New EU tax regulations affecting digital business

On 21 March 2018 the Commission proposed 2 Council Directives addressing the taxation of digital businesses.

Purpose. One dealing with setting up rules for establishing taxable nexus (i.e. significant digital presence) when operating across borders and attributing profits to digital business. The second one introduces Digital Services Tax (DST) that will be levied on revenues resulting from the supply of certain digital services related to user value creation. However, Directive on DST shall apply to multinationals only.

Purpose of the first directive is to catch and tax digital businesses operating in EU that avoid taxation simply because they have no physical presence in the country or otherwise meeting no outdated criteria set in Double Tax Avoidance Treaties or local tax legislation that do not capture digital development.
Directive on DST is introduced for the purpose to: 1) tax revenues that cannot be directly attributed to the scope of the first Directive; 2) avoid distortion of competition between digital services providers since number of companies may not equally compete with multinationals and ensure consistent approach through EU towards giants of digital business. DST is interim solution and shall be amended later.

Key points of the first Directive:
1) The Directive shall adopt rules for the digital development, modernizing definition of permanent establishment (PE) and profit allocation;
2) Introducing definition of significant digital presence (SDP) that relates to taxable nexus and right to tax income in appropriate country;
3) SDP is based on revenues, number of users and B2B contracts criteria as well as thresholds set for each of the criteria;
4) Profit is attributed using the same allocation keys that is currently in place: assets used, functions performed and risks assumed.

Key points of the DST Directive:
1) Apply to listed services only related to user value creation;
2) DST applies in a member state where the user is located and distributed between the members states;
3) Tax is 3% on gross revenues;
4) DST pays entities having worldwide revenues of EUR 750,000,000 and EU sourced revenue of EUR 50,000,000;
5) All DST obligations may be performed though one-stop-shop point even though activities carried out across the borders.

Impact on digital business
1) Impact is direct and straight forward to the digital businesses (including EU and non-EU) that renders digital services in different EU countries, i.e. digital businesses meeting SDP criteria will be required to register PE in this country and pay corporate tax there based on allocation key set in the Directive.
2) Giants of digital business have to be prepared to pay DST: set the country of destination, register for DST in the member state and identify services subject to DST (that may be rather challenging).

The Directives shall come into effect from 1 January 2020 but analysis of the existing structures and evaluating impact of new regulations have to be started now.

Arūnas Šidlauskas
Attorney at Law | Tax law & disputes