERNATIONAL TAX LAW A more coherent solution for tax avoidance in digital economy demands a clear notion of the concepts involved. With this in mind, it is important to define a uniform vocabulary for the discussion, considering that the myriad of national tax law concepts are obstacles for a focused analysis. Therefore, the first part of this chapter gives an outlook of the core legal concepts necessary to grasp the implications of digital economy in taxation, whereas the second part focuses on with law principles, relevant to digital taxation. The chosen language of the paradigm is from the OECD legal tradition. This option is justified because such entity is the most developed one in pre-existing research for international taxation, considering the focus in digital taxation hereabouts. Accordingly, the OECD has been in the upfront of the digital economy since the last decade, having hundreds of studies already published on the challenges of the theme. Countries and other international entities have been explicitly holding positions in order to encompass their tax policies with OECDs understandings. Notwithstanding, some references from European Union (EU) law are also in place, mainly taking account of the recent proposals to tax digital assets made by EU Commission4, but also in relying on directives and related case law decisions. Marginally, some national domestic law vocabulary will appear in this work, while the domestic law-making processes can result from the advancements in multilateral negotiations taken in OECD, EU or within another international institution and vice versa . In other words, the development of international law comes usually from complex negotiations between states. Thus, an implementation of a treaty or a directive (in the case of EU law) may cause causing changes in domestic legislation. One last reservation is necessary: not all international tax law concepts are defined here, but just those whose reasoning are direct consequences of actual blemish in digital taxation. 4 Directive proposal 2018/0072 and Directive proposal 2018/0073. 8 1 TAX AVOIDANCE DEFINITION One of the crucial concepts in this research is tax avoidance , being it a negative conduct that leads to the economic problem of base erosion. In terms of tax avoidance, it does not matter whether the economic activity is either intangible or tangible. In both cases, the taxpayer may operate with the intention to avoid artificially the incidence of a tax. Then, before tackling the transformations of digital economics, it is necessary to differentiate tax evasion , tax avoidance and tax planning . Tax evasion is a general term for efforts made by taxpayers to mitigate taxes by illegal means, considering that what is illegal may vary according to domestic legislation. In tax evasion, the taxpayer avoids the payment of tax without avoiding tax liability. Although he or she escapes from the payment of tax, this levy is unquestionably due according to the law of the taxing jurisdiction5. Tax evasion is usually easier to identify, as the law objectively defines it. Regarding tax avoidance, there is not a properly illegal conduct in sight. Instead, in this case, a taxpayer should not be allowed to use legal constructions of transactions to avoid similar situations, and he or she must be subjected to the same tax burden. Thus, this means taxpayers should not abuse their right to minimize tax burden. Otherwise, tax authorities may consider the existence of an unacceptable conduct, by categorising the taxpayers’ actions by their intentions. Notwithstanding, tax planning is perfectly acceptable, when reasoning derives from basis of consideration of economic efficiency and fiscal justice6. Going further, more details are necessary to differ tax avoidance from legitimate tax planning. In fact, the notion of tax avoidance may vary from country to country, because each state will have different notions regarding: what is a circumvention of tax liability; what is abuse of law; and what are domestic principles of economic efficiency and fiscal justice. Indeed, the multiplicity of definitions reveals the need for harmonisation in international taxation, in order to constrain efficiently tax avoidance, causing different consequences to the taxpayer. As an example, a taxpayer conduct may be considered as tax planning in country A, but tax avoidance (or tax evasion) in country B. Adding, the expression “abuse of law/right”7 is only known in civil law jurisdictions, being alien to common law jurisdictions such as the USA, UK and Ireland8. Thus, there is not a definitive 5 RUSSO, Fundamentals of International Tax Planning, 2007, p.50. 6 Idem , p.52. 7 “Abuse of legal provision can be said to consist in using or claiming a right in a manner that conflicts with the aims of the provisions granting it” ( Ibidem ). 9 international legal conceptualisation to separate tax avoidance from tax planning, requiring a case-tocase analysis of comparative law in order to solve questions regarding the nature of the conduct. Whereas the concept of tax avoidance is still open, it is difficult to reach an international consensus on a concept. In an international tax law perspective, it is necessary to converge a definition of tax avoidance in standardised concepts, at least for tax treaty interpretation. That is an ongoing challenge for OECD, EU and the international community as a whole, although some attempts have been made through reforms in bilateral treaties and by multilateral agreements. In this sense, it is worth highlighting the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), as the effort taken by the G20. However, multilateral provisions have only been adopted by some of the economies, staying out of MLI relevant countries, such as USA, Brazil, China and Russia. Moreover, G20 is still far from a practical consensus in terms of tax avoidance. Indeed, many Contracting States (including China and Russia) are pending ratification, but, in any case, there are dozens of nations that have adopted implicit policies such as low tax jurisdictions, weakening the effectiveness of the instrument. As stated, there is a significant difference between tax evasion and tax avoidance: the first is illegal and the second legal. However, as tax planning is also legal, there is a subjective aspect in tax avoidance that separates it from tax avoidance, and such aspect has to be clearly defined, at least for the purpos of this thesis. As a first step of clarifying the used language, tax avoidance must be delimited. According to the OECD, tax avoidance is a term that is difficult to define but which is generally used to describe the arrangement of a taxpayer's affairs that is intended to reduce his tax liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow9. Unfortunately, there is no further definition of what it means to act in contradiction with the intent of the law while been lawful, while distinguishing from legitimate actions. The openness of this concept is a powerful tool for arbitrary decisions in a case-by-case grounding. As the OECD definition of tax avoidance is too broad in scope, it is therefore necessary to borrow the reasoning from another international organisation. In the EU law, the lawmakers are reticent regarding tax avoidance definition, leaving the conceptualisation task for each Member-State legislation. Nevertheless, in domestic law, the approximation made is usually to the concept of abuse of law in EU 8 Ibidem . 9 OCDE, Glossary of Tax Terms, 2019, Retrieved from https://www.oecd.org/ctp/glossaryoftaxterms.htm 10 Law10. Accordingly, abuse occurs when the application of a rule cannot be extended to protect abusive practices made by economic operators, when transactions carried out are not in the context of regular commercial transactions, but solely for wrongfully obtaining advantages provided for by EU law. In this sense, the main aspects of anti-abusive EU’s policy are in the Directive 2003/49/EC of 3 June 2003, regarding common system of taxation applicable to interest and royalty payments, there is the recognition of avoidance practices. In this sense, article 5 of Directive 2003/49 states the following: Fraud and abuse 1. This Directive shall not preclude the application of domestic or agreement-based provisions required for the prevention of fraud or abuse. 2. Member States may, in the case of transactions for which the principal motive or one of the principal motives is tax evasion, tax avoidance or abuse, withdraw the benefits of this Directive or refuse to apply this Directive. The article 5 establishes the non-application of taxpayer protection against double taxation in case of transactions for which the principal motive or one of the principal motives is tax evasion, tax avoidance or abuse, or withdrawing the benefits held in the directive (recital 6)11. Although Directive 2003/49 itself does not define abuse, other EU directives provide necessary pointers. For example, the Mergers Directive refers in the second sentence of Article 11(1)(a) to an absence of valid commercial reasons for the operation as a typical example of such motivation. Furthermore, the recent Directive 2016/1164 (ATAD – Anti Tax Avoidance Directive) held main rules against tax avoidance practices that directly affect the functioning of the internal market), diplaying in article 6 a more precise definition of tax abuse: an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part12. The touchstone in identifying tax abuse is whether a non-genuine arrangement has been put into place for the main purpose , or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law. According to Article 6(2), an arrangement is regarded as 10 C-115-16N Luxembourg 1 v Skatteministeriet, Opinion, §59. 11 See also, judgments of 22 November 2017, Cussens and Others, C-251/16, EU:C:2017:881, paragraph 27; of 5 July 2007, Kofoed, C-321/05, EU:C:2007:408, paragraph 38; of 6 April 2006, Agip Petroli, C-456/04, EU:C:2006:241, paragraph 20; of 12 September 2006, Cadbury Schweppes and Cadbury Schweppes Overseas, C-196/04, EU:C:2006:544, paragraph 35; of 21 February 2006, Halifax and Others, C-255/02, EU:C:2006:121, paragraphs 68 and 69; and of 9 March 1999, Centros, C-212/97, EU:C:1999:126, paragraph 24 and the case-law cited; see also my Opinion in Kofoed, C-321/05, EU:C:2007:86, point 57. 12 EU Directive 2016/1164. 11 non-genuine to the extent that it was not put into place for valid commercial reasons, while not reflecting economic reality. In the context of ATAD, Raffaele Russo admitted difficulties in defining tax avoidance, notwithstanding he considers, in sum, that: Tax avoidance can be defined as a way of removing, reducing or postponing a tax liability, otherwise than by means of tax evasion or tax planning. It may be seen as the exploiting of areas that the legislator intended to cover but, for one reason or another, did not. More generally, tax avoidance can be viewed as the achieving of tax consequences that the government of the country concerned considers unacceptable, or at least undesirable13. Case law can lead to a better understanding of tax avoidance delimitation. In Imperial Chemical Industries plc (ICI) v Her Majesty's Inspector of Taxes , the European Union Court of Justice (CJEU) held that: tax jurisdiction shopping is a legitimate activity in the internal market, even if the choice of jurisdiction is solely based on the wish to circumvent less attractive domestic rules. However, there are certain limits to this principle. From the ICI case it may be concluded that the ECJ will accept restrictive anti-abuse measures if, disregarding the tax effects, the corporate or trade arrangement at issue is “wholly artificial14. Considering the subjective definition of abuse according to CJEU, there were Court discussions about what limits the interpreter has to respect. In case law N Luxembourg 1 v Skatteministeriet , the CJEU recognised some general boundaries about tax avoidance. Juliane Kokott, Advocate General (AG), in an opinion narrowed the definition of tax abuse, as following: (…) for a restriction of freedom of establishment to be justified on grounds of the prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory15. Therefore, according to EU case law, it suffices if the business arrangement is set not with the sole aim, but with the essential aim, of obtaining a tax advantage which otherwise would be regularly charged. In N Luxembourg 1 v Skatteministeriet , Kokott understands that two requirements must be fulfilled for an arrangement to qualify as abusive circumvention of the objective of the law. First, in the case of direct disbursement, tax must be chargeable in source country. Second, there must be a risk 13 RUSSO, Fundamentals of International Tax Planning, 2007, pp.58-59. 14 Case C-264/96 ICI. 15 C-115-16N Luxembourg 1 v Skatteministeriet, Opinion, §63. 12 that the income will not be caught in the actual State of receipt and thus will not be taxed16. For encompassing a tax avoidance, it suffices to recognise an abusive circumvention of the objectives of the law, whose list of possible conducts may vary according to the objectives themselves. For instance, if a new tax law had been enacted explicitly to restrain a specific operation, any conduct that clearly aims such undesired operation is deem to be a tax avoidance practice. In sum, according to EU case law perspective, tax abuse or tax fraud relies on the intention of the taxpayer. It is an illegitimate arrangement (tax avoidance) when the decisions carried out in the context of normal commercial transactions or solely for the purpose of wrongfully obtaining advantages provided for by EU law. Such behaviour involves the creation of wholly artificial arrangements not reflecting economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory. Although, the concepts of tax avoidance and tax abuse are not objective, there are still relevant grounds for a general application of sanctions, respecting the rule of law. For the purposes of the discussion regarding digital taxation, this research opted to use the EU case law tax avoidance concept, as described above. It is important to mention, that such options were made without underestimating any other domestic law concept. The EU case law has been chosen by two reasons: it is broad enough to be applied in at least 27 EU Member-States; and it does not represent a national imposing definition, which otherwise would possibly be challenged in a foreign court. The adoption of the European notion of abuse derives in two possible scenarios: either an absence of a law aiming explicitly towards digital taxation, or the existence of such rule. In the first case, taking advantage of the reliance in intangibles to circumvent tax collection is a legitimate tax arrangement; whereas only in the second scenario there will be a tax avoidance practice. Accordingly, if the tax authority already has a firm understanding about the legality of the operation, such understanding would be enforced in a back door stance17. This conclusion justifies – at least in theory – the need of elaboration on specific digital taxation rules, revealing the urgency in tackling the matter of BEPS in digital businesses. Without a legislation 16 Idem , §87. Also, the case discussion in N Luxembourg 1 v Skatteministeriet essentially exposed an open antinomy between OECD principles and EU principles. In the decision, the CJEU found that the exemption from withholding tax on payments of interest to a company resident in another member state (Directive 2003/49 on interest and royalty payments) did not apply in circumstances where the recipient companies were mere conduits. Notwithstanding, the CJEU found that outside situations of fraud or abuse, national legislation which taxes payments of interest between resident companies differently from payments by resident companies to companies resident in other member states is precluded by TFEU, article 63. 17 Indeed, a back door law making process may is valid. Notwithstanding, the legitimacy of the decision is a relevant concern in terms of a democratic society and rule of law in a deeper sense. 13 focused in intangibles assets (digital economy), it is difficult to frame a conduct in the area as tax avoidance practice. 2 RESIDENCE AND PERMANENT ESTABLISHMENT The second concept to take account to deal with digital taxation is residence in tax law. The situs of a company is a crucial legal element concerning digital economy while it is possible that the business is located far away from the customer, due the intangible nature of the product or the ability to deliver it in a reasonable time. Due to changes in the economy, the definition of the prevalent nexus in terms of residence is a major concern, as the physical location no longer necessarily corresponds to the economic value produced. Usually, the basic concepts of international taxation are differentiated between residence income and source income, which may cause double taxation if there is no treaty limiting the taxing rights. For further considerations, it is paramount to expose this qualification process, relying on typical double tax conventions (DTCs). The article 4 of 2017 OECD Model convention defines resident as: any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof as well as a recognised pension fund of that State. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein18. The subsequent paragraphs of the same article are rules to determine which of the Contracting States will prevail as residence state for tax purposes. It may be, in the following order: due permanent home available, centre of vital interest, habitual abode, nationality and mutual agreement of the Contracting States. Paragraph 3, by its turn, held rules for a person other than individual , which means legal entities have more than one residence. The Model Convention will regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. The Model Convention applies the concept of PE to identify whether the company is or is not subdue by domestic taxation as resident. PE is a concept of international tax law that limits the taxing power of different countries. In international affairs, it is common for two countries to claim to have the 18 OECD 2017 Model Tax Convention on Income and on Capital, 2017. 14 ability to tax the same income, because of this, they often enter into international tax treaties to establish criteria that identifies which State Party can tax in a given situation. If there is the possibility of identifying more than one PE between the signatory countries of the bilateral treaty, the bilateral ruling must provide a solution, pointing out the prevalent criteria. Bilateral treaties usually follow the OECD Convention Model, which in article 5 states that there is the legal concept of PE, being “ a fixed place of business through which the business of an enterprise is wholly or partly carried ”. According to paragraph 2 of the referred article, the term “permanent establishment” includes specifically: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop, and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. In practice, a foreign company may operate, for example, in a country without being registered locally (being a tax resident only), and consequently not being treated as a domestic company in turn. This does not mean - from the perspective of international tax law - that tax authority cannot calculate and collect taxes derived from the operations of this foreign company. Such power, however, can neither extrapolate local law nor act in the contrary of the content of the treaty concluded by the taxing country. Finally, with the existence of an international tax treaty, it is possible to verify if any of the countries exceed the limits determined with respect to the taxes collected. Following, in paragraph 4, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity; f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character. The referred paragraph will not be applicable if the overall activity results from the combination of the activities carried out by the two enterprises at the same place, or by the same enterprise or if 21 creation reasoning is the taxation of royalties. Companies that host R&D sectors, or hold an Intellectual Property Rights (IPR), are usually bound to the tax jurisdiction where they are established. Value creation is the group of actions responsible for increasing the worth of goods, services or business. The adoption of the principle of value creation is a complicated matter, because it grants to administration a too large power to tax. From a more democratic perspective, it is up to the lawmaker as to decide the definition what should be taxed. The principle of value creation is more an economic principle than a tax law principle. Some entities (EU Commission, UK Treasury and OECD) argue that the existing system is based on the principle of value creation, notwithstanding others support the view that the existing system does not actually follow this principle. It is not clear that the international tax system should follow the principle that profits are taxed where value is created, bringing into question the choice of this principle as a guide to the allocation of profit among countries26. For example, in terms of economic development, it is not wise to tax R&D, and it is still too early to say that technologies, as algorithms and big data are well established. Then, maybe an attempt to tax will hold the use of new technologies and stunt economic growth. 4.3 PROCEDURAL PRINCIPLES Procedural principles relate to public administration’s concepts that evaluate how well a tax authority acts, whether in economic terms or in moral terms. The most typical principles are simplicity, efficiency, cost minimisation and good faith. The notion of procedural principles are rather arbitrary, in opposition of the former groups. Yet, these principles do not fit in those categories, being better set in a tertium genus of principles, more related to economic efficiency parameters. Broadly speaking, in establishing a new tax on the digital economy, this new levy would have to be fair, simple, applied to an effective economic event - showing the creation of wealth or the provision of a service - and instituted without causing special difficulties or a high cost of conformity. Therefore, it would be compatible with principles like simplicity, efficiency and cost minimisation. Moreover, it is the Uricchio's opinion that the introduction of these new taxes would help to reduce the existing tax bias in 26 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p. 19. 22 favour of the Internet and make it possible to reduce the tax pressure on other productive factors, including work27. Adding, simplicity, efficiency and cost minimisation consist in a group of principles that summarise what is desired in the bureaucracy. When projecting or reforming a taxation system, the news rules cannot transform the subject in an insurmountable law area. Entrepreneurs, accountants and lawyers have to have a way to predict - in the majority of cases – when and how a taxable event will occur. Therefore, when dealing with digital taxation, lawmakers have to grant sufficient clarity to their theoretical proposals and bills presented in parliaments, otherwise digital taxation reforms would become much more of a problem than a solution overall. The final principle to take into account is good faith. Its understanding requires acknowledging that most of the international regulation in tax law comes from bilateral treaties, so international law then affects the creation and the interpretation of these agreements. In planning an international system of digital taxation, the lawmakers will definitely have to deal with these general rules. When celebrating a DTC, states must follow general principles of international law. The main principles are codified in the Vienna Convention on the Law of Treaties (article 31 et. seq. ). According to article 31 of Vienna Convention, a treaty must be interpreted in good faith with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. For the purpose of interpretation of the treaty, paragraph 2 of the same article states that context covers the text, the preamble and annexes. Therefore, any agreement made between the parties in connection in the treaty must be interpreted accordingly. In the same sense, the good faith must prevail in any instrument made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty. According to paragraph 3 of article 31, there shall be taken into account any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions, any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation, and any relevant rules of international law applicable in the relations between the parties. 27 URICCHIO, A. (2016). A Few Ideas for Reforming Internet Taxation. In F. &. BOCCIA, The Challenges of the Digital Economy (pp. 83-96). Roma: Palgrave Maximilian, pp. 91-92. 23 In a broader perspective, international law rules of interpretation do not significantly differ from domestic law. Thus, one also uses the grammatical, the systematic, the teleological and the historical interpretation methods28. A DTC’s interpretation usually relies in a combination of these methods with the principles of Vienna Convention. However, the convention cannot be interpreted as unlimited authorisation for the development of the law by tax authorities, as contracting parties celebrate a tax treaty to limit the power to tax. Any enlargement of this limitation must derive from an amendment to the convention, when the parties agree29. Considering aggressive tax planning in the digital economy, treaties’ benefits can be denied in cases of abuse, because the principle of good faith is binding on states and can be relied upon by the citizens. Lang understood that international law contains a prohibition against abuse of law, mainly because of the principle of good faith. Considering relationships between contracting states, there is a general prevention from interpreting law unfairly in their own favour, by consequence against taxpayer. Moreover, most states recognise the possibility of considering the substance over the form , if the result contradicts principles of justice30. Many states also prohibit the abuse of law in a sense, as they usually rely on specific anti-abuse rules, however Lang adverts that one cannot derivate from those a general prohibition against abuse of law. Moreover, he says “ the policy considerations underlying those specific anti-abuse rules are unequivocally subordinate to international law and in particular treaties” , but these so-called anti-abuse rules “ would have to be at least on the same level as international law treaties ”. Adding, human beings can only exceptionally be subjects of international law, which does not happen in the area of DTC. In conclusion, a general principle of (international) law cannot be binding on taxable persons, but only to contracting parties31. 28 LANG, M. (2010). Introduction to the Law of Double Taxation Convention”. Vienna: Linde, p. 37. 29 Idem , p.38: a change in the DTC may require authorisation by parliament; and administrative bodies cannot change DTCs by way of a new interpretation. As consequence, the purpose of a DTC is to restrict existing tax claims; they cannot be interpreted in an opposite sense. Furthermore, any interpretative rule derived from national law must be taken cautiously, while they must not add or change the original meaning of the DTC. Moreover, when celebrating a treaty, there is an implicit conformity with constitutional principles of each member state. Even in the case of mutual agreement between the competent tax authorities, they cannot alter the provisions of domestic law after the incorporation of the treaty in domestic law 30 Idem , pp.60-61. 31 In other words, technically only a party may infringe the treaty, in terms of international law. As consequence, abusive practices regarding DTC are hard to be contained. Then, a practical solution is to implement anti-abuse rules in a multilateral level. In this case, these rules would have a status in international law, but in a multilateral level, anticipating abusive practices by binding general rules. The first large implementation of such policy is the Multilateral Instrument (MLI). The MLI already covers 93 jurisdictions and entered into force on 1 July 2018. Signatories include jurisdictions from all continents and all levels of development. 24 CHAPTER II – BASE PROBLEMS 1 DIGITAL BUSINESSES CHARACTERISTICS Prior to highlighting the stressing aspects of digital taxation, it is necessary do define what are digital businesses, at least for tax purposes. This research does not cover all MNE tax arrangements, yet only those engaged in digital activities as a main business. Nevertheless, not all MNE in the digital sector are low-taxed nor have exclusively non-physical assets; sometimes the tax authority already has an interpretation that classifies the business as a traditional model, despite of its disruptive features. A digital company can then have many intersections with traditional businesses, making the need of delimitation of digital business a more complex challenge. As a preliminary consideration, there is still no official definition for the digital economy. Most often, the term digital refers only to the economic value derived from the Internet, for instance in Electronic Commerce (E-Commerce), but may also refers to economic and social activities resulting from other information and technology source. Accordingly, International Monetary Fund (IMF) defines digital economy as “ the incorporation of data and the Internet into production processes and products, new forms of household and government consumption, fixed-capital formation, cross-border flows, and finance ”32. The OECD, by its turn, defines digital economy as “ comprised of markets based on digital technologies that facilitate the trade of goods and services through e-commerce ”33. Adding, according to European Parliament, a digital business model can be defined as “ the global network of economic and social activities that are enabled by platforms such as the Internet, mobile and sensor networks ”34. In resuming conceptualisation, the digital economy is a global network of economic and social activities that are enabled by platforms such as the Internet, mobile and sensor networks. 32 IMF, Measuring the digital economy, Washington-DC, 2018, p. 6. 33 OCDE, Hearings - The Digital Economy, 2012, p. 5. The OECD BEPS Action Plan on Base erosion and Profit Shifting also did not define the digital economy per se , but nevertheless described its characteristics as: " reliance on intangible assets, the massive use of data (notably personal data), the widespread adoption of multi-sided business models capturing value from externalities generated by free products, and the difficulty of determining the jurisdiction in which value creation occurs " (OCDE, Request for Input Regarding Work on Tax Challenges of the Digital Economy, 2013, p. 2). 34 European Parliament, “Effective Corporate Tax Rate” and “Digital Business Establishment” in the Corporate Tax Base Proposals, 2017, p. 2. However, the categorisation of the digital business models is a challenge in itself. The European Commission in its Communication of September 2017 uses the following categories: Online retailer model, social media model, subscription model and collaborative platform model . The OECD, on the other hand, identifies four business models in its Interim Report on Tax Challenges Arising from Digitalisation of 16 March 2018: Multi-sided platforms, resellers, vertically integrated firms and input suppliers. 25 The quoted definitions are not narrow enough for taxing purposes. Otherwise, one must considers any economic activity that benefits from Internet as digital. This includes mobile and sensor networks, mechanised agriculture, bureaucracy, education, and so on. Also, digitalisation increasingly intertwines with the traditional economy, making the differences between them less clear. Going further into the argument, as the global economy has greater reliance on nonphysical assets, in many cases exchanges made have moved from face-to-face dealings to remote negotiation. In doing so, from a legal perspective, when the Internet is used as an intermediary, the services are still physically provided, and therefore are not technically considered a digital. In this situation, the network acts merely as a media tool for the ease of business. A typical example is a teacher that uses a videoconference app to teach remotely, or a psychologist that meets her patients using the same app. In addition, eventually, these dealings may be replied to off of the Internet, such as a typical purchase contract solely being facilitated by the Internet. The communication changes regarding the Internet occur due the interaction of spontaneous forces such as supply and demand for a more open, interconnected and borderless environment. The use of a digital channel is merely a communication tool to keep negotiations fluid, whereas in the end the contract will be fulfilled in person. For instance, in a purchase contracting, negotiations and a contract may be concluded remotely, but the delivery of the object and the payment end up being closed in a traditional way, because of practical reasons35. In a different scenario, in case of a service that operates exclusively on the internet, otherwise being impossible to exist, one can consider the existence of a pure digital economy. Practical examples are brokerage services offered by a web site of a travel agency or a market place for distance learning. In both cases, the online service provider is usually due a commission for the contracts signed, in addition to subcontracting some insurance and other ancillary fees. Largely, the financial returns of digital companies come from the typical digital service, although it is commission based36. This type of intermediation of services is already known by private law and it is not exactly considered a new legal institute altogether (possibly being characterised as agency services), therefore demanding no greater 35 This many times results in the so-called “Research Online, Purchase Offline” effect, whereby the network favours market activity, but does not replace it, being legally recognized only as a facilitating means for negotiation and contracting (URICCHIO, Antonio, A Few Ideas for Reforming Internet Taxation, in BOCCIA, Francesco & LEONARDI, Robert, The Challenges of the Digital Economy. Palgrave Maximilian, Rome, 2016, p.86). 36 Examples of new digital businesses include: 1) multidimensional businesses where two or more user groups benefit from using the digital platform (for example, search engines are used by both individuals to access information on the internet and by advertisers to access their spectators); 2) outside-in business, where an organisation makes its own resources available to customers ( e.g. Amazon Elastic Compurter Cloud Service, a third-party cloud solution, based on insight developed by Amazon Web Servives around the cost of maintaining a reliable infrastructure and scalable on a traditional multidata center model); and 3) collaborative consumption, by which an economic model based on sharing, exchanging, negotiating or renting access to products as opposed to ownership. In the latter, there is the example of Airbnb's innovative business model, which brings together people looking for vacation rentals and other short-term accommodations with hosts who have unused space for rent. 26 concern in terms of legal definition. Notwithstanding, controversy mainly arises in tax law, while the PE may be not easily identified, creating conflicts of laws in international taxation. The digital economy is characterised by an unmatched reliance on intangible assets, the massive use of data (notably personal data), widespread adoption of multilateral business models capturing value from externalities generated by free products and the difficulty of determining jurisdiction in which value creation occurs. At the same time, new ways of doing business lead to the reallocation of resources in the production chain. The most central part of the debate is questioning how companies in the digital economy add value and make a profit, and how the digital economy relates to the concepts of source and residence or the digital economy overall while taking into account the results operated for tax purposes. In this sense, OECD has identified some recurrent characteristics of digital companies that are indeed able to benefit from the actual tax systems, distinguishing from traditional ones. According to some recent reports conducted by the OECD, three characteristics are frequently observed in certain highly digitalised business models: 1) scale without mass; 2) heavy reliance in intangible assets and data; and 3) data and user participation. The OECD described those three as the following: Scale without mass impacts the distribution of taxing rights over time by reducing the number of jurisdictions where a taxing right can be asserted over a business’s profits. A heavy reliance on intangible assets strains the rules for allocating income from intangible assets among different parts of an MNE group, creating uncertainties and opportunities for locating income in low or no tax entities. Data and user participation poses challenges to the existing nexus and profit allocation rules, especially in situations where the highly digitalised business that exploits the data and user-generated content has little or no taxable presence in the jurisdiction where the users are located37. These features (altogether or autonomously) allow for exponential use of aggressive tax planning in order to pay less tax, generating unease towards tax authorities. Nevertheless, taxation should not determine the motto of business models or indicate which companies outperform the competition, but instead be neutral in relation to the applied business model. This seems to be the best way to ensure a level playing field between all economic operators, which rewards success, innovation and job creation, while ensuring that companies contribute their fair share to the overall tax base. Notwithstanding, many of the recently reported cases of MNE arrangements in digital business for lower taxation on profits catalysed the OECD BEPS Project ( e.g. 37 OECD/G20 Base Erosion and Profit Shifting Project Addressing the Tax Challenges of the Digitalisation of the Economy Public Consultation Document, p. 6). 27 Amazon, Google, Apple and Facebook). Several of these companies are extremely profitable and generate a significant portion of their corporate value in world markets. This, however, is not always reflected in the share of business taxes paid by these companies. In this sense, the European Commission (EC) suggests that low taxation is caused by the fact that digital economy companies operate outside the traditional rules and, by extension, that existing international tax standards designed in the pre-digital age are inadequate in accurately capturing the digital market38. This disparity needs to be addressed in fiscal policies, as there is a tendency for revenue to be lost in traditional markets, which are gradually replaced by the marginally taxed digital market. Then, for practical purposes, this research will consider digital business, for taxing terms, as any relevant taxable event may arise from one of the following business models: 1) intensive innovation and greater use of new sources of finance; 2) emphasis on the importance of intangible assets39; 3) new business models based on network effects, user generated content, collection and exploitation of personal data; and 4) significant cross-border transactions through new communication channels. Other perspectives of the digital economy can still be touched on the research, because a new technology allows for an optimal allocation of available resources. 2 PRACTICAL PROBLEMS There are many relevant perspectives to discuss in terms of digital taxation. In this sense, extensively listing the problems may not be the best approach. Instead, it is more productive to start highlighting some practical cases in order to better determine the scope of the matter. The OECD’ 2015 report illustrates a few hypothetical cases by which the base problems become exposed40. There are four typical arrangements: online retailer, internet advertising, cloud computing and internet app store. Considering the need of synthesis in this research, only cloud computing had been chosen to describe, as follows. 38 EU Commission (2013). General Issues. Brussels: Directorate-General Taxation and Customs Union, p.3. 39 Oftentimes patents, trademarks, copyrights, franchises and licenses. 40 OECD, Addressing the Tax Challenges of the Digital Economy. Action 1: 2015, Final Report, p. 167. 28 2.1 MODEL CASE The model case chosen involves online gaming service through cloud computing. According to the National Institute of Standards and Technology, cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction41. In essence, cloud computing is the delivery of computing services – including servers, storage, databases, networking, software, analytics and intelligence – within the Internet. Cloud computing allows the user to store data in multiple and redundant ways, usually far away from the user, leaving free memory in devices to store and process non-shared data. As users accessing more of the web through mobiles phones and tablets, the utility of cloud computing has been increasing. Nowadays, notable cloud computing services are provided by Amazon.com , Google Apps and Microsoft Azure to mention a few. Considering the disruptive nature of cloud computing, it necessary to determine how and where to tax it. A typical use of cloud computing is seen in online gaming, and can be found in a previous OECD report42. Hypothetically, the enterprise is from a country “A”, where is the R&D sector is located, as well as the original ownership of the IPR. The PE is moved to country “B”, having there the IPR management and co-ordination services. In state “C”, there is the software localisation, the transaction processing and the datacentre (server). Adding, in state “D” is located the marketing promotion. Finally, consumers are in state “E”. For exemplificative matters, the entire arrangement is from a sole group of companies, using internal contracts and relatively autonomous local administrations. Using inner contracts, the IPR are transferred from country “A” to “B”, whereas the licencing of IPR are made from “B” to “C”. Clients in state “E” pay directly to the company located in state “C” for the services provided. The company in state “C” pays a service fee to the market company in “D”, in a cost-plus basis. Finally, royalties and management fees as paid to the PE in state B. Here follows the arrangement: 41 MELL, Peter; GRANCE, Timothy. The NIST Definition of Cloud Computing Recommendations of the National Institute of Standards and Technology. National Institute of Standards and Technology, 2011, p.2 42 OECD, Addressing the Tax Challenges of the Digital Economy. Action 1: 2015, Final Report, p. 167. 29 Figure 1 There are many reasons for such complex arrangement to exist. Most of the group of companies’ profits are allocated in state “B”, within a low tax jurisdiction. As there is a minimal taxable income in state “E”, a local subsidiary receives no income from sales. In this theoretical case, domestic law (or a treaty) prohibits taxation of sales in the absence of a PE in country “C”. Although state “C” imposes income tax to the profits derived by “C” from sales, a large part of the local company income is offset by the royalties (and management fees) paid to the parent company for its licence of technology used, which represent cloud computing services to consumers. In the case, state “C” does not impose withholding taxes on royalties and fees, due a tax treaty celebrated with state “A”, considering the payment to be received by the parent company based on state “A”. Adding, state “B” grants benefits for PEs with a low rate in corporate tax and preferential regime for intangibles (for royalties included in taxable profits). In state “A”, home of the parent company, corporate tax is levied on a territorial basis. There is a tax treaty with state “B”, ruling that all royalty income and management fee are attributable to a PE in state “B”. The capital gain from the IPR transfer is not taxable under the rules of cross border transfer of assets in the “A-B” region, a free market zone. Research and development costs may be deducted 30 on the revenue of management fees, and finally, there is no Controlled Foreign Corporation (CFC) regime in state “A”43. In sum, the excessive malleability of a cloud computing service allows for the described arrangement, using the transfer of PE, in-group contracts and taking advantage of lack of multilateral rules on taxation. As shown above, the challenges are many in taxing digital business that tax authorities have to deal with. However, the state’s intention is not to increase the tax burden, but to create equal rules for all, allowing positive development to society as a whole. In this sense, the cornerstone of a prosperous economy is to grant free competition and fair conditions that favour free enterprises. According to OECD’s studies44, digital businesses have a tendency towards monopolisation due to network effects, scale effects, restrictions of use, potential to differentiate and multi-sided platforms. Yet, they are volatile and easily contestable by disruptive newcomers, as barriers of entry and exit are low45, if compared with brick and mortar business. Going further, when a new digital business starts to compete with a traditional one, majority of the costs (labour, middlemen, infrastructure) are not applied to the new enterprise, which cuts general expenses and circumvent regulatory systems. There are many contemporary examples in this case: Uber, Airbnb, Transferwise, Nubank, etc. By deflecting regulation and other traditional costs of operation, they enjoy comparative advantages to other traditional products. Adding, the digitalisation has been changing many aspects of business management. AI can make the operations of companies more efficient and faster while permitting time and cost savings to the product and service development processes. In order to improve the corporate decision-making processes, enterprises following the path of data-driven-decision-making can enjoy 5-6% output in 43 In spite of not being the object of the research, the example also has repercussions in terms of indirect taxation. The VAT on B2B transactions will be levied either through the supplying business charging of the tax, or the recipient business self-assessing it. There may be tax exceptions on supplies. Considering VAT on B2C transactions, supplies, in state “C”, to final consumers in state “E” should in principle be subject to VAT there. However, difficulties will emerge in tax enforcing cloud services acquired abroad, where are the final consumers (residents). 44 “In the discussion on the tax policies implemented by the large multinational corporations that dominate the Internet, we are referring to large Web multinationals, such as Google, Facebook, Amazon, AirBnB, Apple, eBay, Baidu, JD.com, Alibaba, Netflix, Samsung and a few others that, under the current conditions, continue to enjoy tax privileges not available to others. With the arrival of the digital economy, the value chain has been deeply and radically changed and the dematerialization of the generation of wealth requires a totally reformed tax system, otherwise we will simply continue to fuel a bad example of unfair competition to the detriment of national financial interests and the overall health of Europe’s economy. It is no longer acceptable to allow foreign companies to pay taxes in the countries where they have their registered office (obviously with a considerably cheaper tax rate) rather than in those where they operate with production and sales activities. The issue primarily concerns the huge market for the sale of goods and services online and the purchase of so-called search advertising, the advertising spaces that appear on the pages of search engines, and secondly, all activities related to online services (music, cinema, tourism and games, to name a few) and the entire sector of electronic commerce (e-commerce). This is the idea of the proposal that, in 2013, was brought to the attention of the Italian Parliament and the European political and cultural debate” (BOCCIA, F. (2016). Introduction: The Digital Economy and Fiscal Policy in the Age of E-Commerce. In F. Boccia, & R. Leonardi, The Challenge of the Digital Economy - Markets, Taxation and Appropriate Economic Models. Rome: Palgrave Macmillan, pp. 2-3). 45 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, pp. 13-15. 37 giants thriving in the data economy today are therefore what Standard Oil was considered to be in the 20th century, being the core business of international trade. However, it may be challenging to assign an objective value to raw data itself, in considering the differences from the means of collection, analysing and end use of the gathered information. The outright sale of data is in fact a way to monetise data. Another way to monetise data one is by looking at the whole value of a business operation itself, having heavy reliance in collecting data. In both cases, the value analysis depends on subjective parameters in the free market. Jurisdictions are inclined to consider personal data of consumers as their property, rather than owned by a company or a public good. Companies are able to collect data through different methods. It can be proactive, requesting or requiring from the user data and using data analytics. On the other hand, they also collect reactively, by the information provided largely within the control of user, as social media and cloud computing. Location-specific data can be collected either from customers or from devices. In both cases, companies may use servers based in a different country. This new “oil extraction” method then raises the concern of whether profit is attributable in the market country or in the server’s country. In a society with free speech, it is almost impossible to delimitate data collection, as a consequence of its value in the market. The data may be stored and processed using cloud computing, scattering its content and making the determination of the location challenging, especially in taxing terms. The EU governments are experiencing political and media pressure, felling compelled to ensure that digital companies pay their fair share of tax where their profits are generated. The quest for fairness is indeed subjective, however it is showing what the public supports in terms of tax policies. A recent survey shows that 74 % of the Europeans believe that current taxation rules allow digital business models to benefit from specific taxation regimes and to pay lower taxes, whereas 82% believe that action to address this should be taken68. In sum, the digital economy undoubtedly contributes to job creation, encourages innovation and stimulates economic growth. Many digital companies are a success story, and countries and international organisations want to encourage more innovation and economic growth, granting tax reliefs to R&D. Policy favouring development is crucial for digital companies to be covered by a fiscal framework that facilitates growth, especially among start-ups, so that they have the opportunity to reach their full potential, while ensuring fair and equitable taxation for all economic sectors. However, in the 68 EU COMMISSION, Questions and Answers on a Fair and Efficient Tax System in the EU for the Digital Single Market, 2018. 38 long term digital assets will be taxed, following the economic transformation that is fostering the digitalisation of the whole market. 2.5 INTERNATIONAL LACK OF CONSENSUS ON TAXING DIGITAL BUSINESSES Most of MNEs’ headquarters of digital conglomerates are based in a few developed countries, even though they hold sizable slices of consumers around the world. This scenario tends to separate countries in two groups: on one side those having companies’ headquarters and royalty’s registers (PE jurisdiction), and a second group having large share markets and almost no legal control over IPR (market jurisdiction). In consequence, there are situations where multinational technology companies are subject to derisory taxation, especially when compared to competing products – from the traditional economy –, which are regularly subject to full taxation69. In addition, taxation on employment contracts turns out to be a further disincentive to job creation, encouraging the search for their replacement by automation. By way of comparison, when customs duties began in modern states, much of the wealth consisted of goods that travelled through ports and border roads. The flow of mercantile was strongly supervised by the state, which guaranteed a relatively effective tax collection. On the other hand, in the twentieth-first century economy much of the world's circulating wealth now consists of intangibles (digital goods, user data, cryptocurrencies, and digital advertising and management services, etc.). The new business models generally rely on intangible property (licenses, brands, trademarks, copyrights) and place greater importance on use of technology (cloud computing, analytics, algorithms, smart machines). This allows for a huge amount of resources to circulate with marginal taxation or without any taxation at all, due to arrangements done with aggressive tax planning in a flawed international tax system. Thus, state border surveillance is no longer satisfactorily in terms of taxes, whether as a source of revenue, or as a way to protect the national market, demanding new forms of burdening the profit generated. 69 BIASCO, S. (2016). The Damages of Fiscal Competition in Europe and Alternatives to Anarchy. Em F. BOCCIA, & R. LEONARDI, The Challenge of the Digital Economy (pp. 17-38). Roma: Palgrave Macmillan, pp. 26-28. 39 Furthermore, considering the profile of a ‘digital business’, the idea of physical presence in a country for business realisation becomes less and less important. As digital goods are highly mobile, the physical presence of a company in the market country is often not a crucial matter, in comparison with brick-and-mortar businesses70. In addition, a digital company is easy to register in almost any country, while authorities consider such facilitation as a way to foster the local economy, while promoting R&D. In financial terms, as Internet traffic is usually free, costumers pay by credit cards, registered payment companies or even by cryptocurrencies. Indeed, some restrictions on digital business may occur in the case of telecommunications regulations, financial system or even government content censorships, which could somehow limit the internationalisation of digital business. In this sense, when choosing a foreign market to operate within, the company must pay attention to public policy rules related to its activity, such as intellectual property and tax regime, in addition to specific regulations. Yet, authorities must be aware that in the innovation culture it is typical to disregard public rules, being in the nature of start-ups businesses to find “out of the box” solutions in terms of doing business. From such considerations, it becomes more clear that sometimes it is notably difficult to track earnings from digital business. For instance, one company may incorporate in state A, have its head office in state B, sell in state C and register the profit in a bank account in state D. Considering this, the traditional way to tax income is sometimes fruitless in a total digital economic activity. As a response to this economic transformation, national governments have been moving toward taxing digital businesses objectively, considering how they can act creatively (and sometimes abusing) in terms of legal concepts that effectively embraces the large sum earned in such activities. The debate that has been raging about what was wrongly and provocatively renamed the “web tax,” “Google tax,” and “Amazon tax” demonstrates how superficially the issue is understood71. However, some more feasible solutions are on discussion, as will be more deeply examined in this thesis. The end of the twentieth century and the beginning of the twenty-first century were characterised by the transition from industrialism to the digitalisation of the economy, as consequence of the diffusion of new technologies, such as the Internet, satellite and optical fiber in communication networks. This technological transformation resulted in the emergence of new forms of wealth, which 70 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p. 16. 71 BOCCIA, F. (2016). Introduction: The Digital Economy and Fiscal Policy in the Age of E-Commerce. In F. Boccia, & R. Leonardi, The Challenge of the Digital Economy - Markets, Taxation and Appropriate Economic Models (p. 148). Rome: Palgrave Macmillan, p. 2. 40 have not been necessarily under territorial control, as the Internet had been facilitating the transfer of resources to various parts of the world. 3 THE GENERAL CONCERN REGARDING TERRITORIALITY In order to understand the central problem involving digital taxation, a deepening on the understanding of the fundamentals of international taxation is necessary, considering territoriality as a connecting factor that centres the whole discussion. Taxing digital events may often involve more than one jurisdiction, raising some concerns in terms of conflict of law. This means that both state A and state B may impose levies on the same event, causing the phenomenon of double taxation . In a broad sense, this double taxation arises from the taxation of the same person with respect to the same income in two or more states. It is also called juridical double taxation . However, it is also possible for the same income to be taxed twice, due being in the hands of different persons. This second situation is called economic double taxation72 . Economic double taxation frequently happens when affiliated or associated corporations – having seats in different states – enter into transactions with each other. Each residence state may determine the taxable base for CIT under its domestic corporate tax law. In this scenario, tax authorities of different states could assign different values to those transactions73. The problem emerges when two or more states are legally capable to tax the same taxable event. In this scenario, due their sovereignty, they can both tax. There is no prior international threshold in the tax rates. However, a double taxation policy would discourage the economic will to form international relations. As consequence, when taxing states understand that is to another state to tax, due the foreign nature of the source of income. If they both considerer the source income as foreign, there is a non-double taxation scenario. This latter situation may incentivise the afflux of income to abroad, causing an artificially shrinking in the domestic economy. Of course, the latter situation is less common, albeit also worrisome, leading to a race to the bottom scenario. 72 LANG, M. (2010). Introduction to the Law of Double Taxation Convention”. Vienna: Linde, p. 25. 73 In this case, Lang ( Ibidem ) uses an elucidative example: “A multinational group of companies has subsidiaries in China and Brazil. The Chinese company sells products to the Brazilian company for CNY 100,000. The Chinese tax authorities consider that the CNY 100,000 price is appropriated whereas the Brazilian tax authorities are of the opinion that the appropriate price would be CNY 80,000. Income in the amount of CNY 100,000 is taxed in China, while the deduction in Brazil is limited to CNY 80,000. 41 While not constraining double taxation, international businesses are usually discouraged, as investors interpret the legal mismatching as additional costs to operation. Thus, a coherent understanding about the situations above is required in order to find solutions to the phenomena of double taxation and under taxation, neutralising the tax policies. Indeed, country policies have to consider the intangible nature of digital business, as unilateral measures may in the long-term harm the internal market. Moreover, unilateral actions taken by states tend to fail, in part due to in significant part to the inability of the source and residence countries to share information, while not forgetting the consequent base erosion of taxable revenue. In fact, the power to tax comes from sovereignty, as a country has absolute power over what to tax. However if a taxable event is outside a state’s own jurisdiction, it will be hardly be enforced by another state, relying only on international cooperation. In common law systems, such situation lead to the rule against foreign revenue enforcement, by which courts of one country will not enforce the tax laws of another country74. The principle is part of the conflict of laws rules developed at common law and forms part of the act of state doctrine75. In civil law jurisdictions, foreign tax claims are generally repealed on the basis that they are public laws, and therefore cannot be enforced outside of the state or territory76. Michael Lang confirms that states can levy taxes due their sovereignty. Yet, tax sovereignty is limited, because there must a personal or an objective nexus between taxpayer and state77. Such threshold is practical, as taxing some events beyond states control would lack of effectiveness. Then, a central idea is that sovereign states have the sole authority to levy taxes in their territories, in respect to other states sovereignty. The nexus between a taxpayer and state is often a connecting factor. For individuals it frequently is domicile, residence or citizenship. In the case of legal entities, the connecting factor is usually the place of incorporation or place of effective management (PE). By using objective criteria, a 74 Court of Appeal, State of Colorado v. Harbeck, 232 N. Y. 71, 133 N.E. 357 N.Y., Nov. 22, 1921. 75 According to English and United States law, states that every sovereign state is bound to respect the independence of every other sovereign state. A court will not inquire into the legality of acts of a foreign state, in particular legislative acts of a foreign state and executive acts of a foreign state concerning property in its territory. Thus, courts shall not sit in judgment of another government's acts or act of any sovereign national in its own territory. CHALK, E. (23 de 01 de 2020). A Reliable Decision: Foreign Act of State Doctrine Applies in English. Fonte: DLA Paper: https://s3.amazonaws.com/documents.lexology.com/315b1de8-df72-49ff-8b66829a697c3df9.pdf?AWSAccessKeyId=AKIAVYILUYJ754JTDY6T&Expires=1579796330&Signature=EX1HvKT5OezXKjthj8RRuprU0Ss%3D 76 RECHSTEINER, B. W. (2012). Direito Internacional Privado. São Paulo: Saraiva, p. 21 77 LANG, M. (2010). Introduction to the Law of Double Taxation Convention. Vienna: Linde, p. 23 42 sufficient factor would be those parts of the transaction or activity involving the taxing state, or somehow connected to the taxing state, therefore excluding a different state78. Legally speaking, identifying the prevalent connecting factor is a matter of jurisdiction. This means that an income may be taxable under the tax laws of a country, because of a nexus between that country and the activities that generate the income (source jurisdiction); or also a jurisdictional claim over income based on the nexus between the country and the person subject to tax (residence jurisdiction). In any case, the territoriality principle prevails, being the basis for bilateral treaties concerning double taxation. The approaches of granting double taxation relief may vary from country to country. They can be precise rules in domestic law; large margins to tax authorities; or even unilateral relief due reciprocity. Nevertheless, not all cross-border relations are covered by DTCs. In many cases, the states enact domestic rules to prevent international double taxation. According to Lang, there are three types of unilateral measures to prevent double taxation: the exemption of foreign-source income; the tax credit for foreign taxes paid on foreign-source income; and the deduction from the taxable base of foreign taxes paid on foreign-source income79. Usually, DTCs use a combination of the first and the second methods, following to OECD Model Convention. In political terms, the open market favours the adoption of legal solutions to constrain the effects of double taxation. Therefore, states share a long-term tradition in celebrating tax treaties aiming to lower barriers to international trade. In this scope, it is relevant to note that direct taxation is the last bastion of a fading fiscal sovereignty (at least in Europe)80, while indirect taxation tends to be fully harmonised worldwide. Thus, there are additional barriers to establish a multilateral system to improve efficiency in direct taxation, as will be discussed below. 78 Adding, Lang argues that there are no significant limits on tax sovereignty in practice. The lawmaker can even tax situations when, for example, only a “genuine link” exits. Then, the tax cannot be levied only when neither the person nor the transaction has any connection with the taxing state ( Idem , p.23). 79 Idem , p.26. 80 About the European sovereignty losing worry: “Tax sovereignty is no longer the same, as exemplified through the ever present interference by CJEU and the fiscal measures imposed onto Member-States (Portugal is a good example). This is what makes direct taxation issues so important. The sovereignty, albeit feeble, that they still entail has great symbolic value since it represents the thin red line that separates the Union from a true Federation. For the Union to become a Federation, there are only two features missing: (i) Power of EU institutions to change the treaties (Member-States remains masters of the treaties; (ii) and tax spending capacity (Fiscal Federalism). At the end of the day, political union and fiscal sovereignty are linked and depend on each other” (RIBEIRO, J. S. (2018). An Overview of European Tax Law and Its Impact on European Member-States’ Legal Systems: the Portuguese Example, in J. S. RIBEIRO, Selected Essays on International Business Law (pp. 285-303). Braga: Universidade do Minho Escola de Direito, p.294). 43 3.1 RULES FOR ATTRIBUTION OF PROFITS TO A PE CONTROL There are uncountable variations in tax treaties ruling taxing rights in double taxation situations, yet they usually follow two model conventions, either from UN or OECD models. There are slight differences between them, nevertheless they tend to have the same objects, focusing on mechanisms against double taxation. The main goals of international tax treaties are to able countries to obtain their share of revenue; minimise double taxation; harmonise taxation; implement capital-export and capital import neutrality; to improve the exchange of information; to enhance competitiveness of the domestic economy; and to prevent fiscal evasion. Nevertheless, focusing on bilateral relations is not enough to deal with global value chains, especially in case of payments for non-physical assets, as nowadays, there are methods of tax evasion that may be favoured in digital businesses, as mentioned below. In the case of outbound payments of dividends, interest and royalties, countries usually impose withholding taxes, on a gross basis and not reduced by the deduction of expenses. The role of a DTC in most cases is to specify a maximum rate at which the source state may impose such tax, keeping the residual right to tax belonging to the state of residence. By standard, the OECD Model Convention establishes rules about this taxing system in articles 10(4), 11(4) and 12(3)81. Treaty abuse may be going beyond the ration of the law, generating the phenomenon known as treaty shopping. In a concise way, the commentaries on article 10 of OECD Model Convention consider abuse in some kinds of dividends sharing, gaining in intermediary establishment to circumvent withholding taxes, taking advantages of a treaty exception82. Nevertheless, there are traditional mechanisms to fight treaty abuse. A general anti-abuse principle of international law is in articles 26 and 31 of Vienna Convention, setting the binding force and good faith, towards parties and third parties. In 2003, the §9.5 of OECD Commentary on article 1 embodied the idea of anti-abuse principle. Not only do states establish rules to prevent tax avoidance. The domestic anti-avoidance rules sometimes are a way to harmonise anti-abuse provisions, if a party may not invoke the rule. On the other side, great controversy exists in whether tax authorities may prevent the improper use of DTCs, especially in case of MNE arrangements. Then, the scope of discussion is, on the one 81 OECD (2017) Model Tax Convention on Income and on Capital, p.27. 82 Idem , pp.241-242. 44 hand, about what constitutes abuse and is thus undesirable and, on the other hand, on the efficiency of rules empowering tax authorities to grant treaty benefits83. 3.2 THE PROBLEM OF PERMANENT ESTABLISHMENT FOR DIGITAL BUSINESS In the global economy, mobility in business makes it difficult to identify where the actual selling is being done. As a consequence, traditional principles are in crisis, and territoriality is not enough anymore to grant tax collection in innovative business. The OECD Model Convention was not made for multilateral relations MNE may scatter businesses easily, circumventing tax obligations. The most striking example is found in the OECD Model Convention, where the convention system relies on binomially determine whether a person is resident in country A or country B. Then, article 5 answers this question by identifying where is the PE, considering a fixed place of business through which the business of an enterprise is wholly or partly carried on. In article 5, paragraph 4.1, the fixed place of business is where an enterprise carries business activities. In this case, there is a PE already or the overall activity resulting from the combination of the activities is not preparatory or auxiliary and the business activities constitute complementary functions that are part of a cohesive business operation. The problem is that qualification is many times manipulated in complex company arrangements, while it can be difficult to deem what is the main activity of a digital business, or if it has preparatory or auxiliary characteristics . In the case of E-Commerce, enterprises may be considered storage companies , not having a PE, according to paragraph 4, “a”, “b”, “c”, “d”, “e” and “f”, as long as the storage activity is classified as preparatory or auxiliary . Moreover, this criterion of PE does not fit in digital business, because of mobility nature of this kind of activity. Moreover, it is a practical consensus to academics that the PE standard is no longer a coherent concept to deal with cross border transactions84, especially considering the crescent relevance of the intangibles market. In OECD’s commentaries on article 5, the commenters touch only the surface of the 83 LANG, M. (2010). Introduction to the Law of Double Taxation Convention. Vienna: Linde, p. 59 84 KEMMERN, Eric. Should the Taxation of the Digital Economy Really Be Different? Editorial of EC Tax Review, 2018-2, p.72. SCHIPPERS, Martijn; VERHAEREN, Constantin. Taxation in a Digitizing World: Solutions for Corporate Income Tax and Value Added Tax. EC Tax Review, 2018-1, p.61. 45 matter, naming the whole problem as “Electronic Commerce”, and proposing solutions for a few practical cases of digital business, as following. First, there is a distinction between computer equipment and the data and software, which is used by, or stored on that equipment. An Internet web site (combination of software and electronic data) does not itself constitute as a “place of business”, as there are no facilities such as premises, machinery or equipment. However, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute as a “fixed place of business”85. The Commentaries do not consider the possibility for a business to be split across many servers around the world, or in a cloud system with multiple fixed places holding the data. Nevertheless, the Commentaries relied on the differentiation between web site and server as a cornerstone for the matter, because “the enterprise that operates the server may be different from the enterprise that carries on business through the web site”86. In the OECD’s commentaries, the premise is that the physical place of the Internet Service Provider is sufficient to determine a PE. In this sense, according to §10 of the Commentaries87, the PE is a place of business any premises, facilities or installations that are being used or at its disposal, with no importance on whether it is owned or rented. In an opposite sense, if the ISP only rendered a service to the owner of the web site, there would be no fixed place of business. Following the discussion, the Commentaries state that: in the case of a server, what is relevant is not the possibility of the server being moved, but whether it is in fact moved. In order to constitute a fixed place of business a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1.88 Again, with the premise is that an ISP is a fixed place of business, the problem is still unsolved, considering the actual technological stage of data storage. It is relatively easy to move a web site to a different host, in a different jurisdiction. As an analogy, a web site is like a merchant ship, and the ISP is a harbour. A change of host involves some costs indeed, but for those who operate as an online business, the know-how of doing so is implicit. Considering the quote above, it seems that the Commentaries lack an understanding of how a server operates. In a first-level tax planned operation, an 85 OECD. (2017). Model Tax Convention on Income and on Capital, p.152 86 Ibidem . 87 Idem , p.57. 88 Idem, p.152. 46 enterprise could move the server abroad just before the threshold that characterises a PE is reached, avoiding the taxation. A second issue is whether the business of an enterprise is wholly or partly carried on at a location where the enterprise has equipment such as a server at its disposal. Moreover, the presence of personnel is not necessary to consider that an enterprise carries on its business, because in many cases no personnel are in fact required to do so. Equipment may operate automatically, without direct human intervention. For instance, the support personnel is in country A, the server is split in country B and C, operating without direct human intervention with automated machines in the market of country D. Then, question of where does the enterprise operate is not easily solved, as the production chain is scattered throughout four different countries. A third concern relates to the fact that there would be no PE where the E-Commerce operation carried on through computer equipment at a given location in a country, if the operation is restricted to preparatory or auxiliary activities covered by paragraph 4. According to the Commentaries, the following activities that are generally regarded as preparatory or auxiliary (therefore not a PE) include: a) providing a communications link between suppliers and customers; b) advertising of goods or services; c) relaying information through a mirror server for security and efficiency purposes89; d) gathering market data for the enterprise; and e) supplying information90. Considering the level of specialisation in digital services, most of these activities are usually outsourced, which means that a MNE would rather create subsidiaries to manage them better. Indeed, what appears clear, is that in the OECD perspective, digital business are not new activities per se , instead the organisations seem to qualify an enterprise by traditional standards (retailer, communication, storage and others), and afterwards tends to see typical technological services as auxiliary ones. In other words, the Commentaries do not go further in the discussion regarding where is the sole place for tax purpose in supplying information, gathering data, securing data and other intangible activities to be performed, relying on traditional legal concepts. The last issue taken on by the Commentaries is whether paragraph 5 may apply to deem an ISP to constitute a PE. According to OCDE Model Convention, the place where the person habitually concludes contracts or plays a principal role is to be considered as a PE. However, there is a caveat in the case of an agency acting on behalf of a person. This exception represents a case where the decision 89 Mirror sites or mirrors are replicas of other websites or any network node. In cloud computing, it is not possible to determine the main server, while data is stored without direct active management by the user. 90 Idem , p.153. 53 CHAPTER III – PROPOSED MEASURES FOR DIRECT TAXATION IN THE DIGITAL ECONOMY The tax authorities are acknowledging the need for measures to deal with the digital economy. In recent years, national governments have been moving towards taxing objectively digital business, being creative (and sometimes abusing) in terms of legal concepts that effectively embraces the large sum earned in such activities. The debate that has been raging about what was wrongly and provocatively renamed the “web tax,” “Google tax,” and “Amazon tax”, which unfortunately demonstrates how superficially the issue is shown to the public102. The countries’ initiatives are divided into three categories, considering the parties involved. The first is the traditional unilateral approach, by which each country individually develops a strategy to constrain tax evasion and tax avoidance. The second is the bilateral approach, also traditional, based on the DTC and other instruments of international law that comprises transactions made between the two parties of the treaty. The third is the multilateral approach, which faces the taxation problems in a broader perspective, and whose results are not yet known from a long-term perspective. What is known is that the attempt to solve digital taxation problems using unilateral and bilateral policies have been unsuccessful thus far, leaving space for bolder proposals in a multilateral perspective, as showed below. As the focus of this research is placed on the multilateral approach, some deepening in OECD’s is required to understand what is in the forefront of digital taxation, and what is expected to change in next years in terms of international agreements. Undoubtedly, the expected progress will change many aspect of domestic legislation as well103. 1 OECD’S RECENT DEVELOPMENTS IN DIGITAL TAXATION In the scope of OECD initiatives, the entity has been at the forefront of dealing with tax evasion, since the London Summit in April 2009. The explicitly reason for this is goal to investigate and end bank 102 BOCCIA, F. (2016). Introduction: The Digital Economy and Fiscal Policy in the Age of E-Commerce. In F. Boccia, & R. Leonardi, The Challenge of the Digital Economy - Markets, Taxation and Appropriate Economic Models (p. 148). Rome: Palgrave Macmillan, p. 2. 103 Law as a whole and tax law specifically are subdue to constant transformation. Whereas international tax treaties tend to represent a more stable regulation, domestic taxation may easily change in a short period. One must realise that we are in a transition period; therefore, some “tests” may happen. 54 secrecy and tax havens, while also addressing tax avoidance by multinational corporations. The first intent of OECD contributions was to reform, reshape and modernise the international tax architecture aiming at artificially shifting profits to locations where they are taxed at more favourable rates, or not taxed at all. The second intent was to increase transparency between taxpayers and tax administrations and among tax administration themselves. The general concern is to end the phenomenon of so-called ‘stateless income’, suggesting rules to tax such income104. Later on, during the beginning of 2013, the OECD and the G20 met in Saint Petersburg, Russia. Leaders agreed on setting out new measures and country-specific reform commitments to boost growth and job creation. The OECD supported the G20 in designing new action plans, from the angle of structural reforms, contributing to make them more concrete, specific and assessable. Then, OECD adopted a 15-point Action Plan to address BEPS, having some advances so far, developing concrete strategies combat international tax base erosion strategies through aggressive tax planning, which has become increasingly important in international discussions tax policies. The OECD/G20 BEPS Project is an indication of how states are unable to maintain fair taxation systems in the new age of the digital economy. OECD developed the project with support from the G20. For instance, there were updates in in OECD Model Convention, mainly from action plans 6, 7 and 14 and commentaries about tax avoidance105. Even before the release of the Action Plans, the OECD’s Task Force on the Digital Economy (TFDE) considered the following proposals to tackle direct tax challenges: 1) modification to the exceptions from PE status; 2) alternatives on the existing PE threshold; 3) the imposition of a withholding tax on certain types of digital transactions; and 4) the introduction of an excise tax or other levy106. Moreover, the TFDE agreed on a framework beginning with the following principles: neutrality, efficiency, certainty and simplicity, effectiveness and fairness, flexibility and sustainability and proportionality. These principles are strongly related to the procedure principles described in the previous chapter. Moreover, the Action Plans were strongly influenced by TFDE’s proposals, which made them a base line for further considerations. 104 G20, Communique: London Summit – Leaders’ Statement, 2 April 2009. 105 OECD (2017) Model Tax Convention on Income and on Capital, p.11. 106 Albeit there are many subjects in the action plans, according to Russo, the OECD reports implicitly indicates three elements of tax avoidance: 1) artificiality of arrangements, having no business or economic aims as a primary purpose; 2) secrecy as a modern feature to tax planning; and 3) actions taking advantage of loopholes in the law or of applying legal provisions. (RUSSO, Fundamentals of International Tax Planning, 2007, p.53.) The TFDE Action Group set up to assess the value chain characteristics of the digital economy, providing for user participation, provision of data, market presence and virtual presence. 55 After the release of the first reports in 2015, there were other publications put forward in the same tone, as follow. In March 2018, the delivery of the Interim Report . In January 2019, the delivery of Policy Note . In February-March 2019, a Public Consultation document. In May 2019, the Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy . In November 2019, the Public Consultation - Secretariat Proposal for a "Unified Approach" under Pillar One . In December 2019, Public Consultation - Global Anti-Base Erosion (GloBE) Proposal under Pillar Two . And in January 2020, the Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy . All of the documents are part of a continuous effort to define and settle the international standards for digital taxation. Although there are still no final agreements on the matter, the developments have shown some alternatives that may be in charge in the near future. The corpus produced by OECD’s releases about BEPS formed a massive content pool regarding the advancements in dealing with the new intangible economy. A complete description of the documents would be unreasonable here. Hence, the most relevant aspects of the reports are described below. 1.1 OECD 2015 ACTION PLANS ADDRESSING DIGITAL ECONOMY The main OECD action plans for digital economy taxation are in the 2015 OECD Action 1 Report – Addressing the Tax Challenges of the Digitalisation of the Economy , acknowledging that the digital economy raises more systemic and broader challenges, summarised as characterisation, nexus and data, for tax policymakers. This report is one of fifteen work fronts on tackling tax avoidance released by OECD. The first part of the report describes the ongoing economic transformations in economy, mainly considering the exponential growth of digital market. The report covers remote selling ( e-tailors ) and new ways of doing businesses, as use of massive data, software as a service and many others new digital products that only make sense in the Internet environment. Considering the argument that digital business are undertaxed, the report discusses possible solutions, such as new nexus, equalisation levy and withholding taxes. 56 In terms of a new nexus, the idea is to reform OECD Model Convention in order to cover business’ establishments that operate mainly on the web, having no significant presence in the physical world. By setting the taxing model to clearly identify a tech enterprise, the country state can apply straightforward rules, constraining tax avoidance practices. An equalisation levy, on the other hand, intends to tax the digital transactions, based on the income accruing to foreign E-Commerce companies acting domestically. It is a direct tax, aimed to cover business-to-business transactions. Finally, withholding taxes represent a way for the country to impose a minimum tax to revenue transferred abroad. Although it is a more aggressive tax policy, in many ways it could be more effective in order to protect the taxable base from erosion. On the OECD Report about digital taxation, there are three broad categories of policy in the area of direct taxation: nexus, data and characterisation107. Whereas enterprises find value in new forms of businesses, the intangible nature of these assets creates natural barriers for tax administrations, demanding new concepts that are able to reach these three aspects. Besides, the free traffic provided by Internet allows cloud computing to move easily to different jurisdictions at the same time, replicating the software and data gathered in as many servers as necessary. In terms of the OECD concerns, it is not a worry that taxing rights that may lead to low taxation are not per se an indicator of defects in the existing system. In this regard, it is paramount to examine how companies make profit to determine whether and to what extent it may be necessary to adapt current rules to take account of the specific characteristics of this industry and to prevent BEPS. In another sense, combating the free rider problem is a goal of OECD BEPS Project. For instance, in the Action Plan 1, of 2015, there were suggestions of the following characteristics necessary for digitalised businesses: reliance on intangibles, scale without mass (minimal or no need for personnel or physical establishment to operate in market jurisdiction) and user value creation108. 107 OECD, Addressing the Tax Challenges of the Digitalisation of the Economy, OECD, Paris, p.99. The first is the continual increase in the potential of digital economy combined with the reduction of physical presence and an increasing role of network effects generated by customer interactions. It raises questions whether the current rules to determine nexus with a jurisdiction for tax purposes are efficient. The second (data) derives from the ability to gather and use enormous amount of data. The concern here is how to attribute value created from the generation of data through digital products and services. Moreover, how to characterise for tax purposes a person or entity’s supply if data in a transaction. Sometimes, data derives from a participative platform fed by usercreated content, making such network the value that attracts more users. The third and latter challenge is the development of new digital products or means of delivering services, generating uncertainties regarding the proper characterisation of payments made, with a special concern to cloud computing. In many of these cases, the users are not directly remunerated for the content they produce, however the business may monetise the content via advertising revenues, subscription, sales or licensing of content to third parties. 108 OECD (2015). Addressing the tax challenges of the digital economy, OECD, Paris, p.66. 57 Although there are significant efforts in searching an agreement on the groundings, no consensus was achieved. The triad nexus, data and characterisation did not have enough support. Nevertheless, the studies kept going, resulting in the Interim Report of 2018. 1.2 OECD’S OTHER ACTION PLANS IN CONNECTION WITH DIGITAL CONCERNS Besides the Action Plan 1, other OECD’s frontlines related to digital economy are found in the other 14 concomitant action plans. For instance, preventing treaty abuse (Action 6), preventing the artificial avoidance of PE states (Action 7) and strengthening CFC rules (Action 3). Also both market and residence BEPS issues are addressed by neutralising the effects of hybrid mismatch arrangements (Action 2), by limiting deductions and other financial payments (Action 4) and by making transfer pricing in line with value creation (Action 8-10). Following others MNEs’ practices, digital economy businesses take advantage of hybrid mismatch arrangements to achieve BEPS. The practice involve stripping income from a particular market or intermediate jurisdiction or by avoiding the application of CFC rules or any other anti-abuse rule. In this case of tax avoidance, the Action Plan 2 recommends the design of domestic rules and the development of model treaty provisions to neutralise the effect of hybrid instruments and entities. The report on Action Plan 3provides recommendations in the form of six building blocks, including a definition of CFC income, which sets out a non-exhaustive list of approaches that CFC rules could use for a definition109. Many digital economy players act acquiring start-ups or other assets with intra-group debt operations. This is an opportunity to engage them in transactions with associated enterprises that have the base erosion effect, capitalising entities in low-tax jurisdictions. A new affiliated company may engage in lending money to high-tax operating entities. The deduction on loans from such operations can represent a BEPS concern. This is a way to create debts artificially to a parent company, reducing its taxable income in the market jurisdiction. The response is seen in Action Plan 4, which sets best 109 They are: (1) definition of a CFC, (2) CFC exemptions and threshold requirements, (3) definition of income, (4) computation of income, (5) attribution of income, and (6) prevention and elimination of double taxation. (OECD, Designing Effective Controlled Foreign Company Rules, 2015). 58 practices through the design of domestic rules, intentionally reducing opportunities for BEPS via interests or any other deductible financial payments. The work undertaken in Action Plan 5 is to constrain harmful tax practices, requiring substantial activity for any preferential regime and as a result, the existing substance factor has been elaborated and elevated in importance. This nexus approach is focused on ensuring that taxpayers can only benefit from IPR regimes while they are indeed engaged in R&D in that jurisdiction. The report Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (Action 6) propose model rules for a minimum standard to address treaty shopping arrangements, aiming fictional activities made in countries to take advantage of the treaty network. The central idea is to prevent double non-taxation, allowing the domestic law to be applicable, unconstrained by treaty rules. The Action Plan 7 suggests a new concept of PE reaching digital economy. It would not only be the recognition of a PE, but also the understanding of a main role for the company's representative in the country, with the conclusion of the contracts set in a routine way. Thus, the goal is to prevent artificial avoidance of the treaty threshold below which the market may not tax. In response of the circumventing practice, the sales should be treated as if they had been made by the parent company, even if registered by the subsidiary company. Another goal of Action 7 is to ensure that the location of where essential business activities of enterprises are carried out at a given location in a country, the enterprise cannot benefit from the list of exceptions usually found in PE’s definition. It was too agreed to modify article 5(4) of the OECD Model Convention to ensure that each of the exceptions included therein are restricted to activities that are otherwise preparatory or auxiliary110 . Alongside, the new antifragmentation rule was introduced to ensure that it is not possible to benefit from exceptions through the fragmentation of business activities among closely related enterprises. As a consequence, significant components of businesses in the digital economy stop from being considered as preparatory or auxiliary, as they will no long be entitled to an exception from PE status. A practical example of inhibition by the new proposed rule is a very large warehouse in which a significant number of employees work for purposes of storing and delivering goods sold online by an online platform to end customers. In this case, the seller would be there constituting as a PE, most definitely discarding the argument for preparatory or auxiliary activities111. 110 OECD, Addressing the tax challenges of the digital economy, 2015, p.88. 111 Ibidem . 59 In the context of the work in Actions 8-10 (transfer pricing concerns), digital companies rely heavily on intangibles in creating value and producing income. Then, most of concerned activities are the transfer of intangibles or rights in intangibles to tax-advantaged locations. Such practice in coupled with the position that these contractual allocations, as well legal ownership of intangibles, justifying large allocations of income to the entity allocated the risk even if it operates with little or no business activity. The last Action Plan, number 15, in a broader sense of international taxation, seeks to develop a legal instrument to accelerate and align the necessary implementation measures for the BEPS project, as it recognises that changes in the bilateral treaty model are not sufficient, as they do not change the treaties themselves. In the plan, the OECD projects, for the near future, a multilateral instrument to amend bilateral treaties. Overall, the effects of the most relevant Action Points to digitalisation, such as Action 7 on PE and Action 8-10 on transfer pricing are rather limited. They do not adequately address taxation of digital platforms and businesses providing goods and services in countries without, or with limited PE presence. What is worse is that BEPS measures can lead to economic distortion while enhancing tax competition if MNEs decide to move their real economic activity to low-tax jurisdictions. What is expected is a consensus-based, long-term solution in 2020, with an update to be presented to the G20 during 2019112. The 2018 Interim Report pointed out that countries already had come a long way in implementing several of BEPS measures, mainly considering Actions 8-10, in spite of no clear coordination in the actions. Also, in response of Action 7, many technological MNE groups changed their distribution models, from remote to domestic selling operations. Overall, the BEPS Project already contributed to realigning income from intangibles with value creation, in regard to Action 5 and Actions 8-10. Therefore, there are correlations from the Action Plans 2 to 15 with digital taxation in mind. However, these plans did not bring concrete solutions for the matter, leaving it open to later discussions made by OECD. The advances are counterbalanced by the lack of mutual understanding in terms of digital economy, which is still underway in developing by the OECD Secretariat, as can be seen below. 112 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, pp. 10-11. 60 1.3 INTERIM REPORT OF 2018 In the year of 2018, OECD finally displayed some progress from the studies carried out to establish parameters of digital taxation. The text represents a clear advance in terms of tax architecture, albeit does not bring a final solution to the matter. In terms of innovation, the Interim Report of 2018 unveiled some economic classifications that help to cope with the disruptive economy today. Thus, the approach taken allows to better understand the proposals released later on. In the OECD’s Interim Report of 2018 , specialists improved the classification of digital businesses, dividing them in four categories: multi-sided platforms, resellers, vertically integrated firms and input suppliers113. For clarification, multi-sided platforms are technologies, products or services that create value primarily by enabling direct interactions between two or more customer or participant groups, throughout online marketplaces. The most known examples are Uber, Airbnb and Google. Following, resellers (or e-tailors ) are companies specialised in selling merchandise in catalogues. They may sell directly or even act amongst other selling partners on the same website. Typical examples in this area are Amazon E-Commerce, Alibaba and Spotify. Vertically integrated firms are businesses that acquire ownership over suppliers, integrating the whole production process ( e.g. Amazon warehousing and logistic, Xiaomi and Netflix). In simpler terms, a vertical integration is an arrangement in which the supply chain of a company is owned by that company, which that controls the entire process. Usually, each member of the supply chain produces a different product or (market-specific) service, and the products combine to satisfy a common need. Finally, input suppliers, in the digital economy, are undertakings that have intermediary inputs for a production in another firm. They do not act directly with the final consumer, instead their products are offered to other digital businesses, for instance Intel, Tsinghua Unigroup, software developers and other programming services. All the models above are covered by OECD’s studies, therefore demanding a coherent solution in terms of taxation. Each of them have special features that easily allow for complex company 113 OECD (2018), Interim Report, OECD, Paris, pp.30-31. 61 arrangements, favouring tax avoidance practices or – in a more complacent perspective – erode the taxable base altogether. The OECD’s Interim Report of 2018 it beacons economically what is under the scope of a tax implementation. In this sense, the report did go further on discussing the matter of value creation, while describing the main features of digital markets. It also showed how they shape value creation114. The study assumes three main features of digital businesses for attributing value as a digital asset: crossjurisdictional scale without mass; the heavy reliance on intangible assets, especially IPR; and the importance of data, user participation and their synergies with IPR. However, considering the three features, “(a)mong members (…) there is no consensus on their relevance and importance to the location of value creation and the identity of the value creator”115, because these factors are not exclusive to digital businesses. Moreover, the interim report highlighted progress achieved regarding minimum standards (Action 5 on harmful tax practices, Action 6 on treaty abuse, Action 13 on Country-by-country reporting or CBCR116, Action 14 on dispute settlement), which are subject to peer review within the MLI. It welcomed the onshoring of IPR by some MNEs as result of BEPS Action 5 as well as the wide acceptance of the CBCR standards. The referred Report changes under Action 6 of the OECD Model to include an anti-abuse rule for PEs situated in third States and a principle purposes rule (PPT), which were both criticised for lack of precision, complexity and subjectivity as previously mentioned. Moreover, the most relevant actions to the digital sector, such as seen in Action 7, Action 8-10 and Action 3, were inadequate to tackle longterm issues in the digital economy, because they failed to address key problems of nexus, profit allocation and separate group entities. According to the Public Consultation Report of 2019117, that complements the Interim Report of 2018 , part of the experts understood that the reliance on data and user participation may lead to misalignments between the location in which profits are taxed and the location in which value is created. The scepticism regarding the data/user participation from the group of studies came from the suggestion that only certain business models have the challenge of taxation, and a large change may alter fundamental principles of the existent tax system118. Considering such stalemate on the definition of 114 Idem , pp.23-79. 115 Idem , p.25 116 Country-by-country report. 117 OECD, Addressing the Tax Challenges of the Digitalisation of the Economy – Public Consultation. OECD, Paris, 2019, p.6. 118 Idem , p. 17. 62 data collection, the OECD’s position in the 2018 report was to consider the need for further work in order to reach a consensus. Nevertheless, the results of 2018 advanced on the discussion regarding economic basic concepts, bringing more data and more arguments towards the urgency and need of a coordinated tax policy concerning intangibles. Yet, the study itself was rather inconclusive and Member States began implementing unilateral policies in digital taxation, weakening the OECD’s role over the matter. The studies continued, enabling an additional two years of releases from the working group. It was only then at the end of 2019 came some more tangible proposals in tax law terms came along. 1.4 INCLUSIVE FRAMEWORK OF 2019 Considering the previous developments, in 2019, the Inclusive Framework was launched. In this brief report, a different approach was taken. The starting point for a consensus was set with two main topics: nexus and profit allocation. Although there was not an official document bounding the Member States, they agreed in two topics: that no physical presence is required for digital taxation; and on the need of modifications beyond the arm’s length principle. Nexus and profit allocation are the two bases for shaping a new tax framework. Nexus, in simple terms, deems which is the strongest connecting factor when more than one jurisdiction claim the ability to tax a particular event. Profit allocation, by its turn, represents which portion of profits should be taxed. That is the intention to calculate the whole liquid revenue of a MNE, no matter how broad its operations are, setting out what is the profit, and distributing it accordingly to the economic value produced. The document is important to represent the overcoming of the question by OECD of where to start to reform digital taxation. It means that the consensus can be made in a two-dimensional argument, which axis are profit allocation and nexus. Then, mapping a solution is now less about how to do , being more about how much to do . Nevertheless, the OECD’s works continued on this topic with the release of the programme of work, as below. 69 cases, the levy would be imposed on the gross value of goods or services provided to domestic customers and users. The original Action Plan 1 also suggests imposing an equalisation levy on data collected from domestic country customers and users127. The metrics could be over the number of users, contracts or volume of data gathered128. Since 2018, the project discharged the proposal, focusing in on taxation as previously exposed (Significant Economic Presence). It seems that the establishment of an excise as an equalisation levy is representative as much more a unilateral solution, which has already been taken in some jurisdictions. In another perspective, the allocation of profits before taxation (item 3.1) is not that different from an equalisation levy, considering that operational costs (expenses) in digital businesses are rather marginal when compared with brick and mortar businesses. Moreover, the proposal is not considered by the Inclusive Framework group as a safe harbour , as it still lacks on simplicity and clarity over the instruments to put the new taxation method into practice. 3.3 THE “UNIFIED APPROACH” More recently, the Pillar 1 panel went further on solutions for digital taxation. On November 2019, the Secretariat published a unified approach, uniting the previous subjects due their commonalities and looking for an easier consensus in the Pillar 1 discussions. In simple terms, the idea is to establish general rules for sharing taxing rights of profits between PE jurisdiction and market jurisdiction. All the proposals under the unified approach agree on the following matters: the length of highly digitalised business (scope), the need for the creation of a new nexus, the implementation of a new profit allocation beyond arm’s length principle and increased tax certainty in a three-tier profit allocation. These advancements represent a clear concept on what is crucial in terms of tax law reform. 127 Ibidem . 128 Idem , p.137. 70 This division above is a condensed result of the previous topics of Pillar 1, they also allows in a future taxing framework a clear understanding of what would be each kind of taxing right, which is in general granting some taxing rights to market jurisdiction. The first three subjects are self-explanatories, whereas the last one requires a deeper analysis for further understanding. According to the Public Consultation Document - Secretariat Proposal for a “Unified Approach” under Pillar One , the three-tier mechanism split taxpayer’s profit in the following sections: Amount A – a share of deemed residual profit allocated to market jurisdictions using a formulaic approach, i.e. the new taxing right; Amount B – a fixed remuneration for baseline marketing and distribution functions that take place in the market jurisdiction; and Amount C – binding and effective dispute prevention and resolution mechanisms relating to all elements of the proposal, including any additional profit where incountry functions exceed the baseline activity compensated under Amount B129. This division is a response to the new proposed rules, combined with existing transfer price rules. The general idea is to grant an agreed quantum profit to market jurisdiction taxation. According to the Secretariat, this would be simpler, and would avoid double taxation while improving tax certainty relative to actual circumstances130. In broader terms, the deemed residual profit would be the profit that remains after allocating what would be regarded as a deemed routine profit on activities to the countries where the activities are performed. Indeed, it requires a prior consensus on what is the extent of routine profit, both in level and proportional terms. Such agreement could be made through a convention. The amount due to the market jurisdiction would be allocated to meet the new nexus rules, according to a formula based on sales. It is important to note that all of the rates would be a part of the consensus-based agreement between the Inclusive Framework members. The second and third type of profit (Amounts B and C) would only apply in reference to the presence of a traditional nexus in the market jurisdiction (a subsidiary or PE), and not in the case of a taxable presence resulting from the application of the new non-physical nexus rule (which would give rise to Amount A). This means that the maintenance of the principle of arm’s length and profit allocation according Article 7, of OECD Model Convention, either in a fixed remuneration or in case of a 129 OECD. Public Consultation Document. Secretariat Proposal for a “Unified Approach” under Pillar One. 9 October 2019 – 12 November 2019. OECD. Paris, p.6. 130 Idem , pp.8-9. 71 dispute resolution. Thus, it would be more easy to predict the results of disputes, because of existence of fixed parameters, than increasing certainty and reducing dissatisfaction with current transfer price rules131. Instead of reshaping the whole international tax system, the Unified Approach promotes inclusion of new rules, while adding new tools to complement pre-existing treaties. The proposal leaves open the option for a country to domestically keep a withholding tax to a non-resident taxpayer, in order to grant the collection of Amount A132 . Moreover, by introducing a threshold based on profitability and targeting deemed non-routine profit, the proposed method is designed to materially limit the disruption of the conventional transfer pricing that is applied to routine activities133, tackling the BEPS practices that are nowadays the core problem regarding aggressive tax planning from MNEs. In the scope of MNEs, the proposal in the Unified Approach to set a € 750 million threshold134, charging only larger tech companies, while still fostering the development of new digital businesses in an international scope. Considering the distinguishing process to identify the taxable amount, the profits regarded as rewarding routine functions are excluded from the calculation of the pool of profits from which the allocation to market jurisdictions would be made. The level of profitability deemed to represent such “routine” profits could be determined using many different methods, but a simplified approach would be a fixed percentage . If that portion of routine profit is x%, then x% would be ignored for the purposes of the calculation of the profits reallocated to market jurisdictions, with only the excess (total profit -x%) being the subject of further consideration. In a second step, the non-routine profit has to be split between market jurisdiction and the portion that is attributable to other factors such as trade intangibles, capital and risk, etc. In this case, an agreed multiplication factor may rebalance the tax due. Comparing, amount B follows a simpler method, establishing a fixed return for certain baseline or routine marketing and distribution activity. Finally, recalling the previous observations within the Public Consultation Document - Secretariat Proposal for a “Unified Approach” under Pillar One still does not represent a consensus view of the Inclusive Framework nor the Committee of Fiscal Affairs, in neither subsidiary bodies. 131 Ibidem. 132 Idem, p.10. 133 Idem , p.13. 134 Idem , p.7. 72 Nevertheless, this last unified approach proposal is headed for the secretariat and has yet noncommitment from the G20/OECD Member States. In conclusion, it is uncertain if the framework will be followed. 4 PILLAR II – GLOBAL ANTI-BASE EROSION PROPOSAL The Pillar 2 establish the need to set a stop mechanism for profit shifting to low or no tax jurisdiction, considering the new business models. The idea is to ensure a minimum level of tax is paid by MNEs, balancing traditional and digital companies. In general terms, the proposal includes a Global anti-base erosion system (GloBE), giving countries a “tax back” profit that is currently taxed below minimum rate135. In this sense, the proposal involves a co-ordinated set of rules to deal with ongoing base erosion due the excessive use of profit shifting practices. The GloBE proposal is based on an effective tax rate (ETR) test it must include rules that stipulate the extent to which the taxpayer can mix low-tax and hightax income within the same entity or across different entities within the same group. According to the Public Consultant document, the four component parts of the GloBE proposal are: a) an income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate; b) an undertaxed payments rule that would operate by way of a denial of a deduction or imposition of source-based taxation (including withholding tax) for a payment to a related party if that payment was not subject to tax at or above a minimum rate; c) a switch-over rule to be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property (which is not part of a PE) are subject to an effective rate below the minimum rate; and d) a subject to tax rule that would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits on certain items of income where the payment is not subject to tax at a minimum rate136. 135 OECD. Update on the Economic Analysis & Impact Assessment. OECD. Paris. 2020. http://www.oecd.org/tax/beps/webcast-economic-analysis-impactassessment-february-2020.htm 136 OECD. Public Consultant Document Global Anti-Base Erosion Proposal (“GloBE”) (Pillar Two). OECD. Paris, 2019, p.6. 73 The GloBE would operate as a “top-up” tax, having the option to go up to the minimum rate, either being applied either on global MNE profit or on jurisdiction-by-jurisdiction basis. The rate of the minimum rate is not set yet, depending or results of a future Inclusive Framework . Pillar 2 shows for the need of cooperation among and between States. The multilateralism is necessary for a balanced outcome. It is the only way to set a backstop to situations where the first pillar is not respect, or when taxation of digital economic goes below minimum rates. Notwithstanding, all jurisdictions remain free to determine corporate rates, whereas other jurisdiction are still able to tax income at a minimum level. Therefore, the second pillar includes actions to strengthen existing international standards, by revising tax treaties and transfer pricing rules, which work well in many cases but fail in many others. In order to grant a minimum rate, the new rule could deny tax treaty benefits provided to business profits, associated enterprises, dividends, interests, royalties and capital gains. Of course, the parties of the treaty would have to commit to the new GloBE rule previously enacted. There is a prevision for a reduce in profit shifting intensity by MNEs, which may yield some lowtax jurisdiction increasing their minimum CIT rate137, allowing them to collect part of the gains of the minimum tax rate. Hence, the expectation is to stop the race to the bottom in terms of CIT rates, in rebalancing investments in the global economy. Comparatively speaking, Pillar 2 is much simpler than Pillar 1. The general idea is to solely establish a comprehensive minimum rate, granting tax back in case of under taxation. This approach works when considering the neutrality principle, because it balances taxation neutralising apparent advantages offered by investment hubs. The global tax estimate gains, from Pillar 1 and Pillar 2 altogether is up to 4% in terms of CIT revenues, which is around US$100 billion per year. Important to note that according to the same OECD group of studies considerations, the implementation of Pillar 2 without Pillar 1 would generate almost no results in terms of an increase on revenue138. One question regarding Pillar 2 that remains unsolved is how to deal with permanent differences , which signifies countries classify dividends received from foreign corporations and gains on the sale of corporate stock. Under a worldwide blending approach, the consolidated financial accounts 137 OECD. Update on the Economic Analysis & Impact Assessment. OECD. Paris. 2020. http://www.oecd.org/tax/beps/webcast-economic-analysis-impactassessment-february-2020.htm . The OECD exemplify with a 12,5% rate. 138 Ibidem . 74 should eliminate dividends and stock gains in respect of entities of the consolidated group without additional intervention. The permanent difference is also a concern between the unequal treatment of corporate acquisitions under financial accounting and tax rules. In a stock sale, the carrying cost of the acquired corporation’s assets may not change for tax purposes but will regularly be adjusted, upwards or downwards, to fair value under the accounting standards. Permanent differences also arise due domestic policy reasons, while the taxable income base excludes certain types of income or disallows certain deductions. Besides permanent differences, the proposal also covers the temporary differences, which “are differences in the proper time for including items of income and expense in the calculation of net income”139. These temporary differences can be the sole cause of a low cash ETR at the beginning of the temporary difference and a high cash ETR upon reversal when the tax liability in the ETR computation is based on the tax liability. The calculation of net income usually takes account of longterm factors, which many times take more than one fiscal year to conclude. Three basic approaches to addressing the problem of temporary differences emerge from Pillar 2 proposal: a) carry-forward of excess taxes and tax attributes, b) deferred tax accounting and c) a multiyear average ETR. Any of these three approaches are typical for CIT or income taxation, both on a domestic base. However, there is no specific detail in the report on how to implement a multilateral system. What is most mentioned is the call for the exploration of different blending options ranging from blending at the entity level to blending at global group level with a particular focus on blending at the jurisdictional and global level. In a way, this approach is a more subtle way to propose harmonisation in direct taxation. In the Public Consultant Document Global Anti-Base Erosion Proposal (“GloBE”) (Pillar Two) there are suggestions involving allocation of profit to a transparent entity, tax credit in another jurisdiction and adjustments to for dividends and other distributions from group members. The need to adjust the tax base for dividends may depend, in part, upon the level of blending ultimately adopted in the GloBE proposal. In this sense, the financial accounts of group entities in different jurisdictions would be prepared on a separate company basis and dividends received from a “separate” corporation ordinarily would be included in the shareholder’s financial accounting income. On a different level, MNE still remains able to take advantage from the hybrid mismatches. 139 Idem , p.12. 75 In the final part, the secretariat recognises the risk of carve-out operations as a way to circumvent the GloBE system. However, operations are more difficult to design and increase complexity as well as compliance and administration costs much more than objective tests. The difficulty of design and complexity often increase the more targeted the carve-out is intended, which would represent a strong factor in company’s management. Beyond the two fundamental pillars, the group of studies also propose actions aimed at ensuring greater transparency between companies and tax administrations, as well as greater security overall. The Action Plans as a whole provide for mandatory disclosure of aggressive tax regimes and a CBCR form to tax administrations about their worldwide profit allocation. It also requires greater transparency between governments, with the additional need for countries to disclose decisions and other tax benefits to their partners and to make dispute settlement mechanisms more effective. Finally, it provides mechanisms for collecting better data so that you can measure BEPS and perform relevant economic analyses. The agreement so far is only about what to discuss. Considering the lack of time as well the current scenario of recession due COVID-19 pandemic, it is difficult to predict a consensus among the Inclusive Framework members until the end of 2020, when the work mandate expires. However, it is clear that a concrete advance in terms of shaping a new tax architecture to cover digital economy in a multilateral approach now exists. 5 OTHER INITIATIVES TOWARDS DIGITAL ECONOMY Not only is the OECD is studying ways to deal with under taxation within the digital economy. Here follows some attempts on the matter. First, there is a brief analysis of the EU’s proposals (which remains a multilateral approach), after some unilateral solutions were already in practice within some large economies. 76 5.1 EUROPEAN DEVELOPMENTS According to the EC in a 2013 study, companies operating in the digital market had an average tax burden of 9%, while companies in the traditional economy have 23%140. In practical terms, it is not new that digital business are under taxed in the EU single market. Nevertheless, it is also clear that the EU has long been discussing regulation of the digital economy. Such worry brought to the table an intricate matter that is far from consensus in the European Parliament. In Europe, unified tax policies are a thorny theme. Though indirect taxation is already harmonised141, there are still many challenges in terms of ideation and implementation of direct taxation142. In this sense, João Sérgio Ribeiro143 previously speculated a distributive justice approach144 through taxes at the European level. This distributive policy has to have a set of conditions considering fiscal sovereignty , political community , welfare model and personal taxes , which must be present at the EU level. Such perspective includes the observation of the principles of equality, proportionality and ability to pay. Even though, a decade later from the publishing of the quote above, those requirements are still not in place, and the development of a unified tax policy. However, some attempts have been done in the Anti-Tax Avoidance Directive (ATAD) and MLI145 to combat tax evasion and tax avoidance. There are specials concerns regarding taxation within the EU that should be listed here. Firstly, domestic and community law cannot infringe on fundamental economic freedoms. A second aspect is that the EC divides digital businesses into online retailer model, social media model, subscription model and collaborative platform model while the OECD defines them as multi-sided platforms, resellers, vertically integrated firms and input suppliers146. Thirdly, within the EU, some harmonisation already exists within CIT in the EU, and is not considered to be in an early stage from a regulatory perspective. 140 EU Commission, (2013). General Issues. Brussels: Directorate-General Taxation and Customs Union. 141 In VAT of EU common market, each Member State has its own tax rate, in spite of having a harmonisation system set by Thirteen Directive. The collection goes directly to the countries, and EU law only requires that the standard VAT rate must be at least 15% and the reduced rate at least 5% (only for supplies of goods and services referred to in an exhaustive list). Actual rates applied vary between EU countries and between certain types of products. In addition, certain EU countries have retained other rates for specific products. 142 Up today, EU revenue is essentially: 1) agricultural levies and duties; 2) common custom tariffs; 3) a percentage of the VAT, calculated on the basis of the common harmonised basis; and 4) transfers from Member States calculated on the basis of Gross National Income. Only the first two are considered as European taxes, even though they do not express a real power to tax in terms of aiming the revenue, but instead a restraint role. The third is a harmonised national tax and the fourth is not a tax at all. 143 RIBEIRO, J. S. (2006). Distribution Justice through Taxation: European Perspective. Jurisprudencija 2, 80–89. 144 According to the author, in this sense, distributive justice is a normative principle that determines how wealth must be distributed amongst taxpayers, following the principle of equality. This latter principle is understood in a material sense, broader than the liberal conception ( Idem , p.80). 145 Not an EU initiative properly. Laws known as a General Anti-Avoidance Rule (GAAR) statutes which prohibit "tax aggressive" avoidance have been passed in several countries and regions including Canada, Australia, New Zealand, South Africa, Norway, Hong Kong and the UK. 146 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p. 13. 77 For instance, there is the Parent-Subsidiary Directive147, which deals with the elimination of economic double taxation arising within a group of companies, including withholding tax on the state of the subsidiary and the corporate tax levied in the hands of the parent. There is also the Merger Directive148, that makes merging operations neutral from a tax point-of-view, and the Interest and Royalty Directive149, setting that these kind of payments between associated companies should not be subject to less favourable tax conditions than those applicable domestically in a Member-State. Currently two proposals for Digital Business Taxation Directive are on standby in the European Parliament: Proposal 2018/0072 and Proposal 2018/0073. The first deals with the taxation of companies with significant digital presence; the second establishes a 3% tax on the revenues of large companies operating on the Internet. What is especially sought by taxing such sectors is a Union action with transparency and harmonisation, is to avoid the erosion of the tax base. As a caveat, small and medium-sized digital companies would be considered as outside of the scope of the norm. Adding, a third proposal – not exclusive for the digital economy – focused on a Common Consolidated Corporate Tax Base (CCCTB) is also in discussion within in the European Council150. The idea in that it is to switch the methods for income allocation from the arm’s length method to a formula apportionment method, considering factors as labour, assets and sales151. There are rules against debt bias, and a super-deduction is given for R&D businesses. Consolidation is envisaged by a separate proposal for a Directive, due for examination at a second stage, after the elements of the common base have politically been agreed upon. Until then, the proposal for a CCCTB also remain pending for further examination in Council. The CCCTB is similar to the USA federal income tax model, addressing a tax harmonisation at the European level, with the distribution of consolidated profit from a single corporate tax base of the company. In short, what is sought for is to combat tax evasion, especially in the form of aggressive tax planning that is currently identified by means of the erosion of the tax base of corporate profits. In this sense, the European Directive 2016/1164 (ATAD) establishes rules for limiting interest on loans (20% of Earnings before Interest, Taxes, Depreciation and Amortization. or EBITDA); exit taxation; general 147 Council Directive 2011/96/EU of November 2011, on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member-States and subsequent amendments. 148 Council Directive 2005/19/EC of 17 February 2005, amending Directive 90/434/EEC 1990 on the common systems of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member-States. 149 Council Directive 2003/49/EC of 3 June 2003, on common system of taxation applicable to interest and royalty payments made between associated companies of different Member-States. 150 COM (2016) 685 final of 25 October of 2016, Proposal for a Council Directive on a Common Corporate Tax Base and COM (2016) 683 final of 25 October of 2016, Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB). 151 RIBEIRO, J. S. (2018). An Overview of European Tax Law and Its Impact on European Member-States’ Legal Systems: the Portuguese Example. In J. S. RIBEIRO, Selected Essays on International Business Law (pp. 285-303). Braga: Universidade do Minho Escola de Direito, pp. 291-292 78 anti-abuse rules; CFC rule; and the recognition of hybrid asymmetries. Regarding exit taxation, the aim of CCCTB is to control the transfer assets from the headquarters to a foreign base company of the same group of companies; transfer of assets from foreign company to headquarters or other foreign company in the same group; transfer of assets from tax residence; the transfer of activity exercised by the company; and avoid double taxation. The objective of the CCCTB is to reach the situations of hybrid asymmetry, which are the asymmetries between tax rules of different states. For example, a certain payment considered a dividend by one state and regarded as interest by another country. The scope of European law also encompasses the exchange of information and cross-border cooperation between tax authorities. Such instruments work along with domestic law, and thus do not conflict with the EU law. In opposite, they render cooperation to fight against tax avoidance. None of these proposals have been adopted yet, mainly because of lack of consensus among Member States. Some of them are eager to tax digital business as they see the erosion of tax base, but others rely heavily on the benefits of a favoured regime to attract digital companies to establish inland, allowing an inflow of capital derived from such businesses. As seen below, usually larger European economies want to tax, whereas smaller Member States rather to adopt low corporate taxation. 5.1.1 DIRECTIVE PROPOSAL 2018/0072 As in the previous chapter, those who are non-residents for taxation purposes become liable to tax in a country only if they have a presence that amounts to a PE there. However, such rules fail to capture the global reach of digital activities where physical presence is not a requirement anymore in order to be able to supply digital services. New indicators for significant economic presence are therefore required in order to establish taxing rights in relation to the new digitalised business models. For this matter and following the reasoning of OECDs recent reports, the EU Commission released a proposal identifying digital business by means of the digital significant presence . Then, according to the Directive Proposal 2018/0072, for the purposes of corporate tax, a PE shall be taken to exist if a significant digital presence exists through which a business is wholly or partly carried on. 85 market. However, the Commission’s proposal is not a State aid itself, yet a general policy covering the entire EU market. At first glance, the EU fundamental freedoms are respected. The Commission considers that the interim solution would not infringe the internal market freedoms of establishment (article 49 TFEU) and to provide services (article 56 TFEU) as interpreted by the CJEU. The scope of the tax includes both non-resident and domestic transactions and companies. Cross-border activities and companies will be not taxed heavier than similar domestic ones. In the light of the ECJ, only one rate will apply163. Then, directive fulfilment of the requirements are as such according to the EU legal basis. In opposite, Nogueira164 argues that it is not possible to ascertain the reasons that support the Commission’s conclusions. The establishment of high-revenue thresholds for the delimitation of the taxable entities would amount to de facto discrimination against third-country companies and, as such, would be incompatible with EU law. In line with the Commission’s preliminary work, the thresholds have to be set as to not systematically exclude domestic companies from the scope of the tax165. In this sense, non-EU situations must be taken into account for EU purposes, since the TFEU liberalises capital movement from and to third countries. However, this is the sole exception, as all other freedoms restrict the geographic scope of protection of these freedoms to the EU. Moreover, if case has two or more fundamental freedoms involved, the CJEU may consider freedom of capital a secondary freedom related to third countries166. In this sense, it is relevant to comprehend the following reasoning. The DST fits quite well with regards to the free movement of services. Then, even if one considers that it also affects the free movement of capital, the CJEU would likely only examine it under the freedom to provide services, not the former. As the latter does not have an external dimension, discrimination against third-country service providers would be therefore lawful. Considering subsidiarity and proportionality, they have to be respected in any EU rule. Subsidiarity is required in areas outside the exclusive competence of the EU. According to this principle in Article 5(3) TFEU, EU action can only take place if it cannot be appropriately carried out at the Member State level. Proportionality, by its turn, requires any EU action to not exceed what is needed to 163 COMMISSION E. , COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence and Proposal for a Council Directive on the common system, 2018, pp. 148, annex 1 164 NOGUEIRA, J. F. (2019). The Compatibility of the EU Digital Services Tax with EU and WTO Law: Requiem Aeternam Donate Nascenti Tributo. Intl. Tax Stud. - IBDF Journals, p. 5 165 COMMISSION E. , Ibidem. 166 NOGUEIRA, J. F. (2019). Ibidem . 86 achieve the goals of the EU Treaties. In determining a policy, EU institutions should choose measures that, while allowing them to reach their goals, are the least restrictive to Member States’ interests. 5.2 UNILATERAL TAX POLICIES As multilateral negotiations are still occurring, some countries do not hold their policies towards digital taxation. They may withdraw their tax laws over intangibles if a cooperative action rises at the same level. However, there is no guarantee in such sense. At the forefront of digital taxation on July 24, 2019, France enacted Law no. 2019-759, introducing a digital services tax, and modifying the CIT base ( impôt sur les sociétés ), by amending the Code Général des Impôts . The new tax applies to groups operating within the digital economy with an annual worldwide turnover of over € 750 million and with at least € 25 million of the turnover generated in France. The tax rate has been set at 3% and there is a possibility of retroactive effect from the date of the announcement of the measure. It is expected to raise up to € 500 million per year and the main concern regarding this topic of the French state was the under-taxation of the so-called “GAFA” (Google, Amazon, Facebook, Apple), the group of large-scale technology giants in the country. From the French lawmaker perspective, this is an express provision of the law in its Article 1: “ Taxes sur certains services fournis par les entreprises du secteur numérique ”167, which explicitly indicate from whom collect taxes. The new law reflects the controversy of a case study where Google France sold advertising space on its websites. These legal deals were conducted through preliminary contracts, and to enter into definitive contracts, the client was referred to Google Ireland, the company that had the legal powers to sell that space. Then, payments were made from customers in France to the company in Ireland, and the income tax due was cleared there. At Google France, there was only a small amount of revenue for the support the local company gave to its Irish associate. Despite this arrangement, the French tax authorities found that in the country everyone accessed the Google France site, generating business, but the tax paid locally was very low. According to the French tax authority, such transaction made no sense, since the market exploited was essentially French. Therefore, so the profit for the sale 167 BOMMIER, A. H. (2019, august 07). Taxe GAFA : une occasion manquée de repenser les règles de territorialité de l'impôt sur les sociétés. Retrieved from La Tribune: https://www.latribune.fr/opinions/tribunes/taxe-gafa-une-occasion-manquee-de-repenser-les-regles-de-territorialite-de-l-impot-sur-les-societes825346.html 87 of advertising space should be determined locally. According to the local tax authority calculations, the tax due on the operations was € 1.1 billion. However, the French courts took a different view compared to the tax authorities, as they did not identify sufficient connecting elements in light of the rules in local law; they considered the respective international tax treaty between countries168. In short, the only recognised (but not fully sufficient) connecting factor was that of the revenue source. The result of the case generated strong political pressure to tax digital services in France, in order to maintain part of the business revenue in the national territory, while exposing the clash between revenue source and value generation as the main taxable digital vector. Notwithstanding it prompted public investigations of tax avoidance and tax evasion practices, while pointing out the artificial use of PE. In the case of the UK, a more generalist stance was originally taken regarding the business of multinational companies, with no emphasis on digital companies. The first step taken to combat tax evasion in the UK was to regulate notifications addressed to multinational companies to inform the tax authorities about their transactions between countries. In April 2015, the UK introduced the Diverted Profits Tax (DPT) institute, imposing a tax presence in the country and the ability to identify when profits are split between tax jurisdictions without economic substance. That is, an official conclusion that nothing is actually transacted or taken into account for the purposes of production or management of the company. Such a move was justified in combating a number of companies that claimed to be based in Ireland, where income tax was only 12.5%. In practice, the tax was unpaid due to the fact that profits were transferred to other parts of the company’ payment for the use of patents or repayment of loans with high interest rates. When profits were reported, tax rates were 18%, but if the revenue direction were discovered by the tax authorities, it would rise to 25%169. Another British innovation was the shift from the focus of taxation from place of production to place of destination. Therefore, in addition to requiring a tax presence in the country, VAT is now charged at the place where the transaction takes place. In the case of an Irish supplier selling in the UK, VAT is now required by HMRC and not by the Irish tax authorities. To be effective, however, such measure depends on an agreement with the EU as well as its Member States. Such practice could help USA companies repatriate their profits due to the global tax system adopted in the USA. 168 EBAG, G. (2019, april 25). Google Wins Again in French Court Fight Over $1 Billion Tax Bill. Retrieved from Bloomberg: https://www.bloomberg.com/news/articles/2019-04-25/google-wins-again-in-french-court-fight-over-1-billion-tax-bill. See also the French agreement between the Procureur de la Republique Financier , SARL Google France and Google Ireland Limited (RFN-15 162 000 335) (https://www.agence-francaiseanticorruption.gouv.fr/files/files/190903_CJIP.pdf). 169 LEONARDI (2016), The Digital Economy and the Tax Regime in the UK, p.106. 88 Faced with the European digital services tax scenario, the UK has announced a measure for digital taxation, starting on April 1, 2020. The provisional rate is placed at 2% and the tax design continues to be under study. It will focus on revenue from specific digital services such as search platforms, social media and online markets. Such revenues are linked to the participation of UK users. The UK DST is not a tax on online sales of goods, so it only applies to income earned through the intermediation of these types of sales, not to the sale itself. Subject to tax liability are companies that have global revenues in excess of £ 500 million and more than £ 25 million of revenue in the country. As incentives, the first £ 25 million of relevant UK revenues will not be taxed. There is also a reduction in the tax burden for low margin businesses. With international consensus, the possibility of revoking the national forecast remains. Finally, regarding the legal nature, as it does not concern the sale of goods, but rather revenue, the tax is considered a type of corporate tax, not VAT170. A third European case shown as an opposite political approach. In March 2019, a vote was imposed on the Assembly of the Portuguese Republic to impose a tax on digital services. The proposal was rejected by the parliament, contrary to the tendency of other southern countries of of the EU, and, with respect to BEPS, Portugal has not yet faithfully followed OECD guidelines. However, it is possible that the country will consent to the adoption of a European DST171. Although Portugal usually aligns with EU policies, it has not followed the unilateral initiatives of other Member States. Far from being a politically accurate conclusion, it is believed that the undertaxation of intangibles is understood domestically as a business attraction in the country, following the model of comparatively small European economies. Spain announced its Impuesto sobre Determinados Servicios Digitales in April 2018, to enter into force in the first half of 2019, to be included in the Presupuestos Generales del Estado project for 2019, with a rate of 3%, with retroactive effect from January 1, 2019. Yet the project was defeated in the Spanish Congress, being considered as the trigger for calls for new elections within the country. Such a framework may lead to further discussions, as a new parliament may revise the issue172. Its impact would be on gross income (excluding VAT) arising from specific digital services, such as 170 Customs, H. R. (2019, julho 11). Introduction of the new Digital Services Tax . Retrieved from Gov.Uk: https://www.gov.uk/government/publications/introduction-of-the-new-digital-services-tax/introduction-of-the-new-digital-services-tax In addition, it should be remembered that the outcome of the June 2016 British referendum, deliberating on leaving the EU, created an environment of uncertainty in the national economy. Financial market reactions have not been positive, and prospects for foreign investment tend to wane and the diaspora of off-island companies has begun. In any case, the OECD commitments to BEPS remain in force, even considering that there will be significant economic asymmetry between the UK and the EU. 171 LOPES, M. (2019, March 20). Direita e PS rejeitam imposto sobre serviços digitais proposto pelo Bloco. Retrieved from O Público: https://www.publico.pt/2019/03/20/politica/noticia/direita-ps-rejeitam-imposto-servicos-digitais-proposto-bloco-1866168 172 MUÑOZ, R. (2019, July 17). El Gobierno se plantea retomar la ‘tasa Google’ española si no hay acuerdo en la UE. Retrieved from El País: https://elpais.com/economia/2019/07/16/actualidad/1563268913_048006.html 89 providing digital interfaces (brokerage services), which allow users to interact with each other, or facilitate the provision of underlying supplies of goods and services directly between users; as well as selling user generated data. In the Spaniard project, the taxable person would be multinational groups that have net overall revenues in excess of € 750 million. There would be incentives similar to the British model: the first € 3 million of relevant revenues obtained in Spain would not be taxed, which is considered a very low limit by national standards. The tax would only apply when the user's digital devices are located or used in Spain, via confirmation via IP address. Finally, the sanctions would be potential fines of up to € 400,000 per year for non-compliance with tax avoidance173. Italy also announced a DST on January 1, 2019, and the enforcement decree was published on April 3, 2019, with a 60-day vacatio legis . Italy has made a previous commitment to implement the tax with the EU, in line with its guidelines. The 3% rate was also adopted, with a focus on gross income - excluding VAT - arising from specific digital services, such as online advertising with digital interface for its users; multilateral digital interface that allows interaction between users, including to facilitate the provision of goods or services; and the sale of user generated data. In terms of territorial base, the user needs to be located in Italy and have a high degree of involvement in value creation. It is interesting to note the focus on the user, Business-to-Consumer (B2C), excluding Business-to-Business (B2B). The taxable person is the company with total revenues of over € 750 million, of which at least € 5.5 million comes from digital services in Italy. On the other side of the Atlantic Ocean, the USA used to maintain a firm stance on not taxing research and innovation, while the digital market is often understood to be essentially an area of innovation (R&D). In terms of the digital market, what is taxed domestically are royalties, or patents. So much so that it has become common practice for large national technology corporations to, officially, relocate their central business establishments to other countries with milder taxation. However, in 2017, as an effort to constrain base erosion, the USA Congress approved the Tax Cuts and Jobs Act of 2017 174, creating the Global Intangible Low Tax Income (GILTI), a new category of foreign income added to yearly corporate taxable income. It is a tax on earnings exceeding a 10% return on a company’s invested foreign assets. GILTI is subject to a worldwide minimum tax of between 10.5 173 Camara de Diputados, (2019, January 25). Boletín Oficial de Las Cortes Generales. Retrieved from http://www.congreso.es/public_oficiales/L12/CONG/BOCG/A/BOCG-12-A-40-1.PDF 174 Pub. L. 115-97. 90 and 13.125 percent on an annual basis and it is supposed to reduce the incentive to shift corporate profits out of the USA by using IPR. Moreover, with respect to groups of companies, the USA follows the arm's length principle, whereby the subsidiary is considered as part of the parent company, if there is a minimum interest in the controlled company's capital. The subject of digital market taxation in the USA is extremely broad, dealing with income taxation, patents (royalties), tax incentives, customs tariffs, services tax, among others. The traditional USA policy of incentives R&D, coupled with other factors, has enabled the world leadership of USA technology companies. 91 CHAPTER IV – CRITICS TO THE MEASURES TAKEN 1 MULTILATERAL MEASURES As shown in the previous chapter, the current stage of OECD BEPS Project has a two-pillar approach. In synthesis, the first combines significant economic presence with an equalisation levy, whereas the second pillar consists of a de minimis corporate tax, considering global standards. In terms of OECD actions, it is notable that the previous MLI is far too complex instrument, taking into account the aims in digital taxation, and having low adhesion in terms of global economy. In this sense, the two pillars approach has the same flaw, by being too complicated as well. The blending approach , by covering so many possibilities, end up making the proposals uncertain and difficult to grasp. Adding, the BEPS measures are still inconclusive within the OECD’s framework. The MLI and others multilateral solutions are having low adhesion, therefore lacking of effectiveness. The efforts in terms of multilateral negotiations are too large, and the results appear too feeble. In terms of tax revenue, there are no reliable arguments that confirm that the methods are being efficient in tackling tax avoidance. The provisory results in OECD Action Plan follow the same pattern. The strategies taken are too complex in order to be applicable on a multilateral level. What is implicit however within the successive OECD reports is that work groups do not reach consensus whatsoever. Even with the advancements in reforming the OECD Model Convention, it is still required to individually reform the tax treaties, otherwise the changes will not be bound, having a marginal repercussion in the real amount of tax collected. Nevertheless, the reasoning of the delimitation of abusive practice is not held by a considerable part of member states. For instance, in the context of EU law in N Luxembourg 1 v Skatteministeriet175 the application of the article 5 of EU Directive n. 2003/49 was prevalent in the case of transactions for which the principal motive or one of the principal motives is tax evasion, tax avoidance or abuse. For the OECD panel, the EU is considered one party, then its 175 C-115-16, see also C-265-04. 92 “domestic” legislation overcome OECD’s premises. Thus, EU law is interpreted autonomously and independently of the commentaries on OECD Model Tax Convention176. In an opposite viewpoint, the EU directive proposal of digital significant presence (Directive Proposal 2018/0072) keeps only the essential in terms of splitting taxing rights of income taxation. The proposal goes straight to the point (lack of proper taxation) and pleases market jurisdictions, which represent the absolute majority of interested countries on the matter. Only countries that are investment hubs would lose revenue due the decrease of international remittances. 1.1 REFORMS ADDRESSING PERMANENT ESTABLISHMENT The erosion of the PE institute is a consensus. In this perspective, both OECD and EU have proposals to consider resident as an undertaking that has heavy reliance on intangibles and acts in the domestic market. The EU digital significant presence (Directive Proposal 2018/0072) would represent a comprehensive solution in the internal market, as all Member States would have to comply with the new rule. Thus, it would be a reasonable solution for the EU economy. On the other hand, the OECD proposal of significant economic presence must have strong mechanisms to constrain low tax jurisdictions to circumvent the new rule. One option is to impose a withholding tax, granting some revenue domestically. Then, it is paramount to adopt one of two solutions: resident due significant economic presence, or imposing withholding taxes higher than PE’s rates, encouraging the taxpayer to be resident. Albeit the PE system has many vulnerabilities, the requirement to incorporate domestically is not feasible, as it would lead to undesirable economic restrictions towards the free market. Some countries indirect drive companies to do so, but it is justifiable in case of existing an attractive internal market. In terms of proposed solutions by OECD, the intent is to grant the allocation of income within a multinational group of companies more directly in line with the location of the economic activity that 176 Idem , Opinion, §109: “For a restriction of freedom of establishment to be justified on grounds of the prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory”. 93 generates such value. In this sense, there are three main approaches taken in the report: a) transfer and use of intangibles including hard-to-value intangibles, and cost contribution arrangements; b) delineating the actual transaction and business risks and c) global value chains and transactional profit split methods177. The first approach involves the transfer of intangibles and right of intangibles at non-arm’s length prices, either in connection with licensing arrangements, cost contribution arrangements or tax structures that separate deductions relevant to the development of the intangible from the income associated with it. Such transfers are beyond arm’s length because of difficulties in valuing transferred intangibles at time they are transferred, unequal access to information relating to value between taxpayers and tax administrations and hidden or unidentified intangibles without payment178. This situation mentioned exposes the need of a clear definition of intangibles for transfer pricing purposes, moreover to consider that, when transferring an intangible between entities, there would be necessary to beacon what the compensation is. The idea is grant that entities within a group that contribute value to intangibles either by performing, managing or simply bearing risks would be appropriately rewarded. This requirement makes the situation more clear regarding tax administration on the size of value involved in an operation, and resizing fictional transactions performed among those companies. A proper valuation technique is used in determining arm’s length transfer prices when comparable transfers cannot be beaconed179. Following, the second approach deals with allocation risks. According to the OECD guidance in Action Plan 6, risks contractually assumed by a party that cannot in fact exercise meaningful and specifically defined control over the risks and does not have the financial capacity to assume the risks, will be allocated to the party that does effectively control and have the financial capacity to assume the risk. In a company law perspective, the proposed solution is quite similar to the Piercing the Veil Doctrine, while a parent company may be liable to a conduct from the subsidiary. Thirdly, there is the transactional profit split method in global value chains. In the case of highly integrated processes (mainly ICT). Although it raises concerns in terms of BEPS, the value creation is indeed scattered amongst different jurisdictions. In a more realistic approach, this is the case of 177 OECD (2018), Interim Report, OECD, Paris, p.91. 178 Ibidem . 179 The proposition is to provide tax administrations a guidance to measure such hard-to-value transfer, yet the lack of standards are too strong of a tool in the hands of authorities, which can then violate the rule of law in a broader sense. 94 legitimate tax planning, not a tax avoidance, because the allocation of steps in the production is in line with value creation splitting. In this case, only a multilateral tax policy can minimise the effects of BEPS. Another critic is about revisions in the concept of PE in the Action Plan 7. The revised OECD Model Tax Convention of 2017 already introduced changes to the PE to tackle problems related to commissionaire arrangements, preparatory and auxiliary activities and fragmentation of group activities. However, it did not alter the physical presence condition, which permits highly mobile MNEs to continue their tax avoidance activities. An important development in this context is the concept of Service PE , endorsed by the UN, which differs from the OECD approach because it is less focused on physical presence. It should be noted that the OECD, when addressing action plans 1 and 7, did not specifically mention changes to the concept of PE. Comments 42 and following are not modified, they are simply reproduced from Action Plan 1. In Action Plan 7 there is concern about fragmentation and recognition of ancillary activities within paragraph 4 of Article 5 of the OECD Model Convention, but there are no significant advances to this either. Not even the MLI has definitive solutions in this regard. On the other hand, it is first necessary to re-discuss the definition of establishment, followed by the PE, in order to know whether or not a digital service fits objectively because of a connecting element. Regarding Transfer Pricing (Action Plans 8-10), the new OECD Transfer Pricing Guidelines of 2017 aim at aligning transfer pricing outcomes with value creation by allocation of profits to jurisdictions where significant functions are assumed yet it does not alter the arm’s length rule based on the separate legal entity principle. This is problematic as a multinational enterprise (MNE) could still book profits in low tax jurisdictions by relocating their senior employees. Finally, the Action Plan 3 on CFC Rules, following BEPS amendments, will be entitled to tax residual income if they perform important functions or assume substantial risks. While the new rules are likely to prevent low level of taxation on passive income earned through CFCs, they do not completely eliminate structures, such as cash-boxes, allowing the shift of partial MNEs income in subsidiaries corresponding to at least a risk-free return. After all, while the OECD’s 117-Member Inclusive Framework is aiming to find consensus on digital taxation, some countries demand targeted solutions, while others are calling for a general reform without ring-fencing the digital sector and a third group seeing no need for further reform following BEPS. This generates an undesired unilateral scenario of taxation, causing more damage to the 101 5 ECONOMIC CONCERNS The natural evolution of business models has resulted in a digital economy where non-resident companies may operate in a market jurisdiction in a fundamentally different way when compared to the models at the time international tax rules were originally made. ICT and liberalisation of trade policy rendered the traditional model of doing business as obsolete. There is an undeniable fear of the consequences of reshaping taxing systems. That is the reason for why only punctual measures have been taken thus far. It is more feasible to focus on an economic sector, rather than looking for a solution for the wholly taxing frameworks as a whole. Nevertheless, the OECD reports exposed the antagonism between market countries and investment hubs. In an integrated market, the lower costs of a small country make attractive the influx of capital, while on the other hand large countries have to deal with infrastructure costs (higher taxes) and political instability. Market countries have to find solutions for the loss of revenue and the tax equilibrium in order to keep the economic functioning. This is all considered to be an aftermath of the free market, and an undeniable commonplace concern. To decide what to tax can be a very sensitive political concern. Firstly because taxpayers tend to dislike such decision of increasing their burden. Second, the object of taxation has to be feasible, otherwise the taxation shall have no practical effect. Thus, it is necessary to understand what has value in the particular market in order to properly tax it. Of course, monetary value itself can be easily measured. However, some other assets, like immobile property, goods, IPR, intangibles in general, depend on a prior evaluation to be fairly taxed. From a business point of view, value is created through development and exploitation of intangibles, effective risk management and operational excellence. Digital networks introduce significant security, reputational and financial risks as companies have to manage, maintain and protect customers and user data. The added value is ultimately created in all cases by the intellectual element of a human being, as raw data does not create value and needs to be processed and analysed in order to be incorporated into the value creation process. This is made possible thanks to the intellectual use of tools, such as algorithms and software by the individual (i.e. programmer). From an economical perspective, that added value originates from a place where the individual adds the intellectual element. Then, taxing digital assets could be attributed according to the current 102 system based on the arm’s length principle and people functions. It is also underscored that human capital, in its specific form of “knowledge based capital”, is becoming a predominant value driver of businesses, particularly in the digital age. This new asset should have substantial weight in the functional analysis of purposes of profit allocation, for instance taking into account the number of days that an individual works in a country190. To some extent, criticism thrives, for while it is true that the era of globalisation and economic interdependence has linked civil and commercial freedoms to the domain of liberalisation, they have also placed a constraint on the political space for domestic regulators. The challenge for the sovereign state is to govern to maximise operational advantages, even though they are irreversible processes, and should not be to maximise its own controlling power in the marketplace. In this respect, the results of previous attempts in the 1930s and 1970s are seen as negative: Attempts in isolation from European economies have always led to productivity losses and produce unwanted results, leading to market outlets and loss of production in the European market. According to Lee-Makiyama, contrary to common belief, globalisation and digitalisation of the economy have not caused unemployment or structural deficits, but make the costs of poor governance and inefficiency more visible191, exposing which sectors of the economy are no longer competitive. The BEPS Project measures have been presented, but there is still a need for calibration as the agency's other actions have not been able to solve the challenges of taxing the digital economy. Concerning the same plan, the April 2018 report reflects on the lack of consensus among countries to seek long-term solutions, leading to the adoption of unilateral measures. The MLI is insufficient as a mechanism for the digital economy, and a specific multilateral instrument is needed to address the peculiarities of this economy. Nevertheless, one must recognise that the convergence of tax systems is not always positive. Although it favours a simpler and more clear taxation, harmonization or unification of tax rules does not always lead to balanced taxation. To be desirable, normative convergence needs to be organized with objectives or general rationality, as to move away from the discussion about the loss of the tax base, as well as to favour job creation and development of the economy as a whole. 190 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p.19. 191 LEE-MAKIYAMA, H. &. (2016). OECD BEPS: Reconciling Global Trade, Taxation Principles and the Digital Economy. In F. &. BOCCIA, The Challenge of the Digital Economy (pp. 55-68). Roma: Palgrave Macmillan., p. 66. 103 The traditional international tax model is not sufficient enough to address the peculiarities of the large-scale digital economy. It is urgent to rethink the structure of tax treaties in the light of the tax arrangements derived from aggressive tax planning. The ultimate goal of a reform in international taxation is to recover the loss of revenue generated by competition between taxing states (tax war), and compensating for the weaker countries - which benefit from the dispute. Another objective to be achieved is to substantially reduce labour market taxation, allowing the wealth generated by the new economies to be distributed equitably across the market itself. 6 OVERCOMING THE BILATERAL BIAS IN TAX TREATIES Through this research, it became clearer that OECD is the best forum to discuss a multilateral solution for BEPS. This is because OECD has been working towards a worldwide tax reform in view of the changes wrought by the digital economy, and several papers have been published on the topic, as shown below. Another multilateral attempt includes the two of the EU Commission proposals for taxation of the digital economy, published in March 2018 (2018/0072 and 2018/0073). As the OECD initiative, the directive proposals remain inconclusive. The preliminary results of OECD’s meetings comprise three value creation processes: value chain, value shop and value network. The latter represents the strongest case for value creation in the market and accounts for online advertising and intermediation services192. Following this premise of multilateralism, a helpful remedy to the problem of tax evasion in the global economy would be OECD's MLI193, even with its difficulties for implementation globally. It establishes a tax morality, ensuring nondouble taxation parsimoniously. The treaty is already in force, having up today 89 signatures, but there are important absences: Brazil and the USA have not signed it; Portugal has signed but not ratified. For those who ratified, in case of the reform of bilateral tax treaties, the preamble must contain the goal to fight against tax evasion. 192 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p. 13. 193 In the article 7 of the MLI there is the PPT, whereby a simplified benefit limitation is adopted, yet detailing specific anti-abuse measures. With the MLI, PPT becomes a guiding principle, ensuring the most favourable fiscal position (subjective element); and verifying whether the advantage is contrary to the object and purpose of the applied norms (objective element). The PPT is the “B” example contained in OECD comments on article 29 of the Model Convention. It is also applicable to example “C”, which deals with forum shopping. 104 Conversely, Leonardi understands that multilateral agreements are not viable within the UN environment or even within regional economic blocs. He argues firstly that the UN has no mandate to make decisions on financial and economic aspects, and securing such power would be very uncertain without any guarantee of a satisfactory result. Secondly, operating in regional economic blocs would face the same problems relating to lack of powers to deal with taxation issues and lack of effective oversight of multinational corporations. According to Leonardi, free trade areas existing in countries lack a mandate to act on such comprehensive international agreements. Thus, only by acting through the G20 would it be feasible to harmonise digital taxation rules, because the combined economic blocs would contain the largest consumer market at the international level194. A disclaimer here is necessary in order to clarify that unilateral measures are not useless in digital economy. Countries can introduce a sort of domestic laws as additional safeguards against BEPS, resulting in short term gains in practical experience with the applications of the options given in the action plans. A second disclaimer is regarding the necessary consistency with bilateral treaties, ensuring the commitment with their obligations. In this sense, any measure (unilateral or bilateral) has to compromise with previous agreements, making the new policy only applicable from residents of nontreaty countries or in case of multilateral anti-abusive rules covering both parties of the treaty. In sum, it is still necessary to deal with countries that have low or non-existent taxation, as they become preferred destinations for low-tax digital businesses (investment hubs). Moreover, it is paramount that large economies take a central role in celebrating multilateral treaties. Therefore, the MLI has to reach the G20’s economies in order to prevail. An intermediate solution would be the conclusion of a multilateral treaty capable of altering the content of bilateral treaties already concluded in the OECD or UN framework. Regardless, some countries are already implementing the changes themselves, concluding amendments to bilateral treaties195. As explained above, under the MLI, acceding countries are required to revise their international tax treaties to comply with BEPS guidelines. The contracting countries of the bilateral treaty must seek out the other party to do so, or to do in bloc. Recently, many countries started to review their positions 194 LEONARDI, (2016) Conclusions: Taxation and the Future of the Digital Economy, pp. 115-116. 195 RUSSO, R. (2016). Base Erosion and Profit Shifting. In F. &. BOCCIA, The Challenge of the Digital Economy (pp. 39-54). Roma: Palgrave Macmillan, p. 46. 105 in DTC, in order to comply with new premises. It may not be practical, nor the best solution, but it is still better than no change at all. 6.1 UNITARY TAXATION AS A POLICY DRIVEN TO DIGITAL TAXATION According to Biasco196, in essence, the idea is to rethink the entire international tax system of global profit distribution based on bilateral double taxation treaties. While continuing to work towards solving double taxation in the pre-existing manner, the same chronic problem will remain, and possibly will worsen in the near future. A large-scale solution to the problem of direct tax evasion is based on an institutional design that allows for the legal recognition of unitary taxation for MNEs. This uniform law or, unit of taxation, shows the application of a CIT to a company's overall profit on an international basis, i.e. the taxation of an enterprise's integrated global income. This new principle makes it possible to achieve an effective and organic way in overcoming of the previous international tax standard. The contents of tax treaties were elaborated on over a hundred years ago, when the current reality of multinational companies did not exist and there was no free movement of capital. Such corporations are not made up of a series of local units to be taxed separately at different locations considered as if they were independent units, nor as the current double taxation convention tends to see them. Instead, they together form a tightly connected business unit that derives its competitive capabilities by combining economic activities in individual locations as well as exploiting the technology and knowledge that belongs to that unit. If they were a single body of which each branch is considered as an organic part, then as a single body they must be treated. Therefore, the benchmark for taxing them should be in considered their worldwide-consolidated budget. This is similar to CCCTB, yet worldwide accepted. MNE would require filing their profit statements in all countries in which they operate, and then their integrated profits must be taxed on a unit basis, according to an agreed formula for income distribution that would reflect their actual presence in each country. Considering the technology available today, it is not something too difficult to imagine nor set; moreover, the costs of data management are quite insignificant comparing to the raise of tax paid. 196 Idem , p.30. 106 To calculate the tax burden, Biasco suggest a formula taking into account the distribution of 1) physical units (or costs) of the employed workforce; 2) physical assets used (excluding intangible assets); and 3) sales made in each country197. Such solution would eliminate internal transactions, making the establishment of tax havens or the movement of profits around the world through transfer pricing meaningless. If a single centre is recognised in the conglomerate, the establishment of or subsidiaries becomes irrelevant. Given the maturity of EU integration, this would be the ideal laboratory for the implementation of a new global regime, based on the support of Canada and the USA. Considering the provisions of the Dodd-Frank Act, many USA states already are adopting some provisions of fiscal competition (tax war) by themselves. In the digital economy sector arises the opportunities also for the taxation of digital businesses, taking in consideration the international market and having to carry out foreign exchange operations to settle the payment of operations. Financial institutions and central banks could tax such transactions at source, facilitating supervision and collection. Such practices could be implemented in B2C operations as well as B2B. There is currently considerable tax revenue not covered by the digital economy, especially from available service applications, as well as music, videos, and other downloadable content. As seen above, there is a huge tax loss remaining unsolved by the PE model, and a harmonised corporate taxation for MNEs is a reasonable solution. Indeed, there shall have exemptions to R&D and to small companies, due the unarguable advantages in development and employment. With regard to exemptions from participation in the corporate regime, the Netherlands adopted an intention test, a declaration test and a subject-to-tax test. Whereas there are other relevant innovations in Luxembourg, Malta and Spain, especially concerning preferential arrangements. 6.2 LIMITS OF LAW ENFORCEMENT IN TRANSNATIONAL BUSINESS The global economy can be split in three distinct phases. The first one in which everything is economically tangible, therefore taxable by traditional means. The second as a transitional phase in which technological instruments allow telecommunication and, consequently, the conclusion of 197 BIASCO, S. (2016). The Damages of Fiscal Competition in Europe and Alternatives to Anarchy. In F. BOCCIA, & R. LEONARDI, The Challenge of the Digital Economy (pp. 17-38). Roma: Palgrave Macmillan. 107 business without physical presence (virtual catalogue purchases, instant messages, services provided by videoconference). In a final stage, the very object of the business relationship is entirely intangible, such as a digital file. Each of these phases demands a different tax structure. The national states have already recognised the flaw in taxing MNEs using outdated legal concepts. Because of the digital economy, the modern state is becoming weaker in terms of tax effectiveness. However, this statement is only partly true, as states integrated into economic blocs (such as the EU) have not lost their power to tax, instead they voluntary restricted their right to tax, fostering commercial integration. As previously mentioned, the EU does not have a harmonised income tax regime, maintaining member states the autonomy to set rates, benchmarks and incentives for direct taxation. In practice, European countries still make extensive use of bilateral tax treaties to establish circumstantial parameters for PE, exemptions and tax credit allowances. As a result, bilateral international policy favours tax planning for MNEs, especially those acting in the digital sector. There is a large margin in treaties for large companies to share their value chain to reduce tax costs. Tax planning gained prominence with the internationalisation of the economy operated by large technology companies. Therefore, at the heart of the problem, therefore, are artificial business arrangements that establish “convenience activities” in low-tax jurisdictions from advantageous triangulation. Thus, as each country seeks unilaterally to generate investment attractiveness by lowering its tax burden, well-structured MNEs take advantages of such policies. On the other hand, multilateral entities as OECD, UN and WTO, are still in their early stages of dealing with digital economy, having few concrete solutions to minimise the damages in the taxable base. In general, the difficulty in taxing digital businesses lies in the effectiveness in ascertaining and receiving the due amounts, because, as stated above, the Internet is usually not restricted to the same physical borders of countries. Considering the nature of tje Internet, parties are generally allowed to perform economic activities in a fractional way around the world. A practical difficulty in this matter is that tax authorities may have to deal with millions of daily transactions throughout the world, having a feeble control of them. Another important concern derived from digital technology is that it is currently causing a number of transformations in the job market: as new job areas emerge, many traditional service sectors are experiencing a crisis due to lack of jobs. However, the problem of labour was already a reality 108 before the emergence of the IoT, which was aggravated in relation to the idleness of labour due to the automation of services. There is another difficulty of determining in which jurisdiction the value creation occurs. If one deals with a two-sided service, the payment and the value recognition is relatively easy to identify (even so having disputes in terms of double taxation, as showed below). Multi-sided business models have a much more complex frame, acting in many countries at the same time. Moreover, sometimes the product offered is apparently free, but the value lies on the information given by consumers. Therefore, to capture value from externalities generated by free products is one of the biggest challenges in terms of digital taxation. As seen, traditional national policies are no longer able to tax businesses that mainly have digital assets. It is then paramount to change the way MNE are taxed, especially those operating mainly with intangible assets. In sum, the main tax challenges of the digital economy include lack of nexus (or taxable presence in a jurisdiction), reliance of intangibles, data and user-generated content, income characterisation, spread of new business models, in which the buyer and seller are in different jurisdictions, and the expansion of E-Commerce198. The central tax problem related to the taxation of digital companies concerns patent taxes (royalties) combined with the existence of low tax jurisdictions. Licensing or administration costs are often provided between companies within the same economic group to reduce profit margins in the highest taxing countries by directing revenues to holdings in low or no income tax countries. This practice leads to the so-called erosion of the tax base (BEPS) due to loss of revenue in countries whose market is effectively exploited. 7 POINTING SOLUTIONS FOR THE MATTER This extensive research provided a broad perspective in terms of solutions for digital taxation. Each proposal has strong and weak aspects. Thus, there is no worthless suggestion, neither a perfect one. Nevertheless, it is possible to rank the most suitable proposed solutions, indicating parameters for law-making process in the near future. Even so, such evaluative analysis is a contribution to the discussion and must not be considered a final argument in the matter of digital taxation. 198 HADZHIEVA, E. (2019). Impact of Digitalisation on International Tax Matters, Study for the Committee on Financial Crimes, Tax Evasion and Tax Avoidance, Policy Department for Economic, Scientific and Quality of Life Policies. Luxembourg: European Parliament, p. 16. 109 The nuances observed in the main proposals allowed the researcher to rank the DST as the easiest, simplest and most favourable solution, considering those analysed. The DST includes the following features: it grants tax collection to market jurisdiction; it does not rely on international agreements, being implemented solely by domestic legislation; it has already been ruled in some countries (France, Spain and India, for instance), enabling an economic analysis in the near future; and – finally – the DST may be subdue to tax deduction. The deduction would constrain the cascade effect, being ruled through a bilateral treaty or a domestic tax ruling. Usually, the critics over DST are based on the arguable lack of value in the market jurisdiction199, or even political arguments200. However, this argument can be used to any tax, being not exclusive to DST. Moreover, there is the possibility to use the new tax to rebalance the international market in order to save jobs, while maintaining traditional brick-and-mortar businesses. A liberal argument must not discard the consequences of a large-scale crisis in people’s well-being. Moreover, the interim character of the DST proposal is a captious feature. Something that is promised to be temporary can become permanent if countries reach no further agreement in digital taxation. Due sovereignty, a unilateral DST implementation may be warranted for countries that aim for a minimal taxation in digital assets. Then, there is no certainty that a multilateral tax ruling would be granted in a large perspective. The significant economic presence (or the EU equivalent significant digital presence ) is a second option, in terms of advantages. Either OECD or EU models of taxation start from the same premise of granting a minimal taxation. Depending on the rate established and the definition of nonroutine taxable events, the tax revenues may be mere symbolic. Moreover, the model proposed by OECD in the Unified Approach is not a consensus in the Interim Framework, which means that there would be resistance in a world-wide implementation. If the significant economy presence is in force only in part of the economy, it is probable to have a diaspora to non-committed countries. It is a soft law, relying on already known means of collection from the OECD Model Convention. Then, any improvement to the model would take years to be effective. The GloBE proposal, from OECD’s Pillar 2, has the same flaws of the Unified Approach from Pillar 1. Both depend on a coordinated action involving a collaborative stance of all major economies, 199 KEMMERN, E. (2018-2). Should the Taxation of the Digital Economy Really Be Different? EC Tax Review , 72-73 (Editorial) 200 NOGUEIRA, J. F. (2019). The Compatibility of the EU Digital Services Tax with EU and WTO Law: Requiem Aeternam Donate Nascenti Tributo. Intl. Tax Stud. - IBDF Journals. 110 otherwise it would lack effectiveness. The GloBE proposal is based on a de minimis taxation over digital assets, granting tax back to harmed countries. The difficulty here is regarding the need of transparency towards the topic of remittance to third countries, requiring an impracticable cooperation to ring-fence the profit. The least recommendable solution is to ignore the digital economic features, keeping international taxation as it is in the present moment. Due the current transformation in the economy, digital assets has an exponential increase in value. 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