No new taxes or recommendations unique to the digital economy were suggested by the Organisation for Economic Co-operation and Development (OECD) but the door is still open for unilateral safeguard actions.

1. Getting to grips with
BEPS
Action 1
Actions 8-10: Aligning transfer pricing
outcomes with value creation
The OECD has recognised the importance of intangibles in
the digital economy. The OECD has emphasised that
entities will earn economic returns based on the value they
create through functions performed, assets used and risks
borne in the development, enhancement, maintenance,
protection and exploitation of intangibles; legal ownership
alone will not determine entitlement to reward.
The framework for analysing intangibles transactions
involves:
• identifying the intangibles used or transferred and the
economically significant risks
• identifying the full contractual arrangements with the
emphasis on legal ownership as a starting point
• identifying the parties performing functions, using assets
or managing risks
• reviewing the legal contracts against the actual conduct of
the group entities
• delineating the actual transaction and determining arm’s
length prices consistent with each parties’ contribution.
Where the actual conduct of the entities differs from the
contractual arrangements, conduct will prevail and the actual
transaction will be deduced from the facts.
Comparability adjustments or adoption of a transactional
profit split method are only required when the intangibles
used are unique and valuable in nature. Where reliable
comparables exist, it is often possible to determine arm’s
length prices on the basis of one sided methods.
Addressing the tax challenges
of the digital economy
The OECD recognised that while certain features of the
digital economy exacerbate BEPS risks, it "would be difficult, if
not impossible, to ring-fence the digital economy from the rest of the
economy for tax purposes". As a result, it is not surprising that the
recommendations in relation to the digital economy really just
draw on wider themes and recommendations from other
actions. These include:
Action 7: Preventing the artificial avoidance
of permanent establishment status
Action 7 recommends changes to the definition of a
permanent establishment (PE) to prevent the artificial
avoidance of PE status. The recommendations significantly
increase the likelihood that the activities of groups with
international operations (both large and small) will now
constitute a PE in another country where previously they did
not. This applies to both outbound and inbound groups in a
UK context.
Where sales activities meet the new definition of "habitually
concludes contracts, or habitually plays the principal role leading to the
conclusion of contracts that are routinely concluded without material
modification by the enterprise" then a PE will now exist. This is not
intended to apply to limited risk distributors.
The specific exemptions from PE status are now all subject to
the ‘preparatory or auxiliary’ test. An activity that has a
preparatory character is one that is carried on in
contemplation of an enterprise’s activity. An activity that has
an auxiliary character is one that supports an enterprise’s
activity, without being a main part of it.
The OECD provided an example of what it sees as artificial
arrangements within the digital economy. The example was of
an online seller of tangible products or an online provider of
advertising services using the sales force of a local subsidiary
to negotiate and effectively conclude sales with prospective
clients.
.
No new taxes or recommendations unique to the digital economy were suggested by
the Organisation for Economic Co-operation and Development (OECD) but the
door is still open for unilateral safeguard actions.

2. Action 1: Addressing the tax challenges of the digital economy
Action 3: Designing effective controlled
foreign company rules
The OECD recognises that in designing CFC rules,
consideration should be given to rules that target income
typically earned in the digital economy which are at present
typically not subject to taxation, such as income from the
remote sale of digital goods and services.
The final recommendations focus on six key 'building blocks'
that the OECD considers are necessary for domestic CFC
legislation to be effective:
• Definition of a CFC
• CFC exemptions and threshold requirements
• Definition of CFC income
• Rules for computing income
• Rules for attributing income
• Rules to prevent or eliminate double taxation
VAT/GST
The OECD commented on the importance of levying
VAT/GST on cross-border transactions and recommends
applying the principles of the previously issued international
VAT/GST guidelines on levying indirect tax on the
destination principle. The OECD recognises that there is a
need for countries to consider the introduction of collection
mechanisms, including the reverse charge, to ensure that
there is a level playing field and that paying VAT/GST
cannot be avoided by exempt businesses who procure
services from overseas.
Door open for a unilateral approach?
The report also considers some of the broader tax challenges
of the digital economy including nexus, data and
characterisation of revenue streams. Worryingly, while the
OECD has veered away from recommending economic
nexus (ie having nexus simply as a result of a threshold of
revenue generated from a territory) or withholding tax, it has
stated that countries could still introduce these unilaterally in
domestic legislation as additional safeguards against BEPS,
provided that they still respect existing treaty obligations, or
in their bilateral tax treaties.
Key dates
See individual actions for detail on the timetable of
implementing key recommendations. It is expected that the
development of a multilateral instrument will be concluded
by the end of 2016. The OECD has said that it will review
new granular tax data from country-by-country reporting and
VAT returns to ascertain if additional multilateral action is
needed in relation to the digital economy (although this is
unlikely to be before 2020).
What next?
We recommend a comprehensive review of your systems to
ensure they are aligned with all the relevant BEPS actions
and they provide sufficient visibility and transparency over
your tax and transactional data.
We can provide advice on the growing trend of specific
VAT/GST legislation designed to force non-resident
suppliers of digital services to register and charge local
VAT/GST on sales. We can help you implement scalable
solutions to meet the challenges around tax determination
and reporting.
Contact
Alex Baulf
Indirect Tax Associate Director
+44 (0)20 7728 2863
alex.baulf@uk.gt.com
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