Article 29 – The Tax Challenges of the Digital Economy

Broader direct tax challenges In our 29th 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 second option to address the broader direct tax challenges of the digital economy, namely the imposition of a withholding tax on certain types […]

Written By Stephen Balzan

On July 11, 2016
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Broader direct tax challenges

In our 29th 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 second option to address the broader direct tax challenges of the digital economy, namely the imposition of a withholding tax on certain types of digital transactions.

Two options have been considered when applying a withholding tax on digital transactions i.e. on payments by residents (and local PEs) of a country for goods and services purchased online from non-resident providers. The first is to impose a final withholding tax on gross revenues, while the second option is to subject non-resident providers to a tax on their net profits, supporting the application of the nexus option described in our previous articles.

The scope of the transactions covered

The scope of the transactions should be clearly defined so that taxpayers and withholding agents will clearly know when the tax applies and for tax administrations to ensure compliance.  The system should be clear and simple, but this must be balanced against the need to ensure that similar transactions will be taxed similarly, to avoid creating incentives to structure the affairs in such a way so as to avoid the tax.

Collection of the tax

In practice, the liability to collect the tax is shifted from the non-resident provider to a local collecting agent such as the customer or a third party payment processing intermediary.  The responsible agent must however have access to information about the covered transactions to be able to know when the tax will apply.

In the case of B2C transactions, requiring the customer to withhold the tax is challenging as private consumers have neither the experience nor the incentive to withhold the tax.  Moreover enforcing the collection of small amounts of tax from large numbers of private consumers would involve considerable administrative costs.

On the other hand, an intermediary would not have access to enough information to enable him to determine its character and hence the amount of tax due.  This could be facilitated by a mandatory registration system for non-resident service providers, whereby a designated bank account is will be used only for all payments from local customers.  Intermediaries will then be required to withhold tax only on payments made to these specific bank accounts.

Negative impact of gross basis taxation and relationship with trade and other obligations

In a number of businesses, providing businesses and services online will require ongoing expenditure for continued product development, thus the imposition of a final withholding tax on gross revenues will be an imperfect proxy for tax on net income.

On the other hand, on the assumption that domestic suppliers of similar goods and services are subject to a tax on their net income, the imposition of a final withholding tax on gross revenues is likely to raise substantial conflicts with trade obligations under agreements such as GATT and GATS.  In addition for some countries EU law imposes comparable obligations and will not allow discrimination between resident and non-resident businesses.

A more viable approach would be to use the final withholding tax on gross revenues as a back-up mechanism to enforce a net-basis system of taxation on the basis of a significant economic presence nexus, rather than a stand-alone option.  Thus this will require a registration system of non-resident providers which will enable such providers to file a return and pay tax on their net profits in addition to the withheld tax and for taxpayers who are in a loss position to claim a tax refund.

In our next article, we shall be focusing our attention on the third and last option to address the broader direct tax challenges of the digital economy, namely the introduction of ‘an equilisation levy’.

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.