Digital Permanent Establishment
‘Significant Digital Presence’ as a Basis for Permanent Establishment Taxation
Kandidatnummer: 513 Leveringsfrist: 25.11.2018 Antall ord: 17 539
i Table of Contents
1 INTRODUCTION ... 1
1.1 Theme ... 1
1.2 Main Question and Structure ... 2
1.3 Sources of Law and Methodology ... 2
1.4 Limitations ... 4
2 DIGITALISATION AND THE TRADITIONAL PERMANENT ESTABLISHMENT ... 5
2.1 Digital Economy ... 5
2.2 Current Rules on PE ... 6
2.3 Challenges with the Digital Economy and Taxation ... 7
2.3.1 The BEPS Project ... 7
2.3.2 Broader Tax Challenges ... 9
2.4 Digital Business Models ... 10
2.4.1 Creating Digital Presence ... 10
2.4.2 Examples of Digital Business Models ... 12
2.5 Peer-to-Peer Ridesharing Case ... 13
2.5.1 Scenario ... 13
2.5.2 Applying the Existing Rules ... 15
3 PROPOSED RULES ON PERMANENT ESTABLISHMENT ... 18
3.1 Challenges ... 18
3.2 Premises for Creating New Rules ... 19
3.2.1 The EU Will Not Wait for the OECD ... 19
3.2.2 The Digital Single Market and Double Taxation ... 20
3.2.3 Consequences of Outdated Tax Rules and Digitalisation ... 20
3.3 The Proposed Directive ... 23
3.3.1 Appeal for New Rules ... 23
3.3.2 Legal Basis and Objectives ... 23
3.4 Implementation and Scope ... 24
3.5 ‘Significant Digital Presence’ ... 26
3.5.1 Scope ... 27
3.5.2 Digital Services ... 27
3.5.3 Quantitative Thresholds ... 29
3.6 Applying Article 4 on ‘Significant Digital Presence’ to the Peer-to-Peer Ridesharing Case ... 32
ii
4 POSSIBLE IMPACT OF THE PROPOSED DIRECTIVE ... 38
4.1 The European Commission’s Assessment ... 38
4.2 Additional Costs and Burdens ... 40
4.3 The OECD’s Grounds for Waiting ... 42
4.4 A Legal Scholar’s Assessment ... 44
4.5 Possibilities for Abuse ... 47
5 CLOSING REMARKS ... 49
BIBLIOGRAPHY ... 52
iii ABBREVIATIONS
BEPS Base Erosion and Profit Shifting
CCCTB Common Consolidated Corporate Tax Base
ECOFIN Economic and Financial Affairs Council (EU)
e-commerce Electronic Commerce
EU European Union
G20 Group of Twenty
ICJ International Court of Justice
ICT Information and Communications Technology
IP Address Internet Property Address
MNE Multinational Enterprise
OECD Organization of Economic Cooperation and Development
OECD MTC OECD Model Tax Convention
PE Permanent Establishment
Proposed Directive (own abbreviation)
Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence
TFDE Tax Force on the Digital Economy
TFEU Treaty on the Functioning of the European Union
UN Model Convention United Nations Model Double Taxation Convention between De- veloped and Developing Countries
VCLT Vienna Convention on the Law of Treaties
1 1 Introduction
1.1 Theme
The theme of this thesis is international tax law and digitalisation. Globalisation has led to national markets being transformed into international markets. Digitalisation has made it pos- sible for businesses to operate across jurisdictions and to participate in these international markets through digital presence. Consequently, highly digitalised businesses can avoid taxa- tion across several jurisdictions because current international tax rules are unable to cover businesses operating mainly through digital presence.
Google is an example of a highly digitalised business. Google’s turnover in Norway in 2017 was estimated to be three billion Norwegian kroner (NOK).1 However, they paid only three million NOK in taxes to the Norwegian state through a subsidiary with low turnover, which shows a large discrepancy between the amount of turnover and the amount of tax paid. This example highlights why renewing current tax rules is a pressing issue. Both the Organisation for Economic Cooperation and Development (OECD) and the European Union (EU) are ex- ploring possible solutions to tackle the growing problem.2
The OECD has not yet presented international rules tackling tax challenges caused by the digital economy. The European Commission has therefore taken matters into their own hands, presenting a digital tax package.3 This digital tax package includes the ‘Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence’4 (Proposed Directive). The purpose of the Proposed Directive is to determine if businesses have significant digital presence in a state, creating a permanent establishment (PE), which is a basis for taxation. This thesis examines how digitalisation creates challenges for current international tax rules, and how the Proposed Directive might present a solution to such challenges.
1 Eckblad (2018).
2 See, for example, OECD (2018a) and SWD(2018) 81 final.
2 See, for example, OECD (2018a) and SWD(2018) 81 final.
3 European Commission (2018).
4 COM(2018) 147 final.
2 1.2 Main Question and Structure
To limit the scope of my thesis, I ask the following question: Will the Proposed Directive Article 4 on ‘significant digital presence’ solve tax challenges caused by digitalisation?
The thesis is divided into three sections. In the first section, current PE rules and their inabil- ity to cover digitalisation of society are explained. Additionally, I present a case with a peer- to-peer ridesharing business based on a digital business model. This case will be used to illus- trate how current PE rules fail to adequately regulate highly digitalised businesses. By testing the current PE rules on the case, I will demonstrate why there is need for a renewal of these rules.
The second section contains my analysis of the Proposed Directive. I look into the scope and implementation of the Proposed Directive to see whom it covers and what it requires of EU Member States. Furthermore, I describe suggested rules and analyse whether they cover the digital presence the peer-to-peer ridesharing case presents.
The third section deals with the European Commission’s assessment of the Proposed Di- rective’s impact. I look into the possibilities for abuse and briefly account for why the OECD currently does not develop their own rules. In addition, I describe what a legal scholar, Eva Escribano, thinks are the main risks when applying rules from the Proposed Directive.
Finally, I summarise whether, and if so how the new PE rules cover gaps where the current PE rules fall short. The main challenge is to apply the Proposed Directive to a scenario origi- nating from today’s digitalised society. Are the new rules sufficiently dynamic to handle challenges arising from digitalisation?
1.3 Sources of Law and Methodology
In international law, relevant sources are laid down in the Statute of the International Court of Justice (ICJ) Article 38 (1).5 These sources are generally accepted as legal sources on an in- ternational basis.6 The ICJ Statute Article 38 (1) consists of two types of sources: primary and subsidiary. The primary sources are ‘international conventions’, international customary law, and ‘general principles of law recognized by civilized nations’; the subsidiary ones are ‘judi-
5 ICJ Statute.
6 Malanczuk (2002) p. 36.
3
cial decisions’ and legal theory. The way these sources are listed does not constitute a hierar- chy; nevertheless, the ICJ is known to use them in that order.7
The most important framework in this thesis is the European Commission’s Proposed Di- rective. All EU Member States must achieve goals set out in directives; see Article 288 of the Treaty on the Functioning of the European Union (TFEU).8 If the Proposed Directive is adopted, each Member State is free to choose how to achieve its goals.
The Proposed Directive was presented on 21 March 2018.9 It has not yet been adopted and it is a relatively new concept to the tax community. Therefore, interpreting and understanding it presents a methodological challenge. No case law on the Proposed Directive exists nor has it been written much about in much detail outside the EU’s institutions. Thus, the interpretation and understanding of the Proposed Directive is based mainly on what the European Commis- sion discussed in their evaluation before creating the Proposed Directive, the wording of the Directive’s provisions and its objectives.
In addition, other legal theory can be relevant in order to understand the Proposed Directive. I have specifically chosen to look more closely at Eva Escribano’s work because she has done a thorough preliminary assessment of the Proposed Directive, introducing some interesting points. She is an assistant professor of tax law at Universidad Carlos III de Madrid. The pre- liminary assessment is integrated into a larger project called ‘Post-BEPS international taxa- tion: are the new rules and proposals suitable for every jurisdiction?’10
Another framework relevant for this thesis is the OECD Model Tax Convention (OECD MTC), a model convention proposing international tax rules to prevent double taxation.11 The OECD MTC Article 5 is of special interest because it contains the current PE rules. The OECD MTC is not a legally binding convention, thus, states are free to choose if they want to implement these rules.12 Nevertheless, over 3 000 tax treaties are based on the OECD MTC.13 Tax treaties are agreements between states where the traditional aim has been to avoid double
7 Zimmermann (2012) para. 270.
8 TFEU.
9 COM(2018) 147 final.
10 Escribano (2018) p. 1.
11 OECD MTC (2017) Preamble to the Convention p. 27.
12 Vega (2011) p. 3.
13 OECD (2017a).
4
taxation.14 Despite this, states may have some objections towards the content; making reser- vations in their tax treaties if they find it necessary.15 Since discussing tax treaties is not the focus of this thesis, I will not elaborate further on such reservations and disagreements.
When understanding and interpreting the OECD MTC, the OECD Commentary is essential.
The OECD Commentary can give guidance to how the OECD MTC and tax treaties should be interpreted. The OECD Commentary’s weight compared to the Vienna Convention on the Law of Treaties (VCLT) Article 3116, containing rules for interpretation of treaties, has been subject for discussion.17 However, it is clear that the OECD Commentary has great bearing when interpreting and trying to understand the OECD MTC.18 Since the focus of this thesis is on OECD MTC and not tax treaties, I will not look closer into how the relationship between the VCLT’s rules and the OECD Commentary works.
1.4 Limitations
The OECD holds forward two ‘fundamental rules of the international income tax system’.19 Firstly, the nexus rule used to determine who has jurisdiction to tax a legal subject outside its resident state, which includes the PE concept. Secondly, profit allocation rules which decides what specific profits should be subject for taxation. Since profit allocation goes beyond the PE concept and scope of this thesis, it will not be explained more in detail.
There are different ways to determine that a PE exists. This can be done, for example, through a fixed place of business or a business agent; see the OECD MTC Article 5. Howev- er, this thesis is limited to explore the OECD MTC Article 5(1) that concerns ‘a fixed place of business’.
Consequently, the agent rule in the OECD MTC Article 5(5) will not elaborated on. Howev- er, this does not mean that it is irrelevant in relation to businesses having significant digital presence. Different types of digital agents can create a PE. A digital agent may create a PE when entering into contracts, for example, IBM’s Watson. Watson is a supercomputer that
14 Zimmer (2017) p. 61.
15 Vega (2011) p. 3.
16 VCLT.
17 See, for example, van der Bruggen (2003) p. 142, Zimmer (2017) p. 84, and Velásquez (2016) p. 960.
18 Zimmer (2017) p. 84.
19 OECD (2018a) p. 167–169.
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uses cognitive technology, which enables it to answer questions.20 Since Watson is a digital agent, it can be several places at once. Locating and determining where Watson’s value crea- tion is happening becomes extremely difficult. Thus, determining where the value creation should be taxed is almost impossible.
The other paragraphs in the OECD MTC Article 5 will not be explained in detail. However, some are mentioned briefly, where it is necessary to understand the context. In addition, Arti- cle 5 applies only to business profits; see the OECD MTC Article 7. Thus, no other types of income are discussed.
The European Commission presented an additional directive on ‘a digital services tax’ to- gether with the Proposed Directive. This is the ‘Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services’.21 It has the same aim as the Proposed Directive, which is to create rules that have the ability to tackle challenges caused by digitalisation.22 Consequently, points I make in this thesis could be highly relevant for both directives. The proposed directive on a digital services tax presents an interim solution, while the Proposed Directive is meant as a long- term solution.23 Because of the scope and the ability to go in depth, I limit this thesis to the Proposed Directive.
2 Digitalisation and the Traditional Permanent Establishment 2.1 Digital Economy
This chapter explains the current PE rules and introduces challenges with the digital econo- my. In addition, this chapter contains a brief explanation of what digital business models are and how they create digital presence. Thus, creating a better understanding of what the cur- rent rules might fail to cover and the Proposed Directive is meant to cover.
This chapter also presents a case about peer-to-peer ridesharing based on a digital business model, followed by applying the current PE rules on the case. The purpose with the case is to
20 Doyle-Lindrud (2015).
21 COM(2018) 148 final.
22 SWD(2018) 81 final pp. 22–23.
23 van der Jagt (2018).
6
illustrate how the digital business model creates challenges for current PE rules. The explana- tion of today’s PE rules is kept short, as the focus of this thesis is on the Proposed Directive.
‘Digital economy’ is a broad term. To make it easier to comprehend, it can be divided into three components:24
- The infrastructure of e-businesses is every construction used to support and ensure that businesses’ processes are carried out correctly and enables the conduct of elec- tronic commerce (e-commerce). Examples of such infrastructures are computers, hard disks, and software.
- E-commerce is the value of buying and selling goods and services online. E- commerce transactions involve two actors agreeing online to the sale or exchange of goods or services. Examples of e-commerce transactions are the sale of a book through Amazon or paying through PayPal.
- Electronic business is every process by profit or non-profit entities conducted online.
Examples of electronic business are logistics or communications through an intranet (i.e., ‘a network operating like the World Wide Web but having access restricted to a limited group of authorized users (such as employees of a company)’25).
These components are closely linked together. For the sake of taxation, all three components are relevant because they can all be a basis for value creation, which could give states the necessary interest to tax.
2.2 Current Rules on PE
States are recognised on an international level as having power to levy tax (tax sovereignty).
This right is normally based on nationality or territory.26 This could create problems with taxation of multinational enterprises (MNEs). States could claim a right to tax residents and their enterprises based on nationality. However, states could also argue that they have the right to tax every enterprise doing business on their territory. This would easily become a double-taxation situation. Double taxation is an ‘imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical pe-
24 Mesenbourg (2001) pp. 2–3.
25 Merriam-Webster (undated a).
26 Avi-Yonah (2015) p. 8.
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riods’.27 To avoid double taxation, the OECD has developed rules (i.e., the OECD MTC) to clarify who has the right to tax the individual MNE.28
The OECD MTC Article 7 is the main rule for taxation of business profits. According to this provision, MNEs are taxable only in states in which they reside. An exception to this is if an MNE has a PE in another state (i.e., source state29); see the OECD MTC Article 7(1). The PE can create a basis for taxation, according to the OECD MTC Article 5.
PE is defined in the OECD MTC Article 5(1) as ‘a fixed place of business through which the business of an enterprise is wholly or partly carried on’. The definition is used in almost all tax treaties and in Article 5 of the United Nation Model Double Taxation Convention be- tween Developed and Developing Countries30 (UN Model Convention).31 This creates a strong indication that the current PE rules are accepted on an international basis. From the wording of the provision, there are three cumulative conditions for having a PE.
1. There has to be ‘a place of business’. This has to be a physical property that the busi- ness has at its disposal.32 A space for a slot machine or a server used to operate a home page can suffice.33
2. The ‘place of business’ has to be a ‘fixed place’. This includes being in a geographical point and having some degree of permanency, normally more than six months.34 3. The actual business has to be ‘wholly or partly carried on’ through this fixed place of
business.
2.3 Challenges with the Digital Economy and Taxation 2.3.1 The BEPS Project
Digitalisation’s rapid advancement has caused drastic changes to the modern economy. Data processing costs have diminished because the use of digital platforms has increased greatly.35
27 OECD Commentary (2017) Introduction no. 1.
28 OECD MTC (2017) Preamble to the Convention p. 27.
29 Naas (2017) p. 66.
30 United Nations (2017)
31 Zimmer (2017) p. 196.
32 OECD Commentary (2017) to Article 5 no. 10.
33 Zimmer (2017) p. 197.
34 OECD Commentary (2017) to Article 5 no. 21 and no. 28.
35 OECD (2018a) p. 24.
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Consequently, businesses’ digital presence worldwide has grown immensely. Determining who has the right to tax has become even harder, partly because of the difficulty with deter- mining where, and sometimes with whom, value creation occurs.36 Since current tax frame- works mainly were developed at the beginning of the 20th century, a revision is long over- due.37
The digital economy cannot be separated from the rest of the economy.38 Thus, existing rules are pressured in trying to cover a part of the economy they were not made for. Member States of the OECD and the G20 seek to solve some of this problem through the BEPS Project, con- sisting of a 15-point Action Plan.39 Base erosion and profit shifting (BEPS) are cases in which MNEs use tax strategies ‘to shift profits away from the locations where the actual eco- nomic activity and value creation takes [sic] place, into low or no-tax locations’.40 This can be done through, for example, the use of digital business models.
The OECD declared that ‘no unique BEPS issues are presented by the digital economy’.41 Nevertheless, some aspects of the digital economy might intensify concerns related to BEPS issues. Such aspects were taken into consideration and worked into the Action Plan (e.g., transfer pricing in Actions 8–10). The OECD concluded that all actions taken in the BEPS Project ‘substantially address the BEPS issues exacerbated by the digital economy’.42 Moreo- ver, the OECD requested that states implement these measures immediately to prevent BEPS.
‘The BEPS Project produced a substantial renovation of the international tax rules, under- pinned by the principle that the location of taxable profits should be aligned with the location where economic activities and value creation take place’.43
However, the Action Plan is incapable of covering all tax challenges the digital economy has to offer.
36 OECD (2018a) p. 35.
37 SWD(2018) 81 final p. 8.
38 Saint-Amans (2016).
39 OECD (undated).
40 Saint-Amans (2016).
41 OECD (2015) p. 94.
42 OECD (2015) p. 94.
43 OECD (2018a) p. 167.
9 2.3.2 Broader Tax Challenges
Society benefits from digitalisation.44 Products and services are developed and used with less resources and information are easier to access, thereby making everyday problems easier to solve.45 Examples of this are food being ordered online and doctors consulting with patients by phone. Simultaneously, digitalisation’s fast development challenges policy makers to adapt current rules into the digital economy.46
The OECD mentions ‘broader tax challenges’ both in the BEPS Action 1 and their Interim Report.47 They raise questions about how well current tax rules are able to adapt to the fast pace in the digital economy. The current PE rules, for example, heavily rely on MNEs having physical presence when deciding who have taxation rights.48
The OECD divides these challenges into three broad categories.49 Firstly, nexus challenges relate to the advancements in digital technologies, which reduce the need for physical pres- ence. MNEs no longer must be physically in a place to conduct business, making it harder for current tax rules to determine whether businesses have a nexus to a jurisdiction.
Secondly, data challenges relate to the way information and communications technology (ICT) has simplified businesses’ ways of getting information. With digitalisation, the infor- mation flow has few limitations that enable MNEs to gather information on, for example, users across borders. Consequently, it is hard to know where to attribute the value each MNE gets from collecting and using such information. This raises questions about how potential value should be taxed; for example, can information collected be considered a free good?
Lastly, characterisation challenges relate to the difficulty with deciding what kind of pay- ments new business models receives. Can such payments, for example, be considered busi- ness profits or royalties?50 Business profits falls under the scope of the OECD MTC Article 7 while royalties fall under the scope of the OECD MTC Article 12. Consequently, how the income is characterised determines which rules apply.
44 OECD (2015) p. 98.
45 SWD(2018) 81 final p. 23.
46 OECD (2015) p. 98.
47 OECD (2015) p. 97 ff. and OECD (2018a) p. 165 ff.
48 OECD (2018a) p. 169.
49 OECD (2018a) p. 169.
50 OECD (2015) p. 106.
10 2.4 Digital Business Models
2.4.1 Creating Digital Presence
After the flourishing of ICT, business models changed and evolved into new digital business models suitable for the digital economy.51 Digital business models have platforms, which lets enterprises interact with users worldwide giving their business a much larger range. These digital business models create opportunities for MNEs to participate in markets across juris- dictions without being physically inside all of them. Thus, digital business models give MNEs the ability to have digital presence in several states. Examples of companies using digital business models include eBay, Google, and Amazon.52
In today’s rapidly evolving digital economy, new digital business models are constantly be- ing developed, and businesses can choose between large variations of structures.53 The vari- ous digital business models can be very distinct from each other, so MNEs can be structured extremely differently and often consist of several types of models concurrently.54 Amazon consists of, for example, Amazon Marketplace and Amazon e-commerce, which use different digital business models.
The OECD points out three characteristics of digital business models, helping to understand why current tax rules struggle to cover digital business models.55 In addition, the European Commission mentions a fourth characteristic.56 These characteristics indicate why current tax rules are struggling to tax businesses using digital business models. When businesses operate through digital platforms and, for example, users clicking on advertisements are the main creation of value, deciding the origin and amount of value created can become extremely difficult.
Digital business models give enterprises the ability to operate across jurisdiction without hav- ing physical presence, this characteristic is called ‘cross-jurisdictional scale without mass’.57
51 OECD (2015) p. 54.
52 Brousseau (2007) p. 82.
53 OECD (2015) p. 54.
54 OECD (2018a) p. 30.
55 OECD (2018a) pp. 24–25 and pp. 51–59.
56 SWD(2018) 81 final p. 14.
57 OECD (2018a) p. 51.
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Thus, MNEs can offer services to users spread across several states. The second characteristic entails digital business models relying greatly on investing in and using intangible assets, including intellectual property assets.58 Support from intangible assets (e.g., software and algorithms) is necessary to ensure operations of digital platforms. Consequently, intangible assets can largely affect produced value for MNEs using digital business models. In addition, the place where intangibles are managed can determine the location of taxation.59
The third characteristic is user participation; digital business models can collect and use data through their users’ activity.60 The more information gathered from each user, the better the data analysis; businesses can increase their profit by mapping what consumers want and cus- tomise content. Collecting and using data enables businesses to use analysed content to create strategies to develop products and target markets and consumers.61
User participation can be either active or passive.62 In active participation, users control what information they share, for example, by liking a picture or clicking on an advertisement. In passive participation collection occurs in the background, for example, when a web page col- lects information through cookies. Cookies are small files stored on computers when users visit web pages, sending information about their activity back to these web pages.63 In pas- sive participation, however, users are not completely inactive; for example, they must still take steps to access a web page.64
Value derived from users’ participating in digital business models is often called network effects.65 Network effects occur when users’ benefit from each other’s use of digital plat- forms. If Facebook, for example, has a single user, this person gets little in return from using it alone because Facebook is a social network. As the number of Facebook users increase, more possibilities to interact with others emerge. Thus, the value of using Facebook increases when the number of people increases.
58 OECD (2018a) p. 24.
59 OECD (2018a) p. 52.
60 OECD (2018a) p. 53.
61 OECD (2018a) p. 54.
62 OECD (2018a) p. 55.
63 Norton (undated).
64 OECD (2018a) p. 55.
65 Escribano (2018) p. 8.
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Opinions are mixed about user participation actually creating value for businesses.66 How much digital business models rely on user participation varies greatly amongst all types. So- cial networks are almost dependent on user participation for their platform to work, while vertically integrated firms (i.e., businesses owning both the supplying and selling side, e.g., Amazon e-commerce67) need little to no user participation, communicating with customers mainly on a buy-sell basis.68 Consequently, it seems user participation to some degree can create value. However, the exact amount of value created is hard to quantify, and varies from business to business.69
The European Commission mentions ‘superstar firms’ as a fourth characteristic in their im- pact assessment.70 Superstar firms are firms, such as Google, Amazon, and Apple, dominat- ing digital markets. Such dominance is typical in digital markets and makes it difficult for smaller firms to succeed. The OECD does not mention this as a characteristic of digital busi- ness models; instead, they mention it when describing digital markets.71
2.4.2 Examples of Digital Business Models
A digital business model common in today’s digital economy is multi-sided platforms. Ex- amples of multi-sided platforms are Uber, Airbnb, and Amazon Marketplace. These busi- nesses connect ‘end users’ (i.e., ‘the ultimate user of a finished product’72) from different groups, enabling them to trade information, goods, and services between each other. Such platforms facilitate communication, but do not produce anything themselves. Businesses ad- ministrating such platforms usually have no responsibility towards end users, the liability lies with suppliers.73
Airbnb, for example, is a business where groups of end users (i.e., renters) stimulate other groups (i.e., owners) to join in. If the demand for accommodation is higher than the supply, prices can be increased. The increased prices probably attract additional renters, leading to the demand being met. The number of owners might even surpass the number of renters,
66 OECD (2018a) p. 54.
67 OECD (2018a) p. 30.
68 OECD (2018a) p. 54.
69 OECD (2018a) p. 56.
70 SWD(2018) 81 final p. 14.
71 OECD (2018a) p. 27.
72 Merriam-Webster (undated b).
73 OECD (2018a) pp. 30–31.
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which again might lead to more people wanting to rent. One group benefits from the growth of the other group.
Another digital business model is that used by resellers. Examples of companies using this model are Spotify, eBay, and Amazon E-Commerce. Resellers are businesses not producing anything themselves. Thus, such businesses buy products from third parties for resale to end users. Resellers are liable to their customers, unlike companies using multi-sided platforms.
End users can interact with other end users in this model. Resellers are responsible for con- trolling prices and for acting as intermediaries.74
Spotify, for example, is a business that buys access to musicians’ products (music), and let people listen to it through their application. Users can choose between a paid subscription (Spotify Premium) and a free subscription.75 Spotify Premium has no limitations, while the free subscription entails advertising and restricted use, for example, with creating playlists.
Thus, Spotify earn money either through people paying to subscribe, or letting advertisers use their application. End users of Spotify can interact with other end users if they want to share playlists, etc. However, they can also hide their activity and not interact with others.
2.5 Peer-to-Peer Ridesharing Case76 2.5.1 Scenario
Uber is a real-life example of peer-to-peer ridesharing, using the digital business model mul- ti-sided platform. This way of constructing a business opens up for questions relating to taxa- tion, which the current PE rules have problems handling. In this subparagraph, a fictitious and simplified peer-to-peer ridesharing business is considered, to see what challenges might arise when applying the current PE rules. The problems and questions presented here do not cover all possible implications with the current rules.
74 OECD (2018a) pp. 30–31.
75 Spotify (undated).
76 Case idea and inspiration from Gjert Melsom; see Melsom (2016) pp. 4–16.
14
Figure 1.77
The aim with this case is to see if an app owner located in country A has a PE in country B. I will explain the case before I apply the current PE rules to examine if they create a PE for the app owner in country B.
Peer-to-peer ridesharing has three actors: the company that started the business (from now on app owner), a driver, and a passenger. The app owner has developed an application contain- ing that connects passengers and drivers. Through the application, passengers get an over- view of available drivers, manage their journey, and pay after the trip is completed. Addition- ally, drivers can manage which rides they want to accept and ensure their pay. The applica- tion has a rating system that both passengers and drivers can use, which creates an opportuni- ty to, for example, decline rides if the person’s rating is low.
The app owner is in charge of managing the application’s infrastructure, functioning, devel- opment, etc. Thus, the app owner ensures that contracts between drivers and passengers are
77 Inspiration from Melsom (2016) p. 4.
15
conducted correctly. The app owner is an intermediator, organising everything behind the scenes. Drivers are not considered professionals, this is why it is called peer-to-peer rideshar- ing. The idea behind this application is that everyone can be a driver when having some spare time.
In this scenario, the app owner is placed in country A, and the driver and the passenger are in country B. Both countries are inside the EU. The passenger does not communicate directly with the app owner when booking a ride. The app owner and the driver have a mediation con- tract where the app owner has certain requirements the driver must fulfil (e.g., a valid driver’s license, ownership of a safe car). In addition, the driver can guarantee his pay and get confir- mation of his right to use the application. The passenger and the driver communicate through the application, where their contract (car ride) is being entered into.
The transaction is done electronically, where the passenger pays through the application to the app owner. The app owner receives part of the payment for enabling the ride (i.e., the mediation fee), and the driver receives the rest. If something goes wrong with the car ride or the transaction, a server in country B, managed by a subsidiary, provides support. The app owner does not have access to this server. The peer-to-peer ridesharing has been operating with a server in country B for 12 months. The app owner has no physical presence in country B and operates only through the application, which means it has digital presence. Does the app owner have PE in country B?
2.5.2 Applying the Existing Rules
Several problems exist in relation to the current PE rules because, as previously mentioned, it relies on physical presence. The app owner does not own any cars, has no office, and are not entering into the contracts establishing rides. Simultaneously, the app owner receives pay- ment from the passenger. The app owner does not have physical presence, but does have great deal of digital presence. All provisions mentioned in this subparagraph are from the OECD MTC.
The rule being applied is Article 5 (1), the rule for ‘place of business’. The three conditions that must be fulfilled are a ‘place of business’, it must be a ‘fixed place’, and the business must be carried out ‘through’ the fixed place of business. For country B to have the right tax the app owner, there must be a PE inside their jurisdiction. Previously, the conditions were mentioned briefly, see paragraph 2.2; thus, this subparagraph elaborates on what has been said.
16
‘Place of business’. The OECD does not have a specific definition for ‘place of business’.
Article 5(2) contains a list of examples for possible places of business: ‘a place of manage- ment’, ‘a branch, an office’, etc. However, this list is not exhaustive, and these examples must be seen in connection with the other conditions in Article 5(1).78 Just having, for exam- ple, ‘a place of management’ does not constitute a PE.
The place of business must be physical property at the taxpayer’s disposal. Intellectual prop- erty assets, for example, a web page, is not counted as a place of business. However, a server where the web page is operated and stored can be regarded as a place of business.79
‘Fixed place’. This condition contains two criteria: geographical point and permanency. The geographical point entails the business being in one defined place.80 The geographical point must be seen as a whole together with the commercial part of the business to count as a fixed place.81 Concerning the permanency requirement, no lower limit is mentioned in the wording of Article 5(1).
Nevertheless, as guidance, the OECD has stated that presence under six months during a 12- month period is considered too short. There are exceptions to the six-month guideline. Recur- ring seasonal work can be seen as permanency (e.g., ski instructors). It also applies to busi- nesses having such a close connection to the source state that the permanency requirement is seen as fulfilled (e.g., the business cannot be performed any other place).82
Carried on ‘through’. The business has to be ‘carried out on a regular basis’ through the fixed place, small interferences in the operation of business are not seen as the business end- ing or the PE dissolving.83 However, if the business stops being active for a long period, it might be regarded as ended and not having a PE anymore. Staff present at a place of business is not necessary, for example, automated factories can suffice to fulfil the condition.84
Will the following activity in country B, by its own or seen as a whole, create a PE for the app owner?
78 OECD Commentary (2017) to Article 5 no. 45.
79 OECD Commentary (2017) to Article 5 no. 123.
80 OECD Commentary (2017) to Article 5 no. 21.
81 OECD Commentary (2017) to Article 5 no. 22.
82 OECD Commentary (2017) to Article 5 no. 28.
83 OECD Commentary (2017) to Article 5 no. 35.
84 OECD Commentary (2017) to Article 5 no. 41.
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- The app owner’s mediation contract with the driver in country B
- An application with a server placed in country B controlled by a subsidiary - Customers from country B
- Transactions of payments from customers in country B - Support being performed by the subsidiary in country B
Following the explanation about the conditions in Article 5(1), the information about the app owner having customers and transactions of payments from country B does not create a PE.
Neither customers nor such transactions can be counted as a place of business since they are not physical property. The question is then if the application on a server in country B creates a PE for the app owner.
The server is a fixed place, it has a geographical point, and it has been there for over six months. As mentioned above, a server can qualify as being a ‘place of business’. For this to happen, the app owner must have the server at its disposal. The OECD says that this assess- ment relies on the business ‘having the effective power to use that location’, ‘the extent of the presence of the enterprise’ and ‘the activities that it performs there’.85 In addition, if the serv- er is at the app owner’s disposal, the business has to be counted as being carried ‘through’ the server.
Furthermore, the OECD elaborates on enterprises having a place of business, saying that if an enterprise ‘does not use that location itself that location is clearly not at the disposal of the enterprise’.86 Consequently, being an enterprise without the effective power to use a location.
Since the app owner does not use the location of the server, it cannot perform any activities there. Thus, the location with the server is not at the app owner’s disposal.
The app owner’s subsidiary performs the support from the server’s location. According to Article 5(7), a company that ‘controls or is controlled’ by a company in another state is not considered a PE of that company, or the other way around. The OECD bases this on a subsid- iary usually being an ‘independent legal entity’.87 However, a subsidiary’s place of business could become a PE for the parent company under Article 5(1) if the place of business is at the parent company’s disposal or the conditions under Article 5(5) are fulfilled.88
85 OECD Commentary (2017) to Article 5 no. 12.
86 OECD Commentary (2017) to Article 5 no. 12.
87 OECD Commentary (2017) to Article 5 no. 115.
88 OECD Commentary (2017) to Article 5 no. 116.
18
As already concluded, the app owner does not have the location of the server at its disposal, so Article 5(1) does not apply. Article 5(5) is the agent rule, and falls outside the scope of this thesis. However, to create a PE under the agent rule it is necessary that the subsidiary ‘habit- ually concludes contracts’ or ‘plays the principal role leading to the conclusion of contracts’
on behalf of the parent company (i.e., the app owner). The subsidiary is in charge of the sup- port and has nothing to do with concluding contracts. Because of this, the subsidiary in coun- try B cannot create a PE for the app owner in country A. The same conclusion, regarding Article 5(5), goes for the mediation contract the app owner has with the driver. Contracts between the driver and the passenger is not concluded on behalf of the app owner. Thus, the agent rule would not have proposed a sufficient solution in this case.
Even though the application might be going ‘through’ the server, it cannot be seen as the app owner’s place of business. Because the app owner does not have physical presence in country B, it does not have a PE. This scenario illustrates how physical presence is essential for cur- rent PE rules.
3 Proposed Rules on Permanent Establishment
3.1 Challenges
Paragraph 2.3 is about tax challenges in the digital economy on a broad scale. This chapter looks at what other reasons the European Commission use to substantiate the Proposed Di- rective.
The European Commission highlights the importance of finding worldwide solutions. This takes time because the challenges on a global level are even more complex and wide-ranging.
The European Commission’s proposed solution could help further the discussion and give an example of what an international framework could look like. Consequently, the European Commission works closely with the OECD and tries to align their suggestion with the OECD’s views as much as possible.89
89 COM(2018) 146 final p. 5.
19 3.2 Premises for Creating New Rules 3.2.1 The EU Will Not Wait for the OECD
The development of the OECD MTC started in 1958.90 The OECD has since revised it eleven times.91 This history makes it natural to assume that the OECD would be the first one to cre- ate rules covering taxation of the digital economy. As previously mentioned, the OECD acknowledges the need for expanding and revising current rules. However, they have de- clared that they will not do so until 2020 at the earliest.92 Their reasons are elaborated on in paragraph 4.3. Consequently, the European Commission has taken matters into their own hands.
The European Commission carefully follows research and developments from the OECD.
Doing this by looking at information and solutions found by the OECD, trying to work it into their rules. The aim is to make rules that coincide with and fit into potential rules made by the OECD. The European Commission proposed rules might even contribute to the OECD’s work with creating international rules.93
In addition, The European Commission has concerns regarding implementation of possible amendments to the OECD MTC rules. As previously mentioned, the OECD MTC is not bind- ing. Even though the OECD MTC is used in most tax treaties, amending the rules to fit the digital economy does not create a guarantee that states want to incorporate such amendments into their tax treaties.94
The European Commission points out three risks specifically explaining why they cannot wait for the OECD to take action. The first risk is in relation to the EU market being as open as possible. Barriers emerge inside markets without rules that can prevent abuse and aggres- sive tax planning, for example, making it difficult for start-ups to participate. The EU aims at everyone being treated fairly by creating coherent rules. The second risk is the loss of compe- tition. The rules are outdated and vary between states, which creates uncertainty for business- es having to compete on different terms. The final risk is regarding a possible future common
90 Owens (2008).
91 OECD (2017b).
92 OECD (2018a) p. 19.
93 SWD(2018) 81 final p. 6.
94 SWD(2018) 81 final p. 27.
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framework. If states take different measures now, the merging and creating of a common framework gets complicated. These risks are elaborated on below.95
3.2.2 The Digital Single Market and Double Taxation
The European Commission has announced the digital single market as one of their top 10 priorities from 2015 to 2019.96 The digital single market refers to a market where barriers are eliminated, and everyone have access to the same digital opportunities (e.g., mobile net- works).97 An example of removing barriers is the removal of roaming costs inside the EU in 2017.98
The digital single market is viewed as a problem area in light of the outdated tax rules. Tax rules that cover the digital economy in a clear and understandable way is essential for the digital single market to function. Such rules should stimulate innovation and ensure fairness for all businesses, and simultaneously identify and prevent loopholes to stop opportunities for aggressive tax planning and abuse.99
The need for new rules is also substantiated with trying to avoid double taxation.100 As previ- ously mentioned, current PE rules rely heavily on physical presence. Tax treaties are based on these rules; consequently, such treaties are not fit to handle the growing digital economy.101 The heavy reliance on physical presence can lead to aggressive tax planning or more than one state taxing the same profit, creating unfairness from both states’ and MNEs’ perspectives.
The efforts put into avoiding double taxation on both national and international levels (i.e., through the OECD MTC and tax treaties) substantiate that there seems to be a common thought that taxpayers should not be taxed twice for the same profit.
3.2.3 Consequences of Outdated Tax Rules and Digitalisation
The outdated tax rules create problems relating to the location of value creation. Business can be conducted with almost no physical presence, creating a loss of revenue in places value is
95 SWD(2018) 81 final p. 7.
96 European Commission (undated a).
97 COM(2017) 547 final p. 2.
98 European Commission (undated b).
99 SWD(2018) 81 final p. 4.
100 SWD(2018) 81 final p. 9.
101 SWD(2018) 81 final p. 9.
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created. At a domestic level, this does not cause problems, since domestic laws cover all val- ue creation inside a state’s jurisdiction. However, on an international level the rules do not cover, for example, user participation across borders. This leads to value creation potentially falling between frameworks without being taxed anywhere.102
MNEs can avoid creating PEs in countries where they generate value in several ways, called
‘artificial avoidance of permanent establishment rules’.103 This can be done by using a sub- sidiary, an independent agent, or if their activity are categorised as one of the exemptions to PE mentioned in the OECD MTC Article 4, etc. In addition, MNEs relying on intangible as- sets can move such assets to jurisdictions with low taxation (i.e., tax havens).104 Intangible assets are hard to value, combined with continuous relocation; this can result in extensive tax planning opportunities. In a study, three out of seven identified tax-planning methods in- volved intellectual property assets.105
The EU wants to encourage and stimulate innovation.106 The outdated tax rules lack the abil- ity to stop aggressive tax planning, which create an uneven playing field and unfair competi- tion.107 Thus, innovation and growth of new businesses can stagnate. Digital businesses pay on average 9.5% in tax, whereas traditional businesses pay on average 23.2%.108 Traditional businesses do not have the same possibilities as digital business to move into low-tax juris- dictions; consequently, traditional businesses are taxed more than digital businesses. Howev- er, such distorted competition can also exists between digital businesses because of differ- ences in levels of tax planning.109
The superstar firms (e.g., Google and Amazon) mentioned previously can illustrate how competition between digital businesses can be uneven. These firms usually have more re- sources to investigate where the tax burden is lowest and can move around if necessary. With more resources, these superstar firms also have greater opportunities for developing new digi- tal solutions. Because of such ability, they oust companies with fewer resources that lack the same opportunity to do so. Not just other businesses in their home state, but also businesses
102 SWD(2018) 81 final p. 16.
103 SWD(2018) 81 final pp. 16–17.
104 SWD(2018) 81 final p. 17.
105 Ramboll Management Consulting (2015) pp. 7–8.
106 European Commission (2016).
107 SWD(2018) 81 final pp. 18–19.
108 SWD(2018) 81 final pp. 18.
109 SWD(2018) 81 final pp. 18.
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inside states these superstar firms operate remotely. Thus, such superstar firms make it im- mensely harder for open innovation and the growth of new businesses.
A research has estimated the loss of tax revenues to tax havens as approximately 40% of the profits on a multinational level in 2015.110 EU Member States want to draft national and uni- lateral rules directed at taxation of the digital economy to stop this loss of revenue.111 A wide variety of national and unilateral approaches can lead to double taxation, uneven starting po- sitions, and different possibilities presented to enterprises.112 Different approaches also create obstacles in the digital single market, which goes against the EU’s aim towards removing such obstacles. Some EU Member States have already finished making their own rules, put- ting further pressure on the EU to act.113
The European Commission stresses the fact that if all EU Member States take individual measures to ensure taxation, it will result in unfairness and legal uncertainty. Mutual rules are necessary, so everyone is taxed correctly and equally. Clear rules with this aim, based on the principle mentioned below, diminishes the possibility for avoiding taxation or being subject to double taxation.114
Taxing profits where value creation occurs is internationally agreed upon as an important principle. The principle is used as foundation for current international corporate tax rules, consequently, the current PE rules. However, the way it is solved in today’s frameworks is outdated, requiring businesses to have physical presence.115
Different sets of rules create uncertainty for actors wanting to participate in the economy. In addition, great variety of national regulations available can make it harder to merge into and agree on a global solution. The European Commission seeks to stop this by creating mutual rules so EU Member States have one set of rules to rely on. Challenges the digital economy brings are international, not specific to a Member State. Therefore, challenges caused by digi- talisation need a solution on an international level.116
110 Tørsløv (2018) p. 32.
111 SWD(2018) 81 final p. 28.
112 SWD(2018) 81 final p. 21.
113 SWD(2018) 81 final p. 21.
114 SWD(2018) 81 final p. 5.
115 SWD(2018) 81 final p. 9.
116 SWD(2018) 81 final pp. 20–21.
23 3.3 The Proposed Directive
3.3.1 Appeal for New Rules
The Proposed Directive is a measure made by the European Commission as an answer to calls from the European Council and the Economic and Financial Affairs Council (ECO- FIN).117 Both institutions have stressed the need for efficient tax rules that can cover the digi- tal economy in a fair way. Even the EU citizens are asking for a solution to provide fair and efficient taxation.118 Over half the respondents in a stakeholder consultation (i.e., EU Member States’ tax administrations, businesses, and citizens) agreed that the best solution would be a comprehensive solution addressing digital presence.119
In the same stakeholder consultation 82% of respondents answered yes to something needing to change about current tax rules.120 However, 41% preferred this to be a global solution. Re- garding a global solution the G20 requested and got the Interim Report from the OECD in March 2018, however, OECD has not yet presented a concrete solution.121
Therefore, the European Commission proposed a solution aimed at the challenges caused by digitalisation.122 One part of the solution is the Proposed Directive.123 It determines a taxable nexus for businesses relying on digital presence and what profits should be attributed where in the digital economy. The European Commission claims to have developed ‘a balanced and proportionate response’ to the tax challenges caused by digitalisation.124
3.3.2 Legal Basis and Objectives
The legal basis for the Proposed Directive is Article 115 of the TFEU. The provision gives authority to create legislation affecting ‘the establishment or functioning of the internal mar- ket’.
117 COM(2018) 146 final p. 1.
118 COM(2018) 146 final p. 3.
119 COM(2018) 147 final pp. 5–6.
120 SWD(2018) 81 final p. 88.
121 COM(2018) 147 final p. 1.
122 European Commission (2018).
123 COM(2018) 147 final p. 2.
124 COM(2018) 146 final p. 4.
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As mentioned above, the Proposed Directive was a part of the digital tax package presented by the European Commission. The package included general and specific objectives meant to be achieved through the two directives. Each directive has a specific objective, while the gen- eral objectives are shared. These objectives are:125
The general objectives are to protect EU Member States from aggressive tax planning and ascertain that their basis for national taxation is secured. The European Commission seeks to develop and maintain a functioning market with fair competition (e.g., the digital single mar- ket, see subparagraph 3.2.2). The directives are constructed to link together international tax rules by covering aspects of the digital economy that today’s rules fail to cover. When creat- ing these directives, the aim is to make rules that more efficiently can identify where and from whom the value creation generates.
The Proposed Directive’s specific objective is to make a framework that can ensure ‘fair and efficient taxation of the digital economy’.126 The European Commission focuses on the Pro- posed Directive being modernised to fit today’s digital economy. In addition, they want the Proposed Directive’s rules to be easily adaptable, to merge with potential future international rules. This is because a worldwide framework is desirable and provides the overall best solu- tion.
The Proposed Framework consists of 11 articles distributed in three chapters. Chapter one with the first three articles and chapter three with the six last articles, deals with more practi- cal and informative aspects (e.g., scope, definitions and transposition). The second chapter is the main and most important part of the Proposed Directive, containing rules for PE and prof- it allocation.
3.4 Implementation and Scope
To tackle tax challenges caused by digitalisation efficiently, the EU has to take measures that are binding for their Member States.127 Consequently, the proposed solutions were made into directives, not soft law (e.g., opinion, recommendation128). As previously mentioned, all EU Member States must achieve goals set out in directives. If the Proposed Directive is adopted
125 SWD(2018) 81 final pp. 22–23.
126 SWD(2018) 81 final p. 23.
127 COM(2018) 147 final p. 5.
128 EurWORK (2011).
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into the EU’s legal sources, it establishes a way to create a PE from digital presence.129 This will be the same throughout the entire EU, creating predictability and fairness.
The Proposed Directive Article 2 contains the directive’s scope. Article 2 begins as follows:
‘This Directive applies to entities irrespective of where they are resident for corporate tax purposes, whether in a Member State or in a third country’. When reading Article 2 together with Article 4(3), the Proposed Directive seeks to cover entities conducting business that
‘wholly or partly’ supply ‘digital services through a digital interface’ inside the jurisdiction of any Member State. Thus, being physically located in another EU state should not matter.
‘Entities’ refers to both a ‘legal person’ and a ‘legal arrangement’ carrying out business
‘through either a company or a structure’; see Article 3(7) in the Proposed Directive. This definition sets the Proposed Directive’s scope apart from current PE rules, which might also include individuals; see the OECD MTC Articles 3(1)(a), (c), and 4(1). However, this proba- bly does not mean much in practice, since individuals seldom are able to reach the high thresholds in the quantitative conditions (explained in paragraph 3.5.3).130
The Proposed Directive also seeks to cover entities from non-EU states, supplying digital services in EU Member States. Furthermore, Article 2 elaborates on this rule and says that the Proposed Directive does not apply in the case of there being ‘a convention for the avoidance of double taxation’ between states (i.e., tax treaties). Except if the convention has provisions similar to the rules laid down in the Proposed Directive ‘Articles 4 and 5 … and those provi- sions are in force’.
Consequently, the European Commission wants the Proposed Directive to cover all entities supplying digital services in any of their Member States, regardless of whether the entity re- sides in another EU Member state or non-EU state. Thus, the Proposed Directive has a broad scope. However, non-EU states have no responsibility to follow these rules in their jurisdic- tion. Because tax treaties with non-EU states normally bind EU Member States, this might open up for unwanted and strategic placing of assets into non-EU states having tax treaties that lack provisions similar to the Proposed Directive Articles 4 and 5.
The European Commission seeks to avoid aggressive tax planning and abuse by encouraging EU Member States to update their tax treaties to include the rules established in the Proposed
129 SWD(2018) 81 final p. 50.
130 Escribano (2018) p. 12.
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Directive.131 If not included, an enterprise from a non-EU state may have digital presence in an EU Member State but not a PE, whereas an enterprise from another EU Member State will have a PE in that EU Member State with the same digital presence.
Nevertheless, there are no guarantees that non-EU states agrees to implement rules in the Proposed Directive. The most likely scenario is that such states will disagree with these rules, since they are very different from and aim at covering something completely different from the rules most tax treaties are based on (i.e., OECD MTC).132 In addition, the Proposed Di- rective could possibly involve a huge imposition on the tax income acquired by these non-EU states, since rules covering digital presence will relocate value to jurisdictions where such value is created. This situation will be elaborated on in paragraph 4.5.
Another element of the solution the European Commission is presenting entails incorporating principles from the Proposed Directive into the Common Consolidated Corporate Tax Base (CCCTB).133 The CCCTB follows the same pattern as current PE rules, primarily using phys- ical presence as a basis for taxation.134 Thus, incorporating principles from the Proposed Di- rective into the CCCTB is necessary to present a sufficient way to solve challenges caused by digitalisation. The European Commission is ready to collaborate with Member States and the European Parliament on incorporating the Proposed Directive’s rules into the CCCTB.135 The European Commission plans to monitor and review this incorporation process in close col- laboration with Member States.
3.5 ‘Significant Digital Presence’
‘Significant digital presence’ is a digital activity threshold set to tax businesses mainly rely- ing on digital services to operate.136 The purpose in this thesis is to see if how the Proposed Directive Article 4 works as a solution for tackling the broader tax challenges, seeking to establish a way of measuring digital presence. Thus, containing the conditions for when busi- nesses’ have significant digital presence creating a taxable nexus – as a PE; see Article 4(1).
The European Commission is not trying to replace other PE rules, the aim is to operate side
131 COM(2018) 147 final p. 4.
132 Escribano (2018) p. 12.
133 COM(2018) 146 final p. 6.
134 SWD(2018) 81 final p. 25.
135 COM(2018) 147 final p. 4.
136 COM(2018) 147 final p. 2.
