Article 21 – The Tax Challenges of the Digital Economy

Broader direct tax challenges In our 21st article in a series of articles on the tax challenges of the digital economy, we shall be providing you hereunder with a brief overview on the first category of the main policy challenges raised by the digital economy i.e. Nexus and the ability to have a significant presence without […]

Written By Stephen Balzan

On May 16, 2016
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Broader direct tax challenges

In our 21st article in a series of articles on the tax challenges of the digital economy, we shall be providing you hereunder with a brief overview on the first category of the main policy challenges raised by the digital economy i.e. Nexus and the ability to have a significant presence without being liable to tax.

The advances in the digital economy have not changed the way businesses do business in order to generate profits.  They still need to carry out market research, marketing and advertising and customer support. What technology has changed is the way such businesses carry out these activities, since these can now be done remotely and with increased speed.  Distance forms less of a barrier to trade, technology has expanded the number of potential customers that can be targeted and reached.

As a result it is possible for a business’s personnel, IT infrastructure and customers to be spread among different jurisdictions, away from the market jurisdiction.  In view of the fact that it is now increasingly possible to generate a large quantity of sales without having a taxable presence, raises questions about whether the current tax rules continue to be appropriate in the digital economy.

The concept of a PE always referred to a substantial physical presence.  It also referred to situation where the non-resident enterprise carried on business in a country via a dependent agent. This raises the question as to whether the existing definition of a PE continues to be relevant also in view of the fact that IT has increased the ability to conclude contracts remotely with no involvement of employees and dependent agents.

Another specific issue which is raised is whether activities which were previously considered to be preparatory and auxiliary (and hence did not constitute a PE) have now become significant components of business in the digital economy. If for example proximity to customers for quick delivery to customers is a key component of a business model of an online seller of physical products, then the maintenance of a warehouse in that jurisdiction could be considered to be a PE.  Similarly where the success of a business depends on the ability to be faster than competitors, that the server must be located closely to the market jurisdiction, questions may be raised whether the automated processes carried out by the server can still be considered preparatory and auxiliary activities.

Tax treaties do not permit the taxation of business profits of a non-resident enterprise in the absence of a PE.  However even in the absence of any limitations imposed by tax treaties, many jurisdictions would not consider a non-resident enterprise to have a PE in their own jurisdiction without any substantial nexus.  For example many jurisdictions would not tax income derived by a non-resident enterprise from remote sales to customers located in that jurisdiction unless that enterprise maintained some degree of physical presence in that jurisdiction.  Thus the issue of nexus is not only related to the issue of a PE under existing tax treaties but also to the domestic rules for the taxation of non-resident enterprises.

In our next article, we shall be focusing our attention on the second category of the main policy challenges raised by the digital economy i.e. Data and the attribution of value created from the creation of such data through the use of digital products and services.

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.