2nd Runner Up: Mazars Tax Essay Challenge by Benjamin Tay

1. Introduction 

Base erosion and profit shifting (“BEPS”) refers to tax planning strategies, usually carried out by multinational enterprises (“MNEs”), that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. Though certain specific strategies might fall afoul of the law, the Organization for Economic Cooperation and Development (“OECD”) has noted that most strategies are not illegal.

BEPS concerns are raised in scenarios where taxable income can be artificially ring-fenced from the activities that generate it. In the case of value-added tax, BEPS concerns are raised by situations in which an inappropriately low amount of tax is collected on remote digital supplies to exempt businesses or multi-location enterprises that are engaged in exempt activities.

If left unchecked, BEPS threatens to undermine the integrity of tax systems. The rapidly developing digital economy has formed lacunae in tax codes. This essay explores the features of the digital economy that exacerbate BEPS risks and analyses how the BEPS Project mitigates such risks.

2. The Digital Economy

The digital economy has developed at a fast pace in recent years, largely the result of advances in digital computing technologies such as the increase in broadband connectivity worldwide.

The Boston Consulting Group suggested that the disruption of the consumer goods and retail industry has shifted to the “fourth wave”. Several trends were identified, for example, the types of consumer goods that were traditionally the purview of brick-and-mortar shops, such as dry groceries and other inexpensive fast-moving consumer goods, are expected to move to online incarnations.

The digital economy is increasingly intertwined with the traditional economy, and a clear delineation between the two will continue to get harder. As a result, any attempt to segregate the digital economy from the traditional economy for tax purposes is likely to prove inordinately difficult.

3. Opportunities for BEPS in the Digital Economy

3.1 Avoiding A Taxable Presence In Electronic Commerce (“E-Commerce”)

E-commerce is “the sale or purchase of goods or services, conducted over computer networks by methods specifically designed for the purpose of receiving or placing of orders”. According to Frost and Sullivan, the business-to-business online retail market is expected to generate total revenues of US$6.7 trillion by 2020. Business-to-consumer sales are estimated by eMarketer to reach US$2.356 trillion by 2018.

Many digital economy business models allow a non-resident company to remotely access customers without maintaining a physical presence in the country. Most countries have domestic tax laws that require a certain degree of physical presence before subjecting corporate profits to taxation. In the OECD Model Tax Convention, for example, a company is subject to tax in a country where it is nonresident only if it has a permanent establishment (“PE”) in that country. As a result, the non-resident company may not be subject to tax in the country of its customers.

The digital economy has greatly expanded the scale to which companies may earn revenue from customers in countries where the company is non-resident. International research by PayPal and Ipsos found that more than two-thirds of online shoppers in Singapore purchase from online retailers in other countries.

3.2 Large Scale Supply Of Low Value Imports And Supply Of Digital Services By Foreign Supplier

Many tax jurisdictions offer low value import value-added tax (“VAT”) reliefs with the primary consideration that the costs of collecting the VAT on such low value goods would likely be incommensurately higher than the potential VAT collected. In Singapore, the de minimis threshold for goods and services tax (“GST”) on imported goods is S$400 in cost, insurance and freight value. 

The assumption behind the relief was that the level of imports that fall under the ambit of the relief was relatively small. However, as the digital economy continues the grow, these reliefs create increasing pressure on tax revenues and unfairly benefit the foreign retailers whilst exerting competitive prejudice on domestic retailers which are obligated to charge VAT to the consumer.

With regard to services, whether GST is chargeable in Singapore depends on the belonging status of the supplier. Where a provider of service belongs in Singapore, GST is chargeable. However, under the current applicable rules in Singapore, where the supplier belongs outside of Singapore, the supply of services made in Singapore is not chargeable. This scenario reflects the inadequacy of the rules, such that even though the services are consumed in Singapore, the rules do not contemplate where the consumption of services do not take place in the same place where the supplier belongs.

The BEPS Project has proposed reform based on four broad models: the Traditional Collection model, the Purchaser Collection model, the Vendor Collection model, and the Intermediary Collection model. However, it has abstained from prescribing one model in particular. 

3.3 Heavy Reliance On Intangibles As A Source Of Value

As a result of the digital economy, business functions have grown increasingly mobile. The taxpayer is more able to locate business functions in a particular jurisdiction for tax reasons. Furthermore, companies may be encouraged to assign or transfer the rights in tangibles to an affiliate in a jurisdiction where the associated income from the intangibles is subject to a lower tax rate.

The problem is exacerbated where the residence country of the ultimate parent company in the group exempts foreign-sourced income or does not have a controlled foreign company (“CFC”) regime that taxes income earned by foreign subsidiaries of the parent.

3.4 Access To Data By Tax Authorities May Be Limited

One reason may be that virtual currencies have proliferated in recent years, and raise substantial policy issues that mainly stem from the anonymous nature of transactions. The touted benefit of Bitcoin, which is the virtual currency with the largest market capitalisation, is the anonymity that arises from the difficulty in linking individuals to their Bitcoin transactions. This may make it more difficult for tax authorities to monitor BEPS.

4. General Measures Developed Across The Beps Project To Mitigate Beps Risks

4.1 Expansion Of The Definition Of 'Permanent Establishment' In The Context Of Intensifying Digitalisation

In response to the situation of intensifying digitalisation as outlined above, Action 7 of the BEPS Action Plan is particularly relevant. The subject matter of Action 7 is the prevention of the artificial avoidance of PE status.

The BEPS Project considered whether certain activities that had been previously considered “preparatory or auxiliary” might take on increased significance for business in the digital economy. This end heralded the modification of the list of exceptions to the definition of PE in Article 5(4) of the OECD Model Tax Convention. The effect of this is to ensure that each of the exceptions included therein is restricted to activities of a “preparatory or auxiliary” character, and to introduce a new
antifragmentation rule to ensure that it is not possible to exploit the exceptions by fragmenting business activities between closely related enterprises. For example, under the new standard, where an online seller maintains a large local warehouse that is staffed by a significant number of employees that store and deliver goods sold online by the seller to customers, that would constitute a permanent establishment for that seller under the new standard.

The BEPS Project also modified the definition of PE to address artificial arrangements relating to the sales of goods or services of one company in a multinational group where, in substance, the sales should be treated as if they had been made by that company. For example, where an online seller maintains a local subsidiary where the sales force habitually pursues the conclusion of contracts with prospective large clients for those products or services, and these contracts are routinely concluded without material modification by the parent company, this activity would result in a permanent establishment for the parent company.

4.2 Revision Of Transfer Pricing Guidance

After the revision of the transfer pricing guidance, legal ownership alone clearly does not necessarily generate a right to all of the profit generated by the exploitation of intangibles. Instead, the companies within the group that perform the important functions and carry economic significance in

terms of assets and risks, as determined through assessing the substance of the actual transaction, will be entitled to an appropriate return. There will also be guidance to ensure that the transfer pricing analysis is not undermined by the presence of information asymmetries between the tax administration and the taxpayer through the usage of special contractual relationships, such as a cost contribution arrangement.

4.3 Effective CFC Design

The BEP Project made recommendations that the ideal design of effective CFC should include definitions of CFC income that would subject income that is typically earned in the digital economy to taxation in the jurisdiction of the ultimate parent company.

4.4 Possibility Of Virtual PE 

The concept of an electronic or virtual PE seeks to justify source taxation of an enterprise in a jurisdiction where it has a sufficiently significant and on-going economic presence, but little or no physical presence.

The Spanish Court introduced the “online permanent establishment” concept in 2012, which was consistent with Spain’s position on software-driven PE. The Court ruled that an online store could qualify as an online PE, even though the server was not situated in Spain and no economic activity was performed through human means or assets located in Spain.

One approach to the virtual PE concept is the On-site Business Presence PE, which considers a new threshold for source taxation that is independent of the existence of a fixed place of business at the disposal of the enterprise as well as the traditional conception which considers whether business activity takes place within a jurisdiction. In contrast, the approach considers whether the foreign enterprise provides remote on-site services, such as professional, management and technical
expertise, at the customer’s location.

Since the approach seeks to allow source taxation when the foreign enterprise makes use of the domestic country’s infrastructure to generate profits, the approach would be in line with the approach to the supply-based view, which considers where profits originate. From the approach to the supply-based view that considers whether the enterprise carries on business activities within the territory, the On-site Business Presence PE is arguably still consistent with the conceptual base for sharing the tax base.

5. Conclusion

In light of the digital economy, reinforcing public trust in the integrity of the tax system has become a greater challenge. The business models in the rapidly growing digital economy has given rise to new BEPS risks that tax authorities must pay heed to. The BEPS Project has developed large swathes of measures across the board, but more must be done in an attempt to mitigate the ever-developing BEPS risks.

List Of References

_{1. BCG Perspectives, Digital’s Disruption of Consumer Goods and Retail. Retrieved 2 November 2017, from https://www.bcgperspectives.com/content/articles/retail_consumer_products_digitals_disruption/}

_{2. Dentons Rodyk (31 March 2017), Taxing the Digital Economy: Impending changes to GST in Singapore. Retrieved 2 November 2017, from https://dentons.rodyk.com/en/insights/alerts/2017/march/31/taxing-the-digital-economyimpending-changes-to-gst-in-singapore/}

_{3. eMarketer (22 August 2016), Worldwide Retail Ecommerce Sales Will Reach $1.915 Trillion This Year. Retrieved 2 November 2017, from https://www.emarketer.com/Article/Worldwide-Retail-Ecommerce-Sales-Will-Reach-1915-Trillion-This-Year/1014369}

_{4. Frost and Sullivan (9 April 2015), The Global B2B E-commerce Market Will Reach 6.7 Trillion USD by 2020, Finds Frost & Sullivan. Retrieved 2 November 2017, from https://ww2.frost.com/news/press-releases/global-b2b-e-commerce-market-will-reach-67-trillion-usd-2020-finds-frost-sullivan/}

_{5. Gabey Goh, Cross-border e-commerce surges; China and Singapore lead. Retrieved 2 November 2017, from http://www.campaignasia.com/article/cross-border-e-commercesurges-china-and-singapore-lead/405216}

_{6. Muhammad Rifky Santoso (2017), Virtual Permanent Establishment For Digital Economy, Economy & Business Journal, International Scientific Publications, Bulgaria, vol. 11(1), pages 268-280 <https://ideas.repec.org/a/isp/journl/v11y2017i1p268-280.html>}

_{7. OECD (2013), Addressing Base Erosion and Profit Shifting, OECD Publishing, Paris. http://dx.doi.org/10.1787/9789264192744-en}

_{8. OECD (2015), Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, OECD Publishing, Paris. http://dx.doi.org/10.1787/9789264241046-en}

_{9. OECD (2015), OECD Digital Economy Outlook 2015, OECD Publishing, Paris. http://dx.doi.org/10.1787/9789264232440-en}

_{10. PWC, Permanent Establishments 2.0. Retrieved 2 November 2017, from https://www.pwc.com/gx/en/tax/publications/assets/pwc-permanent-establishments-atthe-heart-of-the-matter-final.pdf}