The challenges of a digital economy

The proliferation of digitization in business raises new questions for tax leaders, not only amongst those leading tax departments in traditionally digital companies, but also across businesses and sectors that have incorporated digital solutions into some aspect of their service delivery or operations—from banks to insurance companies to car manufacturers and beyond.

The digitalization of the economy has often served as an overarching topic for a number of connected but not interchangeable categories in relation to tax. As has been written about, by Tim Gillis, Global Head of Tax Technology & Innovation at KPMG International, we can think of the impacts of digitization on tax across three distinct areas: 1.) The digitization of tax collection; 2.) The digitization of the tax function; 3.) The digitalization of the economy (taxation of digital aspects of business.) Each of these has an impact on tax systems, taxpayers, administrators and the tax function itself and needs consideration and discussion.

European Tax Summit Poll results

At the 2018 KPMG European Tax Summit, we were able to poll approximately 100 tax leaders from around the world on the challenges posed to existing tax norms and potential responses, with some interesting results. As an overarching theme throughout the session, the key factor identified by tax leaders (35%) was that international tax rules are out of date for the modern day and that changes are needed. A further 24% thought the issue was a perception that countries’ tax bases are being eroded by digitized companies. However, 26% thought the reasons were more opportunistic with a desire by some countries to tax new sources of revenue. Given the concern with rules being outdated, it is perhaps not surprising that, when it comes to finding a way forward, the preferred route was an internationally agreed change of Permanent Establishment (PE) rules to focus on what it means to do business in another country (37%) – ie the solution should not ring-fence the so called “digital economy”. This contrasts with 20% who favored an internationally agreed-upon virtual PE concept, and 16% suggesting it be a turnover or withholding tax – solutions which would focus specifically on digitalized business. 16% preferred a move away from corporate tax to focus on indirect taxes.

This finding is consistent with what we are seeing more broadly, including in our online polls at kpmg.com/responsibletax, where more than 70% of respondents indicate their belief that international corporation tax principles need to be fundamentally changed for the modern context. There, just 13% say such change is needed only in regards to highly-digitized businesses, underscoring the recognition that ring-fencing digital business is challenging when nearly every business today is digital to some degree.

However, when it came to what they think will happen – as opposed to what they thing the best solution to be - tax leaders responded slightly differently. When asked which of the three groups identified by the Organisation for Economic Co-Operation and Development in their Interim Report would win the debate - namely, those countries favoring focused changes to tax digitalized business, those believing wider changes to international are needed and those which hold that the BEPS project has already addressed any problems - just over half (51%) thought the first group would prevail. 36% thought countries wanting wider changes would succeed while only 13% thought those in favor of no change would win

There seems to be consensus that change is needed, but mixed views as to how soon it will come. When asked whether tax systems will change in the near future in the EU, the majority of respondents said they expect to see agreement on a directive on digital services tax, but not before 1 January 2019 which is the date proposed by the current Austrian Presidency . Interestingly, just over one-quarter of respondents said they do not expect to see a directive on digital services tax in the EU come to fruition at all. Over three quarters (78%) said they expect the EU will introduce a directive on the concept of a significant digital presence.

To explore tax leaders’ predictions for how the digitization of companies might shape tax systems more broadly in the future, we asked what trends they expect to see in relation to corporate taxation of highly-digitized businesses in the next ten years. A significant number of respondents predicted “the beginning of ‘tax wars,’ including double taxation as international accords break down” (34%), and an equal number of respondents saw an overall diminishing of relevance of corporate taxation (presumably to be replaced by higher indirect taxes). Only just over one-quarter (26%) expect the emergence of a new international accord to replace what we have today.

A consensus that change is needed

Though the solutions will undoubtedly vary, there is clear consensus that change is needed, and will indeed happen. There also seems to be a dichotomy between what tax leaders think is the preferred way forward and what they think will happen. The majority views seem to be that there will an increase in disputes, controversy and double taxation – which is not good for business. There may also be a shift from corporation tax to indirect tax – something likely to be opposed by civil society. The results of our poll therefore suggest the need for constructive engagement from companies and all stakeholders if we are to see the emergence of a new international accord which works for all.