Print-Taxation of the Digital Economy

May 11, 2019 | By Jesse Eggert, KPMG in the United States; Andy Hutt, KPMG in Australia; Conrad Turley, KPMG in China; Matthew McRae, KPMG in Australia; Robert van der Jagt, KPMG in the Netherlands; Grant Wardell-Johnson, KPMG in Australia; and Brett Weaver, KPMG in the United States


This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Read June 27, 2019 update here

The OECD released this month details of the next steps to be taken in studying several possible tax proposals to revise geographic allocation of taxation rights through amended profit allocation and nexus rules. 

2019 to be a pivotal year

The (many) highlights since 2017

Since the release of its Public Consultation Document (PCD) in February 2019, the Inclusive Framework on BEPS (Inclusive Framework) of more than 100 member jurisdictions, led by the OECD and G20, has continued to make progress towards its goal of achieving a multilateral solution to the tax challenges of digitalization by the end of 2020.

The PCD explains the tax policy features that the Inclusive Framework will explore further, on a “without prejudice” basis over the next two years, refining the focus from the many issues canvassed in the Inclusive Framework’s March 2018 interim report, Tax Challenges Arising from Digitalisation.

Inclusive Framework member countries identified three characteristics of highly digitalized (and digitalizing) businesses that present the greatest challenge to current international tax principles:

1 – Cross-jurisdictional scale without mass

  • Digitalized businesses can earn significant revenue in a particular country with minimal or no local physical presence and tend to earn revenue from a lot of countries with a physical presence in only a few, or even one.

2 – High reliance on intangible assets including intellectual property (IP)

  • Intangible assets (sometimes located in lower-tax jurisdictions) are having a growing impact on how businesses create value.
  • A business often has flexibility about where it locates its intangibles, and this has a significant and possibly disproportionate impact on where its profits are taxed.

3 – High importance of data and user participation

  • By using data more extensively, businesses have been able to significantly improve their products and services.
  • The collection, analysis, and monetization of user data in particular (as distinct from customer data) is creating more profit for a growing number of firms.


Consequently, the Inclusive Framework’s quest for a potential solution will be based on twin “pillars”:

  • Pillar 1 – modification of the international tax rules that allocate taxing rights among jurisdictions
  • Pillar 2 – resolution of remaining BEPS issues in order to provide a remedy where income is subject to no, or very low taxation.

The Inclusive Framework is focusing on developing a coordinated, global response that could reshape the tax system fundamentally for all types of business. The response would impact business structures that had no tax-motivated features, as well as those designed to realize tax-advantaged outcomes.

2017 and 2018 also saw significant acceleration in the pace at which countries and the European Union (EU), collectively, are developing measures to address the impact on the international tax system of highly digitalized businesses.

Major developments in 2017

  • In December, the U.S. tax reform bill H.R.1 was signed into law. Known widely as the Tax Cuts and Jobs Act (TCJA), one of its key features is the introduction of a minimum tax rate (effectively 10.5 percent) on the profits deemed to arise from intangible assets held by certain foreign subsidiaries of a U.S. entity. The TCJA also introduced a new tax intended to address erosion of the U.S. tax base, which targets deductible payments to related foreign parties.

Major developments in 2018

  • The European Commission (EC) published draft directives for the adoption by member states of a long-term solution (including the concept of a digital permanent establishment, or DPE) and an interim digital services tax (DST) pending the implementation of the long-term solution. However, the finance ministers of member states failed to agree on the adoption of any specific EU-wide measures by the end of the year.
  • Italy legislated a 3 percent revenue-based DST that is intended to apply from mid-2019 to digital advertising, intermediary transactions, and proceeds from the sale of user data related to Italian users. The DST is patterned largely after the EC’s failed draft directive.
  • Austria, France, Spain, and the United Kingdom all announced an intention to introduce a unilateral form of DST as an interim measure in 2019 or 2020.
  • India announced the introduction of its significant economic presence rule (a similar concept to the DPE) from 2019, supplementing its revenue-based equalization levy, which has applied since 2016.

Increasingly, we are seeing unilateral and, in the case of the EU, multilateral plans to introduce a revenue-based DST or similar tax, intended to apply to larger, highly digitalized businesses. In general, the relevant governments have stated that they only intend for these measures to operate on an interim basis, until the international community reaches agreement on a longer-term solution.


Status of revenue-based measures as of April 2019

The color-coded table to the right shows the status of various major jurisdictions’ consideration of the adoption of revenue-based measures, typically involving a tax on in-scope sales of certain digitally facilitated services.

These represent one element of a spectrum of measures that different jurisdictions have undertaken. The other measures include expanding the scope of withholding taxes (in some cases to include a payment from one nonresident to another, where the payment relates to IP exploited within the jurisdiction) and penalty tax regimes applying to so-called “diverted profits.”

Action taken        
  • The government released a discussion paper on corporate income tax and the digital economy in October 2018. In March 2019, the government indicated that it would not proceed with any revenue-based DST or similar tax.
  • At the end of 2018, the government announced the intention to introduce a provisional 3 percent DST.
  • The government is currently considering a 5 percent digital tax on large corporations.
  • Draft bills introducing a provisional 3 percent DST and a DPE have been submitted to the lower house of the Belgian Parliament for consideration.
  European Union
  • The meeting of the member states' finance ministers (ECOFIN) in December 2018 failed to reach agreement on the terms of an EU-wide DST.
  • A technical working group produced a draft legislative text based on a Franco-German proposal for a digital advestising tax (DAT), limited to the supply of digital advertising space.
  • At their meeting in March 2019, member states' representatives at ECOFIN were unable to agree on a legislative tax foa a DAT.

Emerging topics in the quest for a longer-term solution

It is clear from the Inclusive Framework’s PCD and the subsequent public consultation meetings that some adjacent BEPS-related measures are impacting the thinking on how a longer-term solution might operate.

The U.S. tax regime for GILTI

The global intangible low-taxed income (GILTI) provisions were introduced as a component of the U.S. tax reform legislation effective from January 2018. They require a U.S. shareholder of a controlled foreign company (CFC) to include in its taxable income its share of the CFC’s net income, to the extent that the latter exceeds a deemed return on the CFC’s tangible assets.

The U.S. shareholder is entitled to a deduction equal to 50 percent of the GILTI income.

In addition, the U.S. shareholder may claim a credit for up to 80 percent of the foreign tax that the CFC has paid on the GILTI income.

Combined with the participation exemption that would also now apply to a dividend received by the U.S. shareholder from the CFC, the GILTI provisions significantly reduce any tax advantage that would arise for a U.S. headquartered group in holding its intangible assets (such as IP) in an offshore low-tax jurisdiction, and retaining the resulting profits there.

The provisions create a minimum global tax rate for U.S. outbound groups on the income deemed to arise from intangibles, effectively a rate of 10.5 percent.

This precedent has led to the Inclusive Framework using it as a prototype for further consideration of whether the adoption of a minimum tax would solve some jurisdictions’ current concerns.

While it could be expected to address concerns about certain enterprises being perceived to pay insufficient tax on profits derived from a jurisdiction, it would not necessarily address the concerns about allocation of taxing rights to market jurisdictions, hence the twin “pillars” of the Inclusive Framework’s future work.

The intersection of corporate income tax and indirect taxes

The global corporate income tax debate centers on whether there should be a shift from a profit allocation approach with a supply-side orientation, toward an approach that achieves more balance with the market jurisdictions.

OECD-driven BEPS actions[1] on the indirect tax front (i.e., value-added tax [VAT] and goods and services tax [GST]) have already bolstered the ability of the country of consumption to impose its indirect tax on services or intangibles that are provided or made available offshore and, therefore, require no physical importation. There is increasing sophistication in indirect tax legislation so as to facilitate the registration of nonresident suppliers, and in tax authorities’ capability to collect such taxes.

Some participants in the debate are, therefore, concerned that a shift in the allocation of profits for the purpose of calculating corporate income tax would prove overgenerous to the consumption location.

Options for a global long-term response to digitalization

Of the core concepts underpinning the international tax rules contained in bilateral or multilateral tax treaties, the Inclusive Framework identified that the two put under the most stress by the emergence of digitalized business models are the “nexus” rule and the “profit allocation” rules.

Nexus rule

The nexus rule determines when a business entity that is resident in one country may be taxed on some of its profits in another country.

Current principles mean that a company resident in one country should not be taxable in another, unless it generates income from that other country through a physical permanent establishment (PE). However, a company offering a digitalized service may generate significant revenue from a country without having a PE there.

Therefore, unless either the concept of PE is expanded, or treaties are modified more broadly such that a PE is not required in order for a company to be taxable, these markets would not be able to levy corporate income tax on the digital business.

Profit allocation rules

The profit allocation rules determine how much of a business entity’s profits may be taxed in a country in which it has a PE. These rules also apply to cross-border transactions between related business entities, in order that multinational enterprises do not manipulate intragroup pricing to achieve tax benefits.

Profit allocation has typically applied the arm’s-length principle, using a functional analysis of each PE or associated enterprise and reconstructing the commercial pricing that would have occurred if they had been at arm’s length.

The question exercising the Inclusive Framework is whether, and if so, how taxing rights over a component of the residual profit of a multinational enterprise (MNE) should be allocated to the market jurisdictions in which it does business.


The Inclusive Framework countries agreed that there is common interest in maintaining a coherent set of international rules for the taxation of businesses that operate across borders.

The table below shows the four proposals, grouped under the twin pillars, which will be the jump-off point for the Inclusive Framework’s next stage of work. The proposal under Pillar 2 could potentially be adopted (wholly or in part) side by side with the agreed Pillar 1 approach.

The proposals feeding into the Inclusive Framework’s twin pillars:

Pillar 1: Modifying the allocation of taxing rights

User value creation approach: This proposal is intended to apply only to highly digitalized businesses. It asserts that active user data and participation make a significant contribution to profits for online advertising and gig economy businesses.

A special new profit split, going beyond existing rules, could be used to attribute part of an affected MNE’s global residual profits (i.e., after remunerating the routine functions of MNE group entities) to the user country. To ensure a taxing right over those profits, foreign enterprises covered by the proposal would be treated as having a taxable presence in the user country, even without having a physical PE or subsidiary.

 Pillar 1

Marketing intangibles approach: This would go broader than the above. A new residual profit split would be used to allocate the portion of the global residual profits that is attributable to marketing intangibles (after remunerating routine functions and other intangibles) to market jurisdictions, on the basis of a new assertion that marketing intangibles are “located there.” The nexus rules would be modified to grant the market jurisdiction the right to tax the allocated marketing intangible profit, even without a physical PE or subsidiary.

Pillar 1

Significant economic presence (SEP) approach: This would develop the BEPS Action 1 Report SEP (i.e., virtual PE) idea with a simplified formulary profit allocation rule that would be easier for emerging economy tax authorities to apply. 

Pillar 2: Providing a remedy for profit shifting to low-tax jurisdictions

A minimum tax rule: This would allow countries to “tax back” profits of an MNE that have been “shifted” into low-tax countries. This would involve a special residence country income attribution rule, drawing on the U.S. GILTI approach.

It would also feature a source country base erosion rule, which could deny tax deductions or deny treaty benefits with respect to payments to countries where “low” tax would apply.

A coordination mechanism to ensure no double taxation, the “minimum rate,” and other details would need to be agreed. 

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What is clear is that a sense of urgency is required in reaching agreement on the key components of what a long-term multilateral solution would look like. The PCD is encouraging evidence of the Inclusive Framework having refined its focus and discarded those ideas that would have the least chance of obtaining multilateral agreement.

Anecdotally, it appears that in the weeks following the public consultation, OECD and government officials’ confidence has increased in relation to the prospects for a multilateral solution. Prior to the G20 summit scheduled for June 2019, the Inclusive Framework intends to release a program of work reflecting how it will carry out its work toward an agreement. This program of work may outline the planned path to reaching a consensus solution.

It will be important to maintain this momentum to avoid an increased risk of the evolution of an international patchwork of unilateral measures, which could inhibit global trade and innovation, and not just in the already highly digitalized sectors.


[1] Refer to OECD's International VAT/GST guidelines.


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