Digital taxation moved to the forefront this week with recent releases on the subject by both the Organisation for Economic Co-operation and Development (OECD) and the European Union (EU), and the United States (US) Government taking a strong position against the imposition of taxes targeting the digital economy. In a recent statement, US Treasury Secretary Steven Mnuchin said, "The US firmly opposes proposals by any country to single out digital companies." Another senior Treasury official this week echoed the sentiment, saying the US opposes a "ring-fencing" approach whereby digital business models would be treated differently than other companies.

On 21 March, the European Commission unveiled a two-phased approach to the taxation of digital activities in the EU: an interim solution called the Digital Services Tax (DST), and a longer term Council Directive laying down rules relating to the corporate taxation of a significant digital presence. The DST is a gross revenues (i.e., turnover) tax, set at a uniform rate of 3% across all EU Member States, while the Common Reform solution focuses on a new concept of digital permanent establishment (PE), along with revised profit attribution rules. The proposed reform of the corporate tax rules is meant to ensure profits are registered and taxed where businesses have significant interaction with users through digital channels.

The proposed reform of corporate tax rules would enable Member States to tax profits that are generated in their territory, even if a company does not have a physical presence in that location. The proposal for a directive on the matter sets criteria for a digital platform to be deemed to have a taxable "digital presence" or a virtual PE in an EU Member State.

The proposals will be submitted to the European Council for adoption and to the European Parliament for consultation. The Commission hopes that final adoption will occur by 31 December 2019, for 1 January 2020 transposition into national law. The timing of the DST is less certain, with proposed adoption dates set out in brackets, indicating that consensus among EU Member States has not yet been reached on timing. In a joint statement issued on 21 March, the Ministries of Finance of France, Germany, Italy, Spain and the United Kingdom (G5) indicated their support for the proposed EC digital measures.¹

The EU action follows the release of the OECD's Interim Report on the taxation of the digital economy on 16 March.² The OECD report, Tax Challenges Arising from Digitalisation – Interim Report 2018, is a follow-up to work delivered by the OECD in October 2015 under Base Erosion and Profit Shifting (BEPS) Action 1.³ The Interim Report provides an in-depth analysis of the main features commonly found in certain highly-digitalized business models and value creation in the digitalized age. It does not make any specific recommendations to countries, however. The report is explicit that "there are divergent views on how the issue should be approached" and that "there is no consensus [among countries] on the need for, or merits of, interim measures, with a number of countries opposed to such measures."

The G-20 published a communique on 20 March at the end of a G-20 finance ministers and central finance governors' meeting, saying they welcomed the OECD interim digital report and were committed to seeking a consensus-based solution by 2020.

Indirectly commenting on the recent digital proposals, a senior US Treasury official said the US is open to discussing how the international tax system should adapt to the modern global economy, but the discussion should not single out the digital economy. The official made the argument that recent US tax reform has addressed "many of the concerns that existed about digital business models" in that profits are taxed somewhere. He pointed to the new global intangible low-taxed income (GILTI) rules which ensure that offshore earnings of US multinationals are subject to tax.

A Treasury official this week said the Government will release guidance on consolidated groups in the context of tax reform's new Internal Revenue Code⁴ Sections 965 and 163(j) in the first week of April. The official was quoted as saying the Section 965 guidance would be "definitional and computational" but also include anti-abuse measures. He indicated that this first guidance on new Section 163(j) would be "low-hanging fruit, to some degree confirming the obvious."

The official added that guidance on the Tax Cuts and Jobs Act's GILTI regime will not be released for another six months. Treasury reportedly is conferring with Congress to determine Congressional intent in regard to the allocation of expenses to GILTI.

A senior Internal Revenue Service (IRS) official this week provided further details, saying GILTI has thrown a wrench into the US foreign tax credit rules, requiring a thorough review of how to mesh the new provision with the existing US foreign tax credit regime. She confirmed that a regulation package is planned for release later this year addressing the issues. One of the topics reportedly under review is how to allocate and apportion expenses among the new GILTI basket and the existing baskets. The official was also quoted as saying the IRS is examining the difficult question of transitional rules for retaining foreign tax credit carryovers and their possible allocation to the GILTI basket.

The OECD on 22 March also released a new report, Additional Guidance on the Attribution of Profits to Permanent Establishments (BEPS Action 7). This latest report sets out high-level general principles for attributing profits to PEs in accordance with tax treaty provisions. It also includes examples of the attribution of profits to certain types of PEs resulting from changes to the PE definition under BEPS Action 7.

And the OECD Multilateral Instrument (MLI) will enter into force on 1 July 2018. The OECD announced that Slovenia on 22 March became the fifth jurisdiction to deposit their instruments of ratification to the MLI. At least five jurisdictions were required to deposit their ratification instruments in order to bring the MLI into force.

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ENDNOTES

¹ See EY Global Tax Alert, European Commission issues proposals for taxation of digitalized activity, dated 21 March 2018.

² See EY Global Tax Alert, OECD releases interim report on the tax challenges arising from digitalization, dated 16 March 2018.

³ See EY Global Tax Alert, OECD issues final report on the tax challenges of the digital economy under Action 1, dated 23 October 2015.

⁴ All "Section" references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.

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CONTACTS

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services, Washington, DC

• Arlene Fitzpatrick
  arlene.fitzpatrick@ey.com
• Joshua Ruland
  joshua.ruland@ey.com

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