As the global economy becomes increasingly digital, tax authorities face challenges in taxing and scoping activities that go beyond existing laws. With changes only continuing to accelerate, existing taxation frameworks must be reviewed and adapted for the future.
The digital economy refers to activities that are online and carried out through technology, as opposed to the traditional economy, which focuses on brick-and-mortar practices. This growing part of the global economy comes from new business models, a lack of a physical presence, and intangible assets.
Existing taxation mechanisms are based on the traditional economy and therefore throw up challenges and complexities when faced with digital alternatives. Some of the key challenges include defining ‘digital’, deciding on which jurisdiction has taxing rights, assessing the value of intangible assets, and what is a ‘fair’ amount of taxation.
The OECD moved closer to a solution at their July 10 meeting, publishing a statement of understanding between countries that has since received endorsement from international bodies. The measures – known as Pillar One and Pillar Two - seek to overhaul global tax rules by 2023, including revising transfer pricing rules for the reallocation of profit to market jurisdictions and setting a global minimum corporate income tax.
While this is the first step towards a global approach to taxation of the digital economy, many hurdles remain; including finalising the details of a global agreement and the many countries which have already introduced digital services taxes (DSTs).
However, the pace of technological development continues to disrupt the traditional taxation model and any replacement must be flexible and nuanced enough to cover further developments. The proliferation of cryptocurrencies and blockchain technology is a recent example of technology that has spread without regulation or taxation. Some countries are now rushing to introduce legislation to tax these goods and services.
As with the broader digital economy, only a multilateral agreement can develop an effective mechanism for taxation of these products.
The OECD has already said it will review the common reporting standards (CRS) to include new financial products – such as cryptocurrencies. Similarly, the EU has approved its latest Directive on Administrative Cooperation (DAC7) to cover digital platforms, but many stakeholders say that this needs to go further, and the European Commission has launched a consultation to include reporting obligations on crypto-assets and e-money in DAC8.
Uncertainty is an inescapable factor in the digital economy. Tax authorities must understand the digital economy scale first to correctly apply tax law and introduce new policies. They need to ensure their compliance systems are robust, flexible, scalable and can handle increasing amounts and complexity of data. Investing in the right technology will safeguard revenue collection and increase transparency.