ECOFIN to Consider Virtual PE Rules to Tax Digital MNEs

September 2017

Multinational technology giants like Google, Amazon, Apple, Microsoft and Facebook could face higher tax bills under EU plans to introduce virtual permanent establishment rules. However, such rules could be difficult for governments to administer.

At the informal EU Economic and Financial Affairs Council (ECOFIN) meeting, which will take place in Tallinn, Estonia, on September 15 and 16, finance ministers will discuss how to address the challenges posed in taxing digital businesses. A key concern to be resolved includes how to ensure companies pay tax in the jurisdiction where value is created.

The issue has become highly topical among EU countries in recent months after the French tax authorities lost a six-year tax dispute with Google over the company’s permanent establishment (PE) status in the country. France is now appealing the Paris administrative court decision, but the case has spurred French Finance Minister Bruno Le Maire to find a way to make large digital companies pay their fair share of tax. Backed by Germany, Spain, and Italy, Le Maire is taking his proposals to the ECOFIN meeting. In a political statement, the finance ministers of the four countries will express their support for a common consolidated corporate tax base and the G20/OECD efforts, but they will also propose charging an equalisation tax on the turnover generated in Europe by digital companies. "The amounts raised would aim to reflect some of what these companies should be paying in terms of corporate tax," the statement said.

During the second day of the ECOFIN meeting, ministers will discuss these proposals, as well as share their views on the other existing issues, the limits of possible "quick fixes" and consider how the EU can work towards finding a resolution and push for a more comprehensive reform of international tax rules at the OECD level.

A Presidency Issues Note said the ministers will consider, among other things, the potential for modifying the concept of a permanent establishment (PE) and enhancing the rules so that profits are attributed according to the value created by the PE. "Under this approach, even without physical presence, a business with significant digital presence would be deemed to have a (virtual) permanent establishment in a jurisdiction of operation and therefore be liable to its corporate tax regulations, including adapted attribution of profit rules," the document stated.

The creation of virtual PE rules could bridge the gap between the old rules and the new business structures. Austrian Finance Minister Hans Jörg Schelling supports the creation of virtual PE rules and plans to develop detailed recommendations for such virtual PEs and present them at the EU level and to the OECD. "Austria has firmly decided it wants to be an international pioneer in this area and will therefore continue to promote these plans also on the European level and during its EU presidency," a spokesperson for the Austrian Ministry of Finance told International Tax Review.

However, the spokesperson said Austria’s plan will be different to the proposals that will be presented by France, Germany, Spain and Italy, although the Schelling is in contact with them.

"Part of this initiative is to provide a transitional solution until there is an agreement on the implementation of a virtual permanent establishment," the Austrian spokesperson said.

Virtual PE rules may not close loopholes

Stefan Bendlinger, partner at ICON Wirtschaftstreuhand Linz and a member of WTS Global in Austria, told International Tax Review that the introduction of a virtual PE is just one side of the coin and the attribution of profits it not as straightforward as ministers suggest.

This is because "the decisive question is what portion of income could be attributed to a virtual PE," Bendlinger said. "Under the current OECD concept, a PE’s profit is to be determined according to 'significant people functions’," as defined by the OECD’s definition, suggesting that digital companies may continue to be outside the remit of the definition. "If no such functions exist, only low or even no profit could be attributed to a virtual PE," he said.

According to the OECD’s definition of a PE, the concept of a "significant people function" is relevant to the assumption of risk and to the economic ownership of assets, but it notes that this will vary for different business sectors. "A virtual PE by definition does not carry out 'significant people functions’ which currently is the OECD dogma for the attribution of profits to a PE and no profit at all could be attributed to such a virtual PE," Bendlinger said.

At the OECD level, the determination of profits of each virtual PE could also result in compliance difficulties for enterprises and tax authorities alike, according to a previous report. Complexities arise on "whether the arm’s length principle is capable of application where profits must be attributed, not by reference to functions performed by people and assets used by the enterprise at a fixed geographical point in the country, but by reference to economic activity generated by the interaction between customers of that country and a website of that enterprise," the report said.

Nevertheless, the OECD’s BEPS project aims to address the current PE definition in order to take the digital economy and borderless businesses into account. However, although BEPS Action 1 addresses the tax challenges of the digital economy and Action 7 deals with the prevention of the artificial avoidance of a PE status, the issue will most likely boil down to having a physical presence in a country.

In addition, Michael Graf, tax partner at Dentons in Frankfurt, told International Tax Review that the complexities of virtual PEs will arise on the methodology of taxation. "If companies from the digital economy sell via the internet, then it is difficult to find out where the person resides. Additionally, the place where the customer uses the software doesn’t define the customer’s residency," said Graf.

Long road ahead for EU ministers

Although EU ministers will air their views on how to tackle the taxation of digital businesses and amend the PE definitions this week, introducing changes will not be simple.

Estonia, which holds the six-month rotating EU Council presidency, plans to agree a common position on the preferred way forward on resolving these tax issues at the December ECOFIN meeting, after which it will give its input to the OECD. Discussions will then need to take place at the OECD level.

However, Maarten de Wilde, associate professor at the tax law department at Erasmus University Rotterdam, believes "there is not enough political willingness to establish real change in corporate taxation".

Belinger added that on an EU level, a lot of analysis will be necessary, taking existing tax treaties into account. "A redefinition of what constitutes a PE by way of an EU guideline would require a very detailed analysis of the multi-models evolving in the digital economy and a clear definition of the relevant factors for establishing a virtual PE. Besides that the EU must consider that almost all EU member states have concluded tax treaties which cannot be overruled by EU law as long as such tax treaties do not cover virtual PEs," Bendlinger said.

The concept of virtual PEs remains unclear and it is uncertain whether this will meet government objectives to ensure companies pay tax in the jurisdiction where value is created. Global initiatives, such as the OECD’s BEPS project, tries to address the complexities of introducing virtual PEs rules, but the question now is whether better cooperation is required among countries to bring the changes to tackle the PE issue at the OECD level, or whether it is more efficient to decide this at a regional, or even domestic, level.

The above article was published on on 13 September 2017 and has been republished with the approval of the Publisher.