THE web economy, specifically digitalisation and e-commerce, has boosted the global economy by increasing productivity, encouraging innovation and driving better consumer experiences.
The Covid-19 pandemic and the ensuing lockdowns have led to a surge in e-commerce and digital transformation.
Many businesses seized the opportunity to go digital and to sell more goods and services online.
The e-commerce environment enables the supply of goods and services into a country without the need for a physical presence, and its robust growth is disrupting national and international trade fundamentals.
Given the trade dynamics and ability to do business without a significant physical footprint, many multinational enterprises (MNE) have rearranged their supply chain and business activities, where commercially possible and within the boundaries of the tax laws, by housing their most profitable business functions in low or no tax jurisdictions.
Meanwhile, the domestic tax laws of most countries require some degree of physical presence or establishment, before business profits are subject to income tax.
In addition, under bilateral tax treaties concluded between countries, a taxpayer is usually only subject to tax on its business profits in the country where it is tax-resident unless it has a taxable business presence in another country.
The e-commerce and digital business models have outgrown the traditional tax rules of source, residency and taxable business presence. In fact, tax authorities are concerned that business profits from the digital economy are not being taxed anywhere, leading to the erosion of the tax base of many countries.
In response to this, the Organisation for Economic Co-operation and Development (OECD), working with the G20 countries, has developed 15 Action steps known as the base erosion profit shifting (BEPS) measures, in October 2015.
These action steps seek to close gaps in international taxation for MNE that seek to reduce their global tax burden by moving their operations or intangibles to lower tax jurisdictions.
As an interim measure, whilst awaiting for global consensus on the taxation of digital activities, several countries have decided to move ahead with unilateral measures to tax the digital economy, in the form of what is commonly known as a digital service tax (DST).
DSTs are imposed on MNE based on their digital activities in a particular jurisdiction.
The application of DST varies across jurisdictions, but typically imposes tax on gross revenue from digital service activities linked to users in a jurisdiction.
The definition of digital services may vary from one jurisdiction to another.
The types of activities which may be considered within the scope of a DST may include online advertising, provision of digital platforms to facilitate the provisions of goods and services, and the transmission or sale of data generated from user activities.
For example, the United Kingdom (UK) imposes a 2% DST on gross revenue of large MNE (that have more than ￡500mil (RM2.86bil) in global digital service revenue and ￡25mil (RM142.9mil) in UK digital services revenue operating search engines, social media platforms and online marketplaces to the extent that their revenues are linked to the participation of UK users.
DST is a tax on gross revenue instead of profits.
Whilst DST appears to be a quick fix to enhance the tax base of countries, the approach may lead to a high marginal tax on businesses and may be regarded as inefficient and ineffective from a tax policy perspective.
It may lead to double taxation where MNE that suffer DST overseas will have to be subject to direct tax on the same income in their home or resident jurisdictions on a net basis, potentially without having any credit or offset on the DST suffered in the non-resident countries.
This is not aligned with the fundamental principles of the OECD, to eliminate double taxation.
DSTs may also lead to trade disputes and sanctions.
As a measure to address the above weaknesses, the OECD began work on a two-pillar “BEPS 2.0”.
Pillar one, addresses how part of the profits of large and profitable corporations should be taxed in the jurisdictions in which the consumers or users of those goods and services reside; and pillar two proposes a global minimum tax rate to address the remaining BEPS concerns.
On July 1, 2021, the OECD released a statement on BEPS 2.0.
After further consultation, on Oct 8, 2021, the OECD published its final statement on the two-pillar solution that has been agreed on by most participating countries and reiterated some key points.
For example, under pillar one:
> Residual profit attribution is applicable to MNE with a global turnover of above €20bil (RM97bil) and a profitability of above 10%;
> Allocation of 25% of residual profits (referred to as the profit in excess of 10% of revenue) to market jurisdictions which meet certain nexus criteria using revenue-based allocation;
> Removal of all DST and other related or similar measures; and
> The residual profit allocation will come into effect in 2023.
It is important for MNE to closely follow and evaluate the potential impact of the global tax changes on their businesses, especially given the OECD’s ambitious implementation timeline of 2023.
In addition, MNE will need to monitor their activity in the relevant countries, related to the implementation of these proposed rules through the changes in domestic tax rules and bilateral or multilateral agreements.
As a member of OECD/G20 Inclusive Framework on BEPS, Malaysian authorities are currently working with various stakeholders including MNE for feedback.
Given that more work needs to be undertaken by the OECD toward the implementation of BEPS 2.0 in 2023, the introduction of any legislative provision or guidance in the upcoming Budget 2022 announcement may be unlikely, although we expect to see significant developments over the course of 2022.
Asaithamby Perumal is a partner in Ernst & Young Tax Consultants Sdn Bhd. The views expressed here are the writer’s own.