Pushing for tax fairness in a digital world

Every two days, a unicorn is created. I’m referring, of course, not to the mythical animal but to the hugely successful startup companies that are less than 10 years old but worth more than $1 billion. When the term was coined in 2013, only 39 companies fit the bill. Today, this list has grown to 452 members.

What many of these unicorns have in common is that they are built on innovative business models powered by e-commerce, the sharing economy and digital tech. Collecting data from users around the world is often at the crux of their business plans.

Such companies also tend to be physically located in tech hubs such as Silicon Valley, London, or Beijing, although their users – and the value they generate – are global.

These companies can bring real poverty-reducing benefits by improving access to all sorts of services, ranging from education to transportation to banking. But they also generate complicated questions, especially around taxation.

Consider, for example, Facebook, which is based in California and whose largest user base – 270 million users – is in India. Who should get the tax revenues resulting from those users’ data and activities? California? India? A third party that just happens to have low tax rates?

There are sound arguments to be made that India should be able to tax profits a distant corporate entity earns from the value created by Indian citizens.

The missed opportunity

Governments around the world are missing out on anywhere from $100 billion to $600 billion each year because of a form of legal tax avoidance, known as base erosion and profit-shifting (BEPS).

BEPS occurs in two ways: when companies use deductible payments, like interest and royalties, to reduce the amount of profits earned in a particular place; or when they move profits to low- or no-tax jurisdictions through in-house transactions.

BEPS is not unique to digital businesses, but the “unicorn boom” has brought this issue to the forefront. Social media companies, search engines, and online marketplaces all derive value and profits from user-generated content and data from individuals located around the world. Every time you – or another one of the billions of users around the world – publish a selfie, you are creating marketable data for a multinational company.

Yet, the countries where those users reside see little-to-no tax income from these operations.

Is this fair? From the perspective of developing countries, no. Today 70% of fragile and conflict-affected countries collect taxes that amount to less than 15% of national GDP. That’s barely enough for governments to carry out the most basic state functions.

This coincides with ever-increasing pressure to invest in achieving the UN's Sustainable Development Goals, while also keeping debt levels low. In this context, mobilizing domestic resources ­– such as those originating from corporate taxes – is a crucial component to the development equation.

The need for coordinated action

Many developed and developing economies agree that BEPS is not fair practice. As a result, a diverse and growing set of countries are beginning to take unilateral actions to address the tax challenges of digitalization.

New taxes are popping up on things like the sale of advertising and data (such as the revenue and user data that results from “free” use of a search engine or social network); the sale or access to digital content (such as online subscription services); the sale or resale of goods (such as online marketplaces); and multi-sided platforms (such as ride-sharing apps and short-term rental platforms).

It is understandable that economies want and need a solution to this tax quandary. But unilateral actions are problematic. They can result in double taxation. They can be used to weaponize taxes – penalizing companies from specific countries, for example, and risking retaliation in return.

Unilateral taxes could also be passed on from companies to consumers, generating unexpected consequences. We saw this earlier this year in Uganda, where millions of people quit using digital services altogether after the imposition of a digital tax.

Disjointed approaches could also drive tax competition ­– a race to the bottom in which no one wins – and greater uncertainty for businesses in an already difficult global economic environment.

Unilateral approaches would also leave unanswered foundational questions about digital taxes, such as: how exactly do we define a digital business? What value do we place on data? What share of profits are owed to a country where users are located?

A globally consistent approach is needed to solve these and other issues. The Organization for Economic Cooperation and Development (OECD) recently released their proposal for coordinating international tax standards, with the aim of coming to a global consensus by the first half of 2020.

We are happy to support the OECD and G20 in their efforts to reach consensus through the Inclusive Framework on Base Erosion and Profit Shifting, which brings together 134 countries and jurisdictions to negotiate new international tax rules for the 21st Century.

The BEPS Inclusive Framework has made significant progress on international tax cooperation, and we agree with the overall direction of the reform debate – that taxing rights need to be shifted away from tax havens and physical home bases to market jurisdictions.

But the proposal should go further in order for these reforms to be effective in developing countries. Specifically, tax reforms need to be enacted with resource-constrained administrations in mind. Rules need to be formulaic and mechanical rather than subjective, or open to interpretation.

Data on the global activities of multinational enterprises need to be more transparent so that developing countries can overcome information asymmetries. And, they need to be adaptable to cover business models that have not been invented yet. If history has taught us anything, it is that innovation will happen fast and we need to be ready.

International tax rules for multinational enterprises are at a turning point - and the surrounding debate provides an opportunity for solutions that benefit developing countries.