1. A Long-Term Policy Solution for Taxing Digitalized Business Models
Should the Permanent Establishment (PE) Definition be Modified or Should the Focus be on a Shared Taxing Rights Mechanism?
Dr. Vikram Chand 1

2. Agenda The current Tax Treaty Policy framework
The International Tax Policy Issue at stake
Existing options to solve the issue at stake
Core of the discussion: A critique of the long term option
The future direction:
Shared Taxing Rights Mechanism; or
Rethinking nexus and profit allocation rules

3. Article 7: Taxation of Business Profits under the current Tax Treaty Policy framework
Residence State
Source State
Enterprise
(Company R)
Business Profits

4. Article 5: Concept of Permanent Establishment under the current Tax Treaty Policy framework
Residence State
Source State
Enterprise
(Company R)
Permanent
Establishment
(PE)
Business Profits
Article 5(1), 5(2) & 5(3): Fixed Place PE – eg. Office
Article 5(5) & 5(6): Agency PE – eg. Employees
Article 5(4): Exclusions to PE concept – eg. Preparatory activities

5. The International Tax Policy Issue
Residence State
Source or Market State
Traditional
Businesses
Tangible presence PE
Digital presence
Highly
Digitalized
Businesses No PE

6. Highly Digitalized businesses that may operate without physical presence – Illustrations
Businesses providing an online marketplace for goods or services
Businesses providing online services
Businesses providing online solutions
Businesses selling digital products through an online platform
Businesses in all verticals

7. Key Features of Highly Digitalized Businesses
Reliance on users and data
Ability to commercialize without physical nexus
Intangibles
Policy question: How do we tax such highly digitalized businesses?

8. I. Turnover Taxes on selected digitalized businesses
Residence State
Source or Market State
Selected
Highly
Digitalized
Businesses
Advertising
Services
Clients
Sales Turnover
Double taxation
Do such taxes fall under the scope of tax treaties?
Within the EU: Do they conflict with EU primary law?
Do they conflict with trade obligations?
Do they conflict with constitutional principles of certain States? E.g. principle of Neutrality in Switzerland
Key issues if
introduced
unilaterally

9. II. Introducing a Digital PE in Tax Treaties
Residence State
Source or Market State
Highly
Digitalized
Businesses
Digital PE
(new paragraph)
Article 5(1), 5(2) & 5(3): Fixed Place PE
Article 5(5) & 5(6): Agency PE
Article 5(4): Exclusions to PE concept

10. Policy question
Does the introduction of a Digital PE concept for highly digitalized businesses make sense?
Prior to that lets look at lessons that we can learn from BEPS Action 7
What happended in the pre BEPS world? What is BEPS? What is BEPS Action 7?
Article 5(4) – Amazon and warehouse
Article 5(5) – Agents
- P&G – Commissionaires

11. Lessons from implementation of BEPS Action 7 through the Multilateral Tax Convention
Exceptions to PE were narrowed
Implemented in only 277 Tax Treaties
Article 5
Post BEPS
Action 7
Art. 5(4)
Art. 5(5)
& Art. 5(6)
Agency PE definition was broadened
Implemented in only 206 Tax Treaties
Lesson 1: Non-uniform adoption of the PE concept by States. States do not like to change the PE definition

12. Profit Attribution to a Permanent Establishment
Principles
Authorized OECD approach (AOA): Attribution of profits depends on significant people functions in the PE*
Formulary approaches such as percentage of sales
Lesson 2: Attribution of profits depends on the wording
of the tax treaty. Uniform attribution rules do not exist
among States
* The AOA focuses on functions, assets and risks and is similar to the Article 9 arm’s length approach

13. Key issue under the OECD AOA approach for profit attribution to a post BEPS agency PE
Residence State
Source or Market State
Question: Are there are significant people functions in the Agency PE?
Co A
Online Service provider
Agency PE
Clients
Business income – USD 1000
Arm’s length remuneration for services under Art. 9
Co B
Sales services
Lesson 3: Attribution of profits under current framework is unsettled and therefore tax uncertainty exists for businesses. This would lead to significant tax disputes

14. Summary: Key Lessons
Lesson 1: Non-uniform adoption of the PE concept by States. States do not like to change PE definition
Lesson 2: Attribution of profits depends on the wording of the tax treaty. Uniform attribution rules do not exist among States
Lesson 3: Attribution of profits under current framework is unsettled and therefore tax uncertainty exists for businesses. This would lead to significant tax disputes
Recap the key lessons

15. Digital PE Proposal: EU Commission and Academics
Nexus
Selected digital businesses that exceed either:
Revenue threshold
User threshold
Number of online contracts
Profit Attribution
Formulary approach: Upfront profit allocation of 30% of profits to the Digital PE; or
Amending the current AOA framework which is already unsettled by introducing additional fictions
The breach of a few key Ottawa Principles of Taxation
Neutrality: Different rules for digital businesses in comparison to traditional businesses
Certainty: Tax uncertainty for businesses
Recap the key lessons

16. Shared Taxing Rights Mechanism

17. A new distributive rule in Tax Treaties
Scope (Illustrative list)
Digitalized businesses providing an online marketplace (goods and/or services)
Digitalized businesses providing online services and online solutions
Digitalized businesses selling digitalized products through an online platform
Taxable Basis
Sources State may tax if the income exceeds a certain revenue threshold;
Charged tax  the lower of either a certain percentage of gross revenues or profits taxed under a net basis mechanism
Residence State to provide relief
Takeaway: Easier to implement and tax certainty for businesses
Status of research: Paper to be finalized end of August and will be submitted for peer review

18. The way forward: Rethinking nexus and profit allocation rules

19. Equality between Traditional and Digitalized Businesses
Profit Attribution
Full formulary approaches should be rejected
A more balanced approach: The transition from a functions, assets and risks to a Functions, Assets, Risks and Market (FARM) analysis
Nexus
All businesses that exceed either a:
Revenue based threshold
User based threshold
Compliance with Key Ottawa Principles of Taxation
Fairness Neutrality Certainty Flexible
Status of research: Detailed paper that will be submitted for peer review