Digitalization of our economies have caused some unprecedented challenges for tax authorities worldwide. In recent years there have been monumental changes in the tax laws globally to address tax issues arising from the digital economy.
Below are five noteworthy tax law updates for digital businesses with footprints across the U.S. and the globe.
1. U.S. State Sales Tax Collection
The Supreme Court Decision in South Dakota v. Wayfair, Inc. in 2018 overruled a longstanding physical presence rule, allowing states to require remote sellers to collect and remit sales tax.
Since then, states have updated their sales tax law in various degrees and flavors to impose sales tax collection and remission responsibilities (known as nexus) on out-of-state sellers for sales to customers within their respective states.
Unfortunately, each state has its own spins in terms of what types of products or services would attract sales tax and the minimum threshold for out-of-state sellers.
States vary, for example, in whether the safe harbor threshold is denominated in gross sales, transactions, or both. South Dakota's threshold, where nexus attaches with either $100,000 of gross sales or 200 transactions in the state, remains the most common, adopted by 24 states and the District of Columbia. Two states (Connecticut and New York) require that both a gross sales and transaction threshold be met, while 17 states rely exclusively on gross sales.
2. VAT (Value Added Tax)
VAT is another form of consumption tax or an alternative to the U.S. state sales tax in terms of taxing sales transactions.
Currently, there are about 170 countries in the world that impose VAT in some shape or form.
Over 70 countries now require remote vendors of digital services to register for and collect VAT.
Under the OECD's International VAT/GST Guidelines, the destination principle is used for taxing business-to-business (B2B) and business-to-consumer (B2C) transactions in the country in which the customer resides.
The guidelines recommend:
- For B2C services, the non-resident vendor should register for and charge VAT in the country in which the customer is located.
- For B2B services, the business recipient should self-assess VAT through a reverse charge or similar mechanism.
- Various countries such as Australia, New Zealand, Singapore, South Africa, and the 27 member states of the EU are proactively implementing new VAT rules to address the new business models created by the digital economy.
- Different countries have different registration thresholds.
3. U.S. Tax Reform (Tax Cuts and Jobs Act)
U.S. federal tax reform that was signed into law in late 2017 and recent IRS regulations have an important impact on digital businesses such as Cloud transactions (SaaS), streaming of digital content, and transfers of computer programs or rights therein, depending which category or categories your business or revenue streams fall into.
For example, if your business makes a payment to a foreign-related party (such as a subsidiary of the U.S. entity) for goods or services, such payments may be subject to a minimum tax add-on.
If you sell your services or goods to a customer outside of the U.S., you may be entitled to a lower tax rate of 13.125% if you meet the IRS' various requirements of qualifying exports of goods or services.
4. OECD's Digital Services Tax
To compete for tax revenues from global businesses that operate on innovative business models or employ disruptive technologies, OECD member countries have joined efforts to develop and implement cohesive measures to tax these new economy businesses based on the location of their customers or users rather than where production or R&D occurs.
These joint efforts, called Pillar One and Pillar Two under the BEPS (Base Erosion and Profits Shifting) Project, are still in progress with a focus on the following digital businesses:
- Consumer-facing businesses that generate revenue from the sale of goods and services of a type commonly sold to consumers, including sales through third-party resellers or intermediaries. Example: sales on Amazon.
- Automated digital services that generate revenue from the provision of automated digital services that are provided on a standardized basis to a large population of customers or users across multiple jurisdictions. Examples are search engines, social media platforms, digital content streaming, online advertising, and online intermediation platforms.
The currently proposed approach seeks to adopt a unified approach whereby market jurisdictions would be allocated three pieces of a global business' profits based on:
- Market/user jurisdictions based on a fractional share of the business's deemed non-routine profits.
- Local activities (e.g. marketing and distribution) in market/user jurisdictions which should earn a fixed minimum return (based on economic arm's length principles) for these local marketing and distribution activities.
- An additional amount over the above fixed return where the taxpayer or tax authority may view for above minimum return for these local marketing, distribution, or other activities.
The OECD, under Pillar Two, seeks to develop a set of global minimum tax rules to ensure global businesses' worldwide profits are subject to at least a minimum rate of tax. The income inclusion and taxing mechanisms are still under discussion.
5. Unilateral Digital Services Tax
Other than the concerted efforts spearheaded by the OECD, certain countries have proposed or implemented their own in-country digital services tax.
- France has passed into law a 3% DST based on certain user data. However, the 2020 collection has been delayed until the end of 2020.
- Italy has a 3% DST effective January 1, 2020 based on gross revenue apportioned to Italy.
- India has implemented a 6% DST based on online advertising payments.
- The UK has a proposed 2% DST based on revenue of the digital business in excess 25 million pounds derived from UK users from social media platforms, internet search engines, or online marketplaces.
Tax authorities worldwide are determined to widen their tax nets and update their tax legislations to tap into the fast-growing global digital economy.
Digital businesses should pay attention to various forms of taxation that may impact their cash flows and bottom lines. For example:
- Sales tax and VAT, where the tax is based on sales transactions. Even though the consumer of the goods or services ultimately bears the burden of the tax, the business selling the goods or services is responsible for tax collection and remittance to the relevant tax authorities.
- Income-based taxes where attention should be paid to how business profits are allocated and taxed in various countries.
Early tax planning is usually worth the time and money to avoid a hefty tax bill later on.
This is an exciting time to experience the Fourth Industrial Revolution, where people discover new ways of living their daily lives and entrepreneurs have amazing opportunities to be innovators and disruptors of the status quo.
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