Model Reforms on Taxation of the Digital Economy
· The ongoing debate over whether and to what extent public international law applies to corporate taxation by States is currently considering a novel facet: digital markets.
· With the advent of globalization and cross-border transactions, States have attempted to reform their tax rules to address challenges, such as double taxation, through over 3000 bilateral tax treaties. Some contend that, when combined with domestic laws, this treaty-based system constitutes an international tax regime, one which imposes not only bilateral treaty obligations but also established norms of customary international law. However, critics argue there is an absence of opinio juris on such matters, contending that the sovereign right to taxation is constrained only insofar as provided by treaty.
· Nonetheless, new challenges posed by digital markets have pressured reform within the treaty-based network. Interestingly, such reform is sought by both developed and developing States. On the one hand, developing States have expressed concern that under current tax treaties their jurisdictions are frequently prevented from taxing the profits of multinational enterprises when derived digitally from their markets. This is because existing agreements largely require the physical presence of enterprises within jurisdictions as prerequisites for exercising corporate tax. Yet such enterprises are typically domiciled in developed States and frequently do not require physical presence to derive revenue elsewhere online. On the other hand, developed States have expressed concern that multinational enterprises are exploiting gaps and discrepancies in existing tax rules by employing strategies, such as shifting profits to States with low or no tax rates, in order to avoid taxation.
· At the international level, these issues are being addressed by two independent initiatives, each aimed at reforming current models of tax agreements. The first is the Organization for Economic Cooperation and Development (OECD)’s Base Erosion and Profit Shifting (BEPS) program which is comprised of 135 States working to address loopholes and inequalities in their tax systems with the objectives of mitigating tax avoidance, improving regulatory coherence and reforming tax division rules in favor of less developed States. So far, the OECD initiative has produced the Multilateral Convention to Implement Tax Treaty Measures to Prevent Base Erosion and Profit Shifting (2018), adopted by 94 States, which modifies the application of State parties’ bilateral tax treaties to eliminate double taxation. More recently, the OECD initiative proposed the Unified Approach as a basis for upcoming negotiations on a multilateral convention which would reallocate certain taxing rights to market jurisdictions.
· The second initiative is that of the U.N. Committee of Experts on International Cooperation in Tax Matters, which has decided to work independently from the OECD on reforming its approach to taxation of the digitalized economy. So far, the Committee has tasked a subcommittee of experts (all from developing States) to draft an optional provision for addition to the U.N. Model Double Taxation Convention between Developed and Developing Countries (U.N. Model Convention) which would favor developing States. Alongside the OECD’s Model Tax Convention on Income and on Capital, the U.N. Model Convention is the most widely used model for bilateral tax treaties.
· In considering the OECD’s initiative at its twentieth session, the U.N. Committee expressed concern that the OECD’s Unified Approach may disadvantage developing States by making it exceedingly difficult to tax profits attributable to their markets and posing practical barriers for implementation of its complex rules. Writing in his personal capacity, Committee member Rajat Bansal proposed an alternative method which he contends would be both simpler to implement and ensure more definite tax revenue for developing States. Mr. Basnal proposed adding a provision to the U.N. Model Convention which would effectively expand developing States’ rights to tax multinational corporations in various situations.
· These dual initiatives are of immense significance to developing States given their potential to expand the scope of their sovereign rights to tax. Engaging in ongoing discussions at the OECD and the U.N. is critical for ensuring that developing States are able to influence development of these legal models in their favor. IILA can work with small and developing States to effectively participate in ongoing negotiations and ensure that they receive fair allocations of tax revenue from economic activity in their markets.