The emergence of tech giants in 21st century has been corollary to the developments leading to the rise of digital economy. This has given rise to a number of challenges for tax administration which transcend national boundaries. The new revenue streams using massive computing power and internet raise various questions about the appropriate characterization of certain payments and transactions for taxation and the usage of these services from anywhere in the whole world. This furthermore entangles the question as to where the actual economic activity is taking place and where the value is created.

Existing Framework

The overwhelming data about the inability of countries to adequately tax the digital economy was predated by burgeoning scholarship both predicting such futility and explaining the legal problems causing it[3]. One reason why the digital business is able to escape the tax administration is the absence of a fixed place of business, with their ability to reach the potential customers multiplied manifolds due to the advent of Information technology.

The traditional approach of taxation based on brick and mortar principle finds itself profoundly inadequate to address the concerns involved in the digital economy of 21st century. The existing models of taxation rely deeply on the physical presence of the company. ‘The almost universal rule tracks the tax treaties norm embedded in Article 5 of the OECD Model, using the PE terminology’[4] which implies that every business shall have a corresponding physical presence which should be significant and permanent, to be made liable for taxation.

The other pillar of international taxation is the reliance on residence paradigm which is translated to mean that the residents are to be taxed on their income from worldwide while the non-residents can be subjected to tax limited to domestic sources. These methods to rely on permanent establishment and residence/source were created to solve the political ambiguity in dividing the share of taxes, this may have allowed the standardization when applied on living beings but the lack of normative principles in these rules makes application of such rules on legal persons rather absurd.

Then the approach to tax on the basis of profit allocation to subsidiaries and using the arms length principle for appropriate taxation which could have been relied upon draws further confusion when applied to digital economies as the major transaction continues to be in the form of intangibles as compared against any other Multi national enterprises.

Difficulty in Taxation

The issues so raised have led to not only Double non-taxation by exploitation of treaty provisions but also red flags the BEPS (Base Erosion and Profit Shifting). ‘BEPS concerns are raised by situations in which taxable income can be artificially segregated from the activities that generate it’[5], resultantly the situations arise with very low tax collection from Multi location enterprises engaged in remote digital supplies. The application of these methods involve a shift of taxable income by the producers away from their home jurisdictions which not only undermines the system in place but also tends to shift the burden of taxes to other taxpayers as the authorities endeavor to meet their revenue goals. The activities involving BEPS lead to the positioning of domestic markets at a much disadvantaged position than their Competitive Multinational enterprises which are able to avoid appropriate tax by shifting the profits to different jurisdictions.

The transfer of profits in a digital economy model (as applied by tech giants) relies to act as a non-resident company in the country of consumers and ensuring a non-taxable presence while continuing to interact by digital means. More often this is done by having a subsidiary in a consumer country which is contractually allocated the assets and the risks with limited capitalization while the principle company enjoys the ownership of intangibles so created, along with there is a generation of excessive deductibles to such subsidiaries or related entities which are themselves located in tax havens. If the allocations of functions, assets, and risks do not correspond to actual allocations, or if less-than-arm’s length compensation is provided for intangible property of a principal company, these structures may present BEPS concerns.[6] All this aggressive tax planning by the multinational enterprises leads to a major risk for base erosion.

These intangibles in digital economy have placed the current regime in a rather bad position, as the data collection from user participation is a major contributor, the problems are exacerbated when the customers remain in an active relationship with the service provider throughout thereby, making it impossible to single out an event which can be called as sale. The line between user involvement and actual creation of content is so blurred that fixing a point of ‘value creation’ for purpose of taxation remains difficult.

The failure (or deliberate ignorance) of BEPS work on action 1 to define the scope of digital economy substantiates that the problem at hand is so huge. The approach in defining digital economy continues to be primarily based on common sense which cannot be of any help in deciding how transactions are to be taxed. Concomitantly, the prevailing definations relied on the application of digital economy, whereby the policy makers continue to limit the definition to e-commerce and all that we have witnessed is tweaking of existing definations to prevent the artificial avoidance of Permanent establishment status (BEPS action 7)

The multinational enterprises tend to create an ecosystem with little or no nexus with a permanent establishment. The same was catered to by preventing the artificial avoidance of Permanent Establishment status (BEPS Action 7), amendment to article 5 OECD ‘to ensure that where the activities that an intermediary exercises in a jurisdiction are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise will be considered to have a taxable presence in that jurisdiction unless the intermediary is performing these activities in the course of an independent business’[7] as it will also ‘restrict the application of a number of exceptions to the definition of permanent establishment’.[8] The same nexus approach for the tech giants in market economies evolved into a virtual Permanent establishment solution by tweaking the existing laws and widening the interpretation of permanent establishment and basing it on concepts of digital footprint, significant economic presence etc, has serious technical flaws.

The breach of the continuity re-quirement (i.e., the non-existence of a PE leads from full to zero taxation) that is present in traditional physical and personal PEs would become even more dramatic in the new nexus, where the lack of a single threshold unit (day, dollar, user, or consumer) could lead from full taxation of income attributable to the Virtual PE to no source taxation at all. [9]

Not to ignore the vagueness and ambiguity that exists in defining these, concomitantly the uncertainty and complexity. Contrary to the application of traditional brick and mortar which could be made to have a standardized trigger for all business alike irrespective of size, such standardization of threshold for digital economy is nearly impossible.

The current taxation regime not only failed to account for direct taxes but in regard to Indirect taxes also ‘it is evident that billions of revenue are at stake when (not) collecting consumption taxes (e.g., the estimated VAT gap amounts to over EUR 150 billion in the EU in 2015’.[10] The result of locating ‘the point of sales in low tax consumption jurisdictions minimizes their VAT (or GST) whenever consumption taxes are levied based on the origin principle.[11]

Unilateral measures by sovereign states

The lack of worldwide consensus on the issues has led to unilateral decisions which continue to affect the already fragile international tax regime. The countries such as UK have adopted the ‘Diverted profit taxes’ more commonly known as Google taxes which imposes a 25% tax on the diverted profits, when such profits arise by using goods and services based in UK. This tax applies irrespective of Permanent establishment. Israel, by giving a wider interpretation to the rules of permanent establishment adopted a version of nexus solution by altering its current regime to allow taxation in case of the company’s significant economic presence. The Slovak Republic adopted, in 2017, a more limited expansion of "fixed place of business" to include online platforms (e.g., Airbnb, Uber).[12]Hungary adopted a tax on net income from advertising services based on the destination of the advertisement and the location of the target- ed public (i.e., without need for physical presence in Hungary).[13] The EU after realizing that the market share of tech companies has increased from 7% in 2006 to 54% in 2017[14] proposed a directive for taxing digital economy based on the ideas of significant economic presence by relying on nexus approach and an interim solution of digital services tax. In Asia, India led the march with a very different approach by leaving its version of what is termed as equalization tax of 6%. The equalization levies as applied by India is based on gross income and is different from nexus based solution, this is surely outside the current international tax regime and lacks the legitimacy and acceptance by majority of states. The alternative solutions so proposed by countries like US to have triggers based on market intangibles may look as a better idea than changing interpretations of permanent establishment but not only lack a comprehensive theoretical basis will find implementation in most of the developing states difficult due to lack of resources. Most of these taxes have come as measures politically motivated and under undue pressure to do something to tax the tech giants.

Proposed Solution

The solution to such an issue can be the introduction of a ‘standard low rated final withholding tax on all base eroding payments to non-residents’[15] the implementation (and enforcement) of the tax will be done primarily with the help of a complementary rule that will require all business expenses to be matched with a specific withholding tax (corresponding to, but not necessarily collected at, a rate above zero) or a specific exemption to be deductible. [16] This, in corollary to BEPS experts recommendations, will increase the taxation at source, and do so without ring fencing the digital economy. This will be the most plausible solution as not only the treaty alterations be minimal but the elements of this solution such as information reporting, denial of deduction on base eroding payments etc is fairly acquainted to the current international tax regime.

[1] OECD, Addressing the Tax Challenges of the Digital Economy (OECD 2014) <> accessed 26 November 2020.

[2] ibid.

[3] See, e.g., Kingson, Taxing the Future, supra note 5, at 642

[4] Andres Baez Moreno and Yariv Brauner, 'Taxing the Digital Economy Post BEPS.. Seriously' (2019) 58 Colum J Transnat'l L 121

[5] OECD, Action Plan on Base Erosion and Profit Shifting (OECD 2013) <> accessed 27 November 2020.

[6] OECD (n 9).


[8] Ibid.

[9] Andres Báez Moreno and Yariv Brauner (n 2).

[10] MARCEL OLBERT and CHRISTOPH SPENGEL, ‘Taxation in the Digital Economy – Recent Policy Developments and the Question of Value Creation’ <>.

[11] ibid.

[12] Andres Báez Moreno and Yariv Brauner, ‘Taxing the Digital Economy Post-BEPS...Seriously’ (2019) 58 Columbia Journal of Transnational law 121.

[13] ibid.

[14] ‘Fair Taxation of the Digital Economy’ <>.

[15] Andres Báez Moreno and Yariv Brauner (n 2).

[16] ibid.

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