International Taxation and the Complex Case of Digitalisation

103 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion CHAPTER 6 In e na ional Taxa ion and he Complex Case o Digi alisa ion MARTTI NIEMINEN Takeaways o Leading Change When he e is a change so undamen al as digi alisa ion, no pa o socie y is le una ec ed. The ansi ion om he b ick and mo a economy o he digi al economy has d ama ically ans o med he se ing o in e na ional business axa ion and basic p inciples o he in e na ional ax sys em ha e become ou da ed. This chap e demons a es how digi alisa ion and he ans o ma ion o he global economy a ec in e na ional axa ion and discusses how o es o e he in eg i y o he in e na ional ax sys em. I also a gues ha managing complex and sys emic changes equi es unde s anding a mul iplici y o ields and leade ship beyond ins i u ional bounda ies. This kind o leade ship is now mo e necessa y han e e due o he inc eased complexi y o he global economy and di e gen in e es s o key playe s. 104 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion T he Leade ship o Change (LFC) app oach is comp ised o h ee co e elemen s: a complex wo ld, ela ional leade ship and dynamic change. Complexi y is he ea u e o he app oach ha bes desc ibes he phenomenon discussed in his chap e – he e ec s o digi alisa ion on he in e na ional ax sys em. The in e na ional ax sys em is a mul idimensional s uc u e which combines a ious ields o socie y and discipline: law, business, poli ics and economics. The ongoing ans o ma ion o he in e na ional ax sys em is also a p ime example o a change p ocess whe e leade ship is a om clea . The challenges caused by digi alisa ion o in e na ional ax egula ion canno be esol ed by any single ac o bu equi e wide- anging solu ions and coope a ion. A he same ime, he ans o ma ion o he in e na ional ax sys em in he digi al age is nei he linea no easily p edic able. F om he pe spec i e o in e na ional axa ion, he key ea u e o he global mega end o digi alisa ion is ha economic ac i i y no longe equi es a physical p esence. This aspec o he in o ma ion and communica ion echnology (ICT) d i en mode n economy e odes he undamen al concep s o in e na ional ax law ha de e mine which coun y has he ju isdic ion o ax c oss-bo de business income. The esul has been he widesp ead phenomenon o in e na ional double non- axa ion o mul ina ional en e p ises. This is a p essing global conce n in e ms o inancing public expenses, compe i ion neu ali y, incen i es o economic ac i i y and ai ness. This chap e demons a es how digi alisa ion and he subsequen ans o ma ion o he global economy a ec s in e na ional axa ion and discusses how o es o e he in eg i y o he in e na ional ax sys em. We begin by looking back o he ea ly 1900s, when ano he ansi ion in echnology and he economy led o a undamen al e-e alua ion o he basic p inciples o in e na ional axa ion. This chap e demons a es how digi alisa ion and he subsequen ans o ma ion o he global economy a ec s in e na ional axa ion and discusses how o es o e he in eg i y o he in e na ional ax sys em. 105 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion Key P inciples o In e na ional Business Taxa ion In ea ly 1900s indus ialisa ion, powe ed by e olu iona y echnological inno a ions such as he in e nal combus ion engine, mode n powe g id and he assembly line, was well unde way. Mo e and mo e capi al, including an inc easing numbe o labou , was in es ed in indus ial manu ac u ing. The s uc u e o socie y was beginning o change om ag a ian o indus ial. Consume p oduc s and indus ial goods we e now beginning o be mass-p oduced. I became necessa y, and inc easingly possible due o he ad ances in anspo a ion and communica ion echnologies, o manu ac u e s o look ab oad o new oppo uni ies o g ow h. One o he po en ial majo obs acles o he eme ging expansion o c oss- bo de ade was he awkwa d and ou da ed cons uc ion o he in e na ional ax sys em. Each coun y had i s own ules on who and wha o ax. This o en esul ed in o e lapping and simul aneous axing claims o wo o mo e s a es (Gadžo, 2018, p. 203–209). The basic se ing was as ollows: The axing claim o S a e A was based on i s unde s anding ha he whole exis ence and ope a ions o Company X we e ul ima ely made possible by he public goods (physical and legal in as uc u e, educa ed and heal hy wo k o ce, e c.) p o ided by S a e A. S a e B based i s axing claim on a somewha simila idea ha he money used o buying he p oduc s om Company X was gene a ed by he esou ces p o ided by S a e B. O , i may be ha bo h s a es simply needed he ax e enue. F om a legal pe spec i e, he e is li le di e ence why a s a e looks o ax ce ain income. Unde in e na ional law s a es ha e ull disc e ion o decide wha hey wan o ax as long as he e is a easonable connec ion be ween he s a e and he income o be ween he s a e and he income ecipien (Gadžo, 2018; Ma ha, 1989). This p oblem o in e na ional double axa ion despe a ely needed o be esol ed o acili a e he expansion o in e na ional ade. The di icul y was ha no s a e was unila e ally willing o gi e up i s axing claim in a ou o o he s a es. In e na ional co-ope a ion was equi ed. The body o ake up he ask was he League o Na ions – he p edecesso o he Uni ed Na ions. I s Economic and Financial Commission on 5 Ap il 1923 eleased a pionee ing epo on double axa ion. The epo laid down he 106 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion basic s uc u e o he in e na ional income ax sys em as i exis s oday, almos a cen u y la e (League o Na ions, 1923; De e eux & Vella, 2014; Whi ake , 2016; De Melo Rigoni, 2017). In he epo , he wo basic p inciples o c oss-bo de business axa ion we e es ablished: he esidence s a e p inciple and he sou ce s a e p inciple. These p inciples mean ha bo h he so-called esidence s a e (S a e A in he abo e example) and he so-called sou ce s a e (S a e B in he abo e example) ha e, as a ule, he igh o ax income gene a ed by c oss-bo de business ope a ions. The esidence s a e has wo ldwide o unlimi ed ax FIGURE 1. Company X made lea he bags (hand bags and sui cases). S a e A was he “home” s a e o he company whe e i was ounded, egis e ed, managed and whe e he manu ac u ing o i s p oduc s ook place. Company X also owned he adema k ha dis inguished i s p oduc s om o he simila p oduc s. S a e B was he “ a ge ” s a e whe e he company looked o expand o sell i s p oduc s o local consume s. Company X had in S a e B a e ail s o e whe e i displayed and sold he lea he bags made in S a e A. The p oblem o Company X was ha he income i ecei ed om selling lea he bags in S a e B was axable bo h in S a e A and S a e B unde he domes ic ax law ules o hese s a es. In o he wo ds, he company was axed wice. In s a e B i would ha e paid a 30 pe cen co po a e income ax (CIT) and in S a e A 35 pe cen CIT. O i s ne p o i he company would he e o e ha e paid a o al o 65 pe cen income axes. This would ha dly encou age Company X o expand in e na ionally. S a e A Company X Re ail s o e S a e B CIT 30% CIT 35% 107 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion ju isdic ion, meaning i may ax any income ega dless o whe e i o igina es. The sou ce s a e has a e i o ial o limi ed ax ju isdic ion unde which i may ax business income ecei ed om i s e i o y. Howe e , he sou ce s a e can ax c oss-bo de business income only when he o eign company has a so-called pe manen es ablishmen (PE) in i s e i o y and o he ex en he income is gene a ed by he ope a ions o ha pe manen es ablishmen . Wha is impo an o unde s and abou his legal concep is ha , in gene al, he e canno be a pe manen es ablishmen wi hou some le el o physical p esence; o example, a ac o y, s o e, o ice o wa ehouse. G asping his ea u e o he pe manen es ablishmen concep is essen ial in unde s anding he cu en challenges o he in e na ional ax sys em. F om he pe spec i e o he esidence s a e’s axing powe s he impo ance o he exis ence o a pe manen es ablishmen is no , in p inciple, as signi ican as i is o he sou ce s a e. The esidence s a e has unde i s wo ldwide ax ju isdic ion he igh o ax c oss-bo de income anyway. Howe e , in p ac ice, whe he he e is a pe manen es ablishmen o no in he sou ce s a e is also impo an o he esidence s a e. I he e is a pe manen es ablishmen he esidence s a e is usually able o ax only “wha is le ” a e he axa ion in he s a e o sou ce due o i s obliga ion o c edi he axes paid in he sou ce s a e (c edi me hod). Al e na i ely, he esidence s a e may be obliga ed o exemp o eign sou ced income al oge he (exemp ion me hod). Following he p inciples se in he 1923 League o Na ions epo , in ou example scena io he axing igh s be ween S a e A and S a e B a e alloca ed as ollows: By alloca ing he axing igh s o business p o i s be ween he sou ce s a e and he esidence s a e, o e lapping axing claims o he wo s a es we e e ec i ely a oided, in e na ional double axa ion was elimina ed and he mos impo an ax- ela ed obs acle o in e na ional ade was emo ed. In he ollowing decades, mo e and mo e s a es adop ed he p inciples laid down by he League o Na ions epo by concluding bila e al ax ea ies wi h o he s a es. These ax ea ies we e based on he Model Tax Con en ion o he O ganisa ion o Eu opean Economic Co-ope a ion (OEEC) ha la e became he O ganisa ion o Economic 108 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion Co-ope a ion and De elopmen (OECD). By he 1950s he OECD had a leading ole in managing he de elopmen o he in e na ional ax sys em (OECD, 1963). In summa y, he in e na ional business ax sys em wo ked easonably well h ough he wen ie h cen u y because he expansion o business o o he s a es usually equi ed some kind o physical p esence. This ensu ed he axing igh s o he sou ce s a e h ough he concep o pe manen es ablishmen . A he same ime he key unc ions and he wo ldwide ax liabili y emained in he company’s esidence s a e. C oss-bo de business income was axable ei he in he sou ce s a e o in he esidence FIGURE 2. Because Company X has physical p esence ( e ail s o e) in S a e B, he e is a pe manen es ablishmen o company X in S a e B. Acco dingly, S a e B has he ju isdic ion o ax he business p o i s o Company X o he ex en hey a e connec ed o ha pe manen es ablishmen . S a e A as he esidence s a e also has he igh o ax he business income Company X ecei es om S a e B. Howe e , S a e A is obliga ed o c edi he axes paid in S a e B. This e ec i ely means S a e A can only ax 5 pe cen o he income ecei ed by Company X om S a e B. O i s ne p o i Company X would he e o e ha e o pay a o al o 35 pe cen income axes. This is much mo e encou aging o Company X compa ed o he 65 pe cen desc ibed in Figu e 1. Company XS a e A PE S a e B Sou ce s a e CIT 30% Residence s a e CIT 35% – 30% = 5% 109 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion s a e o in bo h s a es, in which case ax ea ies ensu ed in e na ional double axa ion was e ec i ely elimina ed. Digi alisa ion E oding he Taxable Base In ecen yea s, he e m digi al economy has eme ged in he language o in e na ional axa ion. The digi al economy is an o e a ching concep e e ing o he en i e mode n economic sys em. I desc ibes a wide ange o ac i i ies, om buying a ain icke online o he wo ldwide ope a ions o a mul ina ional echnology company (OECD, 2015). F om he pe spec i e o in e na ional axa ion, he main ea u e o he digi al economy is ha economic ac i i y no longe equi es physical p esence, he phenomenon o “scale wi hou mass” (OECD, 2018a). This is impo an because wi hou physical p esence no pe manen es ablishmen is c ea ed in he sou ce s a e. This means he sou ce s a e has no axing igh o e he business income ecei ed by a non- esiden company. Figu e 3 illus a es he e ec o digi alisa ion. This example demons a es how he undamen al concep o in e na ional business axa ion, he pe manen es ablishmen , and by ex ension he en i e sou ce s a e p inciple, is comp omised in he digi al wo ld. The absence o axable p esence in he sou ce s a e has become an all-encompassing issue as mo e and mo e goods and se ices can be deli e ed o cus ome s (consume s o o he businesses) in o he s a es wi hou a physical p esence. Sou ce s a es in many cases no longe ha e he ju isdic ion o ax ou bound business income. This is p oblema ic in wo ways. Fi s , and mos ob iously, he sou ce s a e loses ax e enue. Fo example, when a Finnish company buys ad e ising se ices om Google, he paymen s o hose se ices go un axed in Finland. F om he Finnish pe spec i e ax e enue “leaks” ab oad. This, o cou se, is a conce n o he inancing o public expenses in Finland. Second, no ha ing o pay axes in he sou ce s a e easily esul s in no being axed a all. The phenomenon e e ed o as in e na ional double non- axa ion e e s o a case whe e a mul ina ional co po a ion is no axed o i s p o i s by any s a e o is axed wi h a e y low e ec i e ax a e. 110 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion This occu s because he esidence s a e p inciple is also being e oded as will be discussed below. The main p oblem wi h in e na ional double non- axa ion is ha i dis o s compe i ion neu ali y be ween global and local o “big” and “small” businesses. I he e ec i e ax a e is 20 pe cen o one company and 1 pe cen o ano he , i is clea hei chances o success a e a om equal. The ac ha mul ina ional en e p ises a e in many cases subjec o ze o o close o ze o axa ion also c ea es p essu e o s a es o compensa e ax e enue losses by ax inc eases in o he a eas, pa icula ly pay oll axes and alue added ax. This educes incen i es o economic ac i i y in gene al. The e is also he issue o ai ness. I one company does no pay i s ai sha e o he s will ha e o pay mo e (Bu ge s & Valde ama, 2017; Lambe s, 2017). Company X S a e A S a e B CIT 30% CIT 35% FIGURE 3. In his case Company X sells lea he bags o cus ome s in S a e B jus like i did in he p e ious examples. The only di e ence is ha Company X no longe has physical p esence ( e ail s o e) and, hus, no pe manen es ablishmen in S a e B. Ins ead, consume s esiding in S a e B can pu chase he p oduc s o Company X h ough a websi e main ained by Company X in S a e A. Company X pays axes, namely a 35 pe cen co po a e income ax, only in i s esidence s a e (S a e A). 111 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion In e na ional double non- axa ion does no occu simply h ough he lack o axable p esence in he sou ce s a e. I also equi es income o go un axed in he esidence s a e. Fo a g owing numbe o mul ina ional companies his has become eali y. Technological de elopmen s no only e ode he sou ce p inciple bu a e also comp omising he unc ioning o he esidence p inciple. Due o he abundan possibili ies p o ided by mode n ICT and logis ics, key unc ions o a mul ina ional en e p ise can be alloca ed o any ju isdic ion depending, among o he hings, on ax conside a ions. Fo example, he cen al managemen (boa d mee ings), ad e ising, inancing, manu ac u ing and esea ch and de elopmen ope a ions can, and ypically a e, si ua ed in di e en ju isdic ions. Mos impo an ly, he possession o in angibles, such as, adema ks o b ands, copy igh s, pa en s, knowhow and goodwill can be alloca ed almos anywhe e. The loca ion o in angibles has become essen ial. Thei impo ance in he global alue chain has signi ican ly inc eased due o he expanded scope o digi al se ices (OECD, 2013). Manu ac u ing goods is now easie and cheape hanks o, among o he hings, he echnological p ocess o au oma ion (p oduc ion wi hou human assis ance). Au oma ion is e ol ing as and goes hand in hand wi h digi alisa ion. Indeed, echnological inno a ions such as 3D p in ing may make manu ac u ing o e e yday goods so simple ha li e ally anyone can do i . This means he eal alue is less whe e he manu ac u ing akes place and mo e whe e he in angibles a e loca ed. And his b ings us back o ax conside a ions. In he p e ious examples, Company X, esiden in S a e A, owned he adema k ha dis inguished i s p oduc s om simila p oduc s o o he manu ac u e s. The example below demons a es wha happens om a ax pe spec i e i he owne ship o a adema k is ans e ed om Company X o ano he g oup company, Company XX, which is loca ed in a low ax ju isdic ion. As demons a ed abo e, he issue o in e na ional double non- axa ion is no some hing conce ning only mode n ICT companies. I is also ele an in he case o mo e adi ional businesses ha sell, unde a global b and, angible goods (e.g. u ni u e o clo hes) o se ices (e.g. co ee shops and as ood es au an s). I is also wo h poin ing ou he e a e a ious o he ax planning echniques besides he one desc ibed abo e ha may esul 118 Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es In e na ional Taxa ion and he Complex Case o Digi alisa ion UK Go e nmen . (2015, No embe 30). Di e ed p o i s ax: guidance. Re ie ed om h ps://www.go .uk/go e nmen /publica ions/ di e ed-p o i s- ax-guidance Uni ed Na ions. (2013). Global alue chains and de elopmen : In es men and alue added ade in he global economy (UNCTAD/DIAE/2013/1). Whi ake , D. R. (2016). An examina ion o he OECD and UN model ax ea ies: His o y, p o isions and applica ion o US. Fo eign Policy. No h Ca olina Jou nal o In e na ional Law and Comme cial Regula ion, 8(1), a icle 4. Leading Change in a Complex Wo ld: T ansdisciplina y Pe spec i es Copy igh © 2019 Tampe e Uni e si y P ess and he au ho s Edi ed by Anni Kangas, Johanna Kujala, Anna Heikkinen, An i Lönnq is , Ha i Laihonen and Julia Be hwai e Tampe e: Tampe e Uni e si y P ess