We are in the midst of a revolution, one that is only just beginning – sometimes called the “Digital” Revolution. It has enabled transformative improvements in business processes. It has spurred innovation across all sectors of the economy. It is ceaselessly adapting technologies to make them more accessible, productive and powerful. It bears little resemblance to any other disruption the world has known – and its magnitude is seismic.
The new norm for today’s customers is to access new products, manage their finances and conduct transactions online. Technology has breached the walls of all sectors: in
The digital economy is characterised by a heavy reliance on intangibles.
logistics, freight companies are able to track vehicles and cargos across continents; manufacturers remotely monitor production processes and use robots, who now harness human capabilities like dexterity, memory and sensing; knowledge is easily imparted through online classes; doctors may diagnose and monitor patients from a distance; and data processing allows retailers and service providers to deliver a more seamless customer experience.
The phenomenon of digitisation is the biggest driver of innovation across businesses; one that is pervasive and knows no physical or territorial borders; one that has bolstered dramatic changes in all disciplines and sectors. Today, virtually all commerce is digital: e-commerce, cloud computing, online payment services, high-speed trading, app stores, online advertising, participative networked platforms… The importance of physical presence in the customer’s market is decreasing, and that of intangibles is growing. It is safe to say that the digital economy is the economy itself, and that it cannot be isolated as a separate sector with its own set of rules.
Against this backdrop is an outdated international tax system fraught with fragilities and deficiencies, leading to abuses. International tax rules, many of which date back to a century ago, are still rooted in boundaries designed for bricks-and-mortar businesses. A good or service was taxed in the country it was produced and sold in. Simple. But where should VAT be paid in the digital age? In the country of purchase? The one where the order was received? Or the one where the product was delivered? That age-old tax regulations are antiquated is apparent.
In parallel to this, new ways of doing business could also result in an unintended relocation of core business functions to a different distribution of taxing rights, ultimately leading to low taxation.
Today, virtually all commerce is digital.
G20 finance ministers and the OECD have joined forces to redefine how tax rules can play catch-up with the needs of new business models, particularly with the BEPS (“Base Erosion and Profit Shifting”) Project’s first action: “Addressing the Tax Challenges of the Digital Economy”. This initiative resulted in a 290- page report published in 2015, after years of studies and discourse. Despite the painstaking effort spent addressing the issue, this report only roughly provides general principles – conclusions may evolve alongside the exponential development of the digital economy. Besides, the outcomes of these measures will be reviewed in yet another report due for release in 2020. Such is the scale of this challenge.
The digital economy is characterised by a heavy reliance on intangibles, the widespread use of data, the adoption of multi-sided business models capturing value from externalities generated by free products. The outcome? A struggle to correctly identify the jurisdiction in which value creation occurs. The definition of “substance”, which is naturally associated to a company with headquarters, employees and tangible assets, has to be restored.
How do enterprises add value and generate profit in the digital economy? And how do we now define the concepts of “country of source” or “country of residence” in this shifting context?
The World Economic Forum characterises this new wave as one in which “the speed of current breakthroughs has no historical precedent.” It builds on the digital disruption set in motion by the Third Revolution, but with added speed, scope and scale, fusing the physical, digital and biological worlds. Tax regulations have never been as high on the international agenda as they are today. It isn’t a question of whether tax will be disrupted – it is a matter of when and how.
As the whirlwind of change sweeps the globe, what is perfectly legal today may not be tomorrow; an organisation that has a monopoly today might go the way of the dodo tomorrow. The tax industry is fair game for experiential change, and there is no end in sight. The answer to adeptly advising and anticipating the future lies in our ability to grasp how companies of the digital economy are adding value and how they are deriving profit.