As digital services businesses continue to replace bricks-and-mortar retailers, many governments are grappling with how they can collect their share of tax from these businesses’ profits. Existing tax laws are not always sufficient to appropriately tax digital activities, leading to a belief that there is a mismatch between where the profits of these activities are currently being taxed and where those digital activities are actually creating value.
Some of the major economies are seeking to implement new measures specifically targeting digital activities. In the EU, the European Commission adopted the fair taxation of the digital economy package comprising of two main proposals:
- A permanent reform of the corporate tax regime to tax businesses with a “significant digital presence” in an EU member state. If passed, entities incorporated in non-EU member states would be caught in the EU tax net where they meet one of the following criteria:
- Greater than €7 million in annual revenues in a member state; or
- Greater than 100,000 users in a member state in a taxable year; or
- Over 3000 business contracts for digital services are created between the company and business users in a member state in a taxable year.
An interim 3% digital services tax on revenues generated by the following activities impacting users in EU member states:
- Targeted online advertising;
- Intermediary services such as online platforms and marketplaces; and
- Collection and transmission of data captured through digital interfaces.
In the UK, Treasury released an initial position paper containing proposed measures similar to those seen in the EU paper:
- A permanent reform of the corporate tax framework to tax revenues generated by businesses with a “user permanent establishment” in the UK (further consultation to follow); and
- An interim 2% digital services tax on revenues generated by the following activities impacting UK users:
- Search engines and targeted advertising;
- Social media platforms and targeted advertising; and
- Online marketplaces.
The above measures are primarily targeting the larger multinationals, but there are also changes to how existing tax laws are being applied and these changes can affect all businesses with digital activities, regardless of size. An example is the recent US court decision in Wayfair case. This decision could have a significant impact on Australian tech companies providing e-commerce or online retailing services to US customers.
The issue in Wayfair was whether a business with no physical presence in South Dakota was required to remit and pay US sales tax on online sales made to customers located there. The Court found that although the business had no physical nexus to South Dakota, there was an “economic nexus” as it was availing itself of customers in that state and so was subject to sales tax. This same interpretation has now been adopted by numerous other US states.
If your Australian tech company is providing digital services to US customers, it may be subject to US sales tax on those services. Besides the immediate impact this could have on the company, business owners should be aware that these measures would undoubtedly be analysed during the due diligence process in the event of a future share or trade sale. Not dealing with these issues would ultimately impact your sale price or could even kill a deal.
Expanding overseas has always brought tax complexities with it and this is even more the case now for businesses with digital activities. With many governments seeking to tax digital services – either directly through income tax or indirectly through sales and use tax – putting in place appropriate strategies to manage these complexities is critical.
To find out more contact: Tax Manager Alex Zinzopoulos
