Introduction
The modern economy is becoming increasingly globalized, in large part due to its growing digitalization. More and more companies are offering their services via online portals, with a considerable portion operating exclusively via the Internet without any physical location. As such, serving customers throughout the world becomes more of a matter of finding an appropriate delivery method instead of expanding the business and opening foreign branches.
The change is convenient for companies and customers alike, as they gain access to a broad base of products or potential buyers without expending the time and effort to go elsewhere and search. However, it presents issues for governments, which currently struggle to adapt to the new model, particularly with regards to taxation. This essay discusses the foremost issues related to the process when applied to digital platforms as well as potential solutions.
Double Taxation
Traditionally, a company that expanded into another country would open a separate branch office, which would process operations and pay taxes locally. However, doing so is no longer necessary in many cases, and so the situation where a company sells a product to someone in a different nation has become commonplace. However, both countries will require a portion of the profits as per their taxation law.
As such, the company has to pay fees twice, which results in a significant economic burden, increased prices to compensate for the loss and a general slowing of business growth. The phenomenon is known as double taxation and is generally considered an unintended consequence of outdated legislation. As such, nations throughout the world have begun taking measures to accommodate businesses by eliminating the tendency via a variety of options.
Generally, different nations will sign conventions that regulate double taxation rules between them by defining which one has exclusive taxation rights or priority. For example, according to Peng, China had signed 99 such agreements with other countries by 2015 (350). However, an issue arises when the interest of both countries are taken into account, as each party will generally want to collect taxes from international business exclusively.
On the one hand, the customer’s nation is opposed to the movement of money beyond its borders without any return investment, as a foreign entity with no local holdings appropriates the money. On the other, the company’s country hosts potentially massive global entities and expects to collect considerable tax revenue from them, which it cannot do if they pay their taxes elsewhere. Nevertheless, different nations eventually settle on agreements that create a compromise between the two sides, partially resolving the issue.
The approach has not been perfect, even before the introduction of digital companies and sales. Devereux and Vella describe issues such as the need to define and police the border between the two countries as well as the necessary awareness of different income types (4). When the varying laws between different countries and the nature of a company that may have assets in dozens of different nations at once are taken into account, the system becomes extremely complicated.
As such, it becomes challenging for the model to adapt to changes in the overall business landscape. Even if some entity develops a solution to an issue, it has to be applied across thousands of agreements worldwide, each with unique circumstances, consistently. Being profit-oriented above all, multinational corporations have found ways to exploit the fact for gain, creating another significant issue of the digital economy.
Tax Evasion
Large companies with international holdings are often accused of employing various methods to avoid having to pay income taxes. American tech giants such as Amazon can serve as an example, growing to gigantic size while effectively paying no tax. The movement of money and assets into locations where legal entities would struggle to discern their existence or size usually facilitates the behavior. Highfield describes the practice as the abuse of some countries’ non-transparent environments to conceal income and assets from taxation (2).
The method arose with the emergence of large international banks that facilitated the smooth movement of money, and with the emergence of new digital methods, such as cryptocurrency, the process is now even more straightforward. However, other, more modern methods have emerged as countries tried to address the problem of offshore assets.
While attempting to minimize tax is normal behavior that has existed for as long as the taxation system itself, the advent of the digital economy creates additional opportunities for companies that want to engage in the practice. As Sand-Zantman notes, the situation where most of the customers are not located where the company’s assets are enables tax evasion and optimization (5). Companies are naturally inclined to place their headquarters in countries with low taxes and to minimize their royalties in high-tax nations to minimize pre-taxation income.
Previously, such behavior was not frequent because it interfered with business, but nowadays, in many cases, there is virtually no difference in the operating capacity of a company. For example, software companies can provide their services worldwide without any difficulty, given the presence of sufficiently robust servers to facilitate operations such as downloads.
It is challenging to address the issue because if legislation aimed at reducing the abuse of taxation differences is adopted in a country, the company can move. Digital assets are not as difficult to transfer to other locations as physical resources are, and so a firm that finds itself in an unfavorable environment can move elsewhere on short notice. There is virtually no way for a country to prevent such an exodus, which would ensure that the company does not pay any income tax altogether, as it becomes a non-resident. As such, the issue has to be tackled comprehensively, with the assistance of all of the world’s countries. The concept presents considerable difficulty due to the complexity outlined above as well as an agency issue. Countries with relatively low tax rates may be interested in housing large companies and refuse to participate in the initiative.
It should be noted that higher tax rates may not necessarily be sustainable for the companies themselves. Bauer claims that many digital companies make less of a profit than what people may initially assume and that increasing their taxation would go against the principle of fairness (12). Many successful digital businesses work by achieving low profit margins or operating at a loss but expanding rapidly through increased popularity and overall market share.
They then invest most of the money back into operations, creating considerable expenses and reducing their profits as a result. The faithfulness of such a model, where the company dominates the market but technically does not make a profit, to the spirit of the law is debatable. Nevertheless, it is true that such firms would not be able to sustain increased taxation without introducing considerable changes in their business models and potentially ruining themselves.
Digital Currencies
Digital commerce would not be successful without an easy method for quickly transferring money internationally. Initially, companies relied on bank transactions, similarly to more traditional companies, but they have since evolved to use various other approaches. Some businesses employ internal currency that can be exchanged for real money and used for purchases while others support a variety of online payment processors.
Regardless of the specific approach, tracing the new methods can be challenging due to their separation from traditional cash flows. A payment processor account’s country can be challenging to determine, though many are trying to implement robust identification and verification procedures. Overall, the determination of taxes that are necessary to collect as well as the location where they are due can be considerably more complicated than in physical commerce, creating issues for authorities.
The situation becomes more convoluted when currencies that are designed for the explicit purpose of guaranteeing the user’s anonymity, such as Bitcoin, are taken into account. They purposely obfuscate the owner’s identity, and so it is necessary to undertake disproportionate effort to determine who made the transaction and where. Nellen also notes that with the constant fluctuation of the currency’s value, the value that should be used for the translation of its value into the national monetary unit is unclear (28).
It should be noted that if the company operates in cryptocurrency and does not translate its holdings into its monetary equivalent, it will potentially be able to conceal all of its income. Such a situation is not currently feasible, as too few entities throughout the world work with such payment methods, but the future may bring considerable change.
It is challenging to respond to the issue of the decentralization of online payments, as it has emerged in response to the inadequacies of traditional money transfer methods. Typically, it was problematic to send money to another nation on short notice, as the process was relatively slow due to incompatible systems and involved a variety of commissions that resulted in an additional financial burden. As such, online processors present everyone with a unified system that people can use regardless of their location and specific currency. While convenient for consumers, the system creates difficulties for governments in differentiating payment sources.
Furthermore, adjustments to the system that enable easier accountability may make them less accessible to consumers, creating a widespread backlash. As such, governments should exercise care and search for methods to deal with cryptocurrencies and their use in business.
Current Solutions
Countries around the world are aware of the rising phenomenon of digital commerce and its implications for taxation. As such, they are taking measures to develop a solution for the issue, both individually and in collaboration with other states. Greggi notes that the Organisation for Economic Co-operation and Development published its first report on the issue of international taxation in 2013 and has been recognized as an appropriate discussion arena (1).
Territorial concerns are the biggest issue with current digital economies, as they do not rely on it as much as traditional markets. As such, research is ongoing into a redefinition of taxation that will accommodate the new paradigm while retaining its ability to police traditional corporations. However, no determinations have been made yet, and the debate is expected to continue in the decades to come until a satisfactory framework can be reached.
The distinction between resident and source countries, which is fundamental to most international trade agreements, is currently being discussed. Greggi describes Action 6 that was undertaken by the European Union, under which some countries would be classified as more deserving of taxation than others, and the less prioritized countries would step back (11). The proposal reduces the ability of multinational corporations to exploit loopholes by moving to countries with low tax rates while operating elsewhere. However, the aforementioned agency dilemma arises, as no country would willingly cede its right to tax a large entity.
As such, the presence of an impartial overseeing agency that is acknowledged by both countries is necessary to make the priority determination. The European Union may partially qualify, but it is biased towards its members, and so it can only make decisions internally, complicating the implementation of the approach.
Another approach would be to disregard the international nature of the company and treat it and its associates as internal entities for purposes of tax collection. Heinemann and Shume note that Australia has decided to collect the Goods and Services Tax from Uber drivers instead of the corporation itself (2). In doing so, it avoids international considerations and removes the loophole that would enable specific taxi services, including Uber, to avoid registering as a provider. Similar considerations can be applied to most sharing services, as the country’s residents own and use the assets, with the company acting as an intermediary.
As such, the country would tax its internal business transactions, avoiding the issue of the corporation potentially avoiding taxes. However, foreign companies that provide clients with services directly are a different matter.
Streaming services, such as Netflix, are such cases and so require additional attention. Fundamentally, Netflix enables owners of content to display it worldwide and receive profits. However, it is not reasonable to expect content producers, especially smaller ones, to be aware of the legislations of all of the countries where their work may be watched and pay taxes accordingly. As such, Heinemann and Murray claim that the Australian Tax Office shifted the responsibility for the tax remits on the operator of the service (4).
This centralization will enable more straightforward and more comprehensive taxation for many large companies, as most of the world’s largest digital firms serve as intermediaries between suppliers of good and services and potential consumers. With that said, there are still significant legal concerns that have to be addressed before the initiative can be implemented and work in the manner intended by its creators.
Theoretical Frameworks
The actions described above have been taken while their effects were not sufficiently theoretically explored. As such, it remains to be seen whether the effects will be positive and what lessons can be learned from these initiatives. For now, scholars and legislators are researching the matter and proposing a variety of potential solutions. As Olbert and Spengel note, many declarations of intent have been made, but common terms such as economic activity and value creation remain undefined (45).
As such, work should concentrate on the creation of a concrete framework that can be used to translate various ideas for improved international digital taxation into practice. It is essential to understand the differences between traditional physical business and its digital counterpart as well as the best way to address both using a single system without damaging the interest of any party.
It is essential to understand that the digital economy has brought about new and unique models that should be approached differently with regards to taxes. Bacache et al. investigate six different models of tax interaction: network rents, two-sided markets, privacy protection, fiscal instruments, platform competition, and fiscal competition (51). Privacy is a particularly interesting concern, as violating it allows companies to save costs, and the idea of consensual data submission can potentially create additional tax consideration. Overall, however, increased taxation will naturally lower the activity of the platform and slow its growth.
However, different tax options can have varying impacts on the performance of the business, and so the research can yield noteworthy results with regards to the methods that can be applied in the situation. As such, the research explores potential options and their effects on specific types of enterprises and aspects of their operation.
Many internet platforms, particularly social networks, have little to no intrinsic product value and generate profits due to the user network they have accumulated. For example, Amazon is famous due to its large consumer base and massive selection of sellers, and without either of the two it would suffer massive financial damage. As a result of this tendency, the quality of the service itself does not matter as much as its network effects.
Thus, according to Bacache et al., such platforms can be taxed directly without any significant distortions to their productivity (52). Naturally, the reduced money supply would make these companies less inclined or able to introduce new features in the future. However, this effect is unavoidable, and the businesses will find a way to remain profitable and sustainable in the long term.
However, many other companies offer multifaceted services that fall under different taxation categories and can switch focus between different revenue sources. Bacache et al. provide the example of a company that responds to increased advertisement taxation by starting to charge users a subscription cost, compensating the loss by switching to a different revenue source (52). As a result, users who are unwilling to pay the cost would no longer be able to use the resource. The reduction in its consumer base would then harm the overall revenues of the company, mainly due to the reduction in its ad income. Other forms of taxation, such as taxes per user, can also lead to the company disregarding its least profitable users. As such, a per-unit tax may be more appropriate than the ad valorem taxation prevalent in traditional fiscal activities.
Many platforms will collect data on their users to offer personalized services and advertisements. In doing so, they can increase their revenue by increasing the probability that the customer will purchase a product or be interested in an advertisement. The data may also be sold to aggregator firms, which then use it for big data analysis, though the practice is generally frowned upon as unethical.
As can be inferred from the profitable nature of data collection, increased taxation leads companies to respond by gathering more information to compensate (Bacache et al. 53). With that said, prolonged use of the practice can lead to adverse consequences due to public backlash or the crossing of the collection and sales into illegal territory. Taxing data collection revenue, specifically, could be a partial solution to the issue, especially alongside other approaches.
All of these considerations apply when the company’s business model is generally immutable, which is generally not the case with rapidly changing digital firms. Some taxation options can have unintended consequences that harm the end-users, such as subscription prices or discrimination based on potential profits. Such flows can also be taxed to discourage the behavior, but the company would suffer significantly as a result.
Bacache et al. propose the option of retaining the current arrangement but having companies pay users for willingly uploading their personal data (54). In such a scenario, everyone can ultimately benefit, and the government can collect taxes on the incomes of its residents without having to apply international considerations. However, it may be challenging to convince companies to follow this paradigm when they have access to large amounts of personal information for all users at no cost.
The effects of taxation on the Internet as a market also should not be disregarded, as it can affect competition. Many digital services are currently asymmetric, with large companies such as Google or Amazon and their divisions such as YouTube or Twitch dominating the field and a variety of smaller competitors. As such, according to Bacache et al., smaller services could be disproportionately affected by taxes and become less competitive while the large services, which are capable of paying the costs without endangering their operations, would become de-facto monopolists (54-55). The situation is not desirable, and so taxes should be applied with care.
Lastly, high tax can lead consumers to avoid paying it through a variety of legally feasible methods. For example, with regional pricing creating different prices for the same software product, consumers can try to pretend to be from the other country and purchase it at a lower price. The money would then go to that other nation, bypassing the fiscal system and resulting in a lowering in overall tax revenue. Bacache et al. suggest price non-discrimination policies and a domestic goods bias as a potential solution (56). However, the policy is dependent on the company, and the countries with lower prices would be disinclined to make their version of the product less attractive.
Conclusion
It is challenging to tax the digital economy, and a practical framework has not yet emerged. International taxation, the primary issue related to the topic, emerged to address double taxation and reduce the unfair burden on large firms. However, the convoluted shape that the system eventually adopted created considerable opportunities for companies, especially digital ones, to minimize the taxes that they pay.
Countries such as European Union member states and Australia have adopted measures to counter aspects of tax evasion, but it is unknown whether the initiatives will have a beneficial effect. These projects are not supported by sufficient research to enable a prediction of whether they will succeed. However, studies are ongoing, and there is a variety of ideas for effective taxation that benefits everyone that may warrant testing and evaluation.
Works Cited
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