BONUS CONTENT: Digital Taxes and the People Principle

There’s a basic mantra in the news business that any story, no matter how esoteric or technical, is ultimately about people. If you can’t figure out the human drama in your assignment—or how the issue you’re covering matters to the humans who are reading it—that’s your failure as a journalist.

Maybe the tax system should have a similar principle. Taxes can often seem like one of the most inhuman subjects there is. But any tax is ultimately paid by someone, whether directly or indirectly, and often finding that person is an implicit goal in tax policy. As tax authorities and experts try to tackle the digital sphere—another area that seems far above us mere mortals—the rules are looking more and more at the person behind the computer screen as a bedrock for the system.

Anyways, this is why the Action 1 report from the Organization for Economic Cooperation and Development’s original Base Erosion and Profit Shifting project in 2015 is something that’s stuck in my mind—even though it has often been seen as an inconsequential document. While that BEPS project dealt with many of the key international tax issues of that time, the participants couldn’t come to any consensus on the key issues relating to taxation in the digital sphere itself. (Except that the digital economy shouldn’t be “ring-fenced,” anyways.)

The report notes some of the action items that touched on issues specific to digitalization—such as new permanent establishment standards and rules on the taxation of intangible assets—and outlined some of the areas where no firm conclusion was reached. Otherwise, it built on some prior OECD work on with consumption taxes, including how to determine which jurisdiction has the right to tax online services or the sales of intangibles.

The failure of achieving a stronger consensus on this topic was seen as directly leading to the Two-Pillar project, and Pillar One specifically, which laid out new rules that could tax online transactions without a physical presence. (Somewhat confusingly, the OECD classifies both Pillar One and Pillar Two as a continuation of Action Item 1.)

The report itself is still very interesting, at least to me. There’s this idea out there that consumption taxes, including value-added taxes, don’t have the same complex and confounding issues that income taxes do. While there are administrative advantages with a VAT, those who specialize in this area assure me that the problems are just as real and substantive as those that the income tax experts tackle. And of course, this is all the more true in the digital age.

I happen to be writing this on a plane (traveling to a tax conference), where most of the passengers are passing the time with music, video, or other wireless entertainment—some supplied by the airline, some through their own devices. In theory, consumption taxes are paid at the place of consumption. But where on Earth are we? (Over Illinois, last time I checked.)

The OECD’s VAT/GST guidelines, published in the Action 1 report, state that when supplies are not “ordinarily consumed at the same time and place where they are physically performed,” at a “readily identifiable place,” then consumption tax systems should default to the customer’s usual residence.

“This approach reflects the presumption that final consumers ordinarily consume services and intangibles in the jurisdiction where they have their usual residence and it provides a clear connection to a readily identifiable pace,” the report said.
Those suppliers also typically know where their consumers are located—at least, within a certain margin of error. If the supplier is foreign to the jurisdiction where the customers are located, they would register with that jurisdiction. (How this would be enforced is something the OECD can’t exactly mandate.)

This seems simple enough, and it probably is most of the time. I do recall writing about angry knitting hobbyists, organizing on the social network Ravelry, facing the possibility of registering with the European Union when they sell knitting designs online. (Speaking of making every story about people.)

That’s the thing, it may be easy for some companies to supply this data, but not every company and not all the time. The OECD said that guidelines should allow companies to use data that they already collect for sourcing, and the system should include safeguards so that they face challenges only if they abuse or misuse that information.

It’s not nearly so simple for business-to-business transactions, where the residence of one individual likely isn’t enough to approximate the place of consumption. The OECD guidelines state that the jurisdiction where the business is located should be seen as the place of consumption. But of course, many businesses exist in more than one country. In those cases there should be some analysis of which “establishment” uses the service or product, including through the “recharge method,” which would look at how the corporate group internally accounts for the transaction through methods such as transfer pricing.

So, we’re back there again. Even a “people”-based system eventually runs into problems at a larger scale.

That was nearly 10 years ago, and the European Union is still using the “place of residence” standard.

The general idea that income is generated where the people are has continued to become more prominent in tax debates, while not yet becoming a universal standard. Part of this is just because market jurisdictions are getting more clout. But it's also because the logic becomes clearer as the online world gets exponentially more dizzying and complex. Yet, it still all comes down to people sitting in front of their computer or idly scrolling on their phone.

As someone who focuses more on international corporate taxation, the idea of looking to usual residence as a proxy for economic activity seems relevant to wider debates about how to determine economic substance. The corporate tax rules don’t normally look at the residence of individuals, but it does look at issues like payroll and, in some cases, where individuals will perform their jobs. As working from home becomes more and more of a norm worldwide, it’s easy to see how corporate tax may have to start looking at personal residence as well.

It all comes down to people, but it’s also important to understand what a person does, and what their interaction is with whatever it is that’s being taxed.

Contact the author at amparkerdc@gmail.com.