Article 17 – The Tax Challenges of the Digital Economy

Tackling BEPS in the digital economy In our 17th article in a series of articles on the tax challenges of the digital economy, in continuation with the 16th article, we shall be providing you hereunder with a brief overview on two other key transfer pricing issues that needs to be focused on to assure that transfer pricing […]

Written By Stephen Balzan

On April 18, 2016
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Tackling BEPS in the digital economy

In our 17th article in a series of articles on the tax challenges of the digital economy, in continuation with the 16th article, we shall be providing you hereunder with a brief overview on two other key transfer pricing issues that needs to be focused on to assure that transfer pricing outcomes are in line with value creation (Actions 8-10), that of (ii) delineating the actual transaction and business risks and (iii) global value chains and transactional profit split methods. 

(ii) Delineating the actual transaction and business risks

BEPS structures, contractually allocate risks to entities in low tax jurisdictions with the aim of shifting substantial amounts of income into low tax environments. The revised guidelines will challenge this by determining that contractual risks cannot be allocated to and assumed by an entity that cannot in fact exercise control over such risk and does not have the financial capacity to assume such risk.  Such risk will be allocated to the entity that actually exercises such control and have the financial capacity to assume it.

This is part of the requirement to accurately delineate the actual transaction between the associated enterprises by supplementing the contract with the evidence of the actual conduct of the parties.  This delineation will lead to the proper allocation of appropriate returns to entities within the group that perform the important functions, contribute important assets and economically control significant important risks.

(iii) Global value chains and transactional profit split methods.

When the ALP was initially devised, it was common that each country in which an MNE group did business in, had its own subsidiary with full functionality and carrying on a broad range of activities reflecting the group’s business as a whole. This structure was dictated by a number of factors, including slow communications, currency exchange rules, customs duties and high transportation costs that made integrated global supply chains difficult to operate

With the advent of improved ICT, reductions in many currency and customs barriers and the move to digital products and a service based economy, corporate legal structures and individual legal entities became less important and MNEs today operate as a single firm, in a coordinated fashion to maximize opportunities in the global economy.  Thus a greater reliance needs to be made on value chain analyses and transactional profit split methods.

The BEPS project confirmed that this method can be useful when applied to align profits with value creation.  Further work on this method will therefore examine its application to highly integrated business operations and develop profit splitting factors that show strong correlation with value creation.  This work should also address situations where comparables are not available.

In our next article, we shall be focusing our attention on measures that will address BEPS issues in the jurisdiction of the ultimate parent.

How can we help?  

For further information, please contact one of the firm’s tax partners, Stephen Balzan on [email protected] or Elaine Camilleri [email protected]. ACT can help you understand the changes to the tax rules and how these can impact your business.  

Apart from its offices in St. Julian’s Malta, ACT operates from a second office in Gozo, which is situated in the capital city of Victoria.  For an appointment in our Gozo office, please call on 00356 21378672 or send us an email on [email protected]. 

Disclaimer: This article contains general information only and is not intended to address the circumstances of any particular individual or entity. ACT, by means of this article is not rendering any accounting, business, financial, investment, legal, tax, or other professional advice or service. This article is not a substitute for such professional advice, nor should it be used as a basis for any decision or action that may affect your finances or your business. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. Before making any decisions or before taking any action that may affect your finances or your business, you should consult a qualified professional adviser. ACT shall not be responsible for any loss whatsoever sustained by any person who relies on this article.