Digital Tax Administration of Cross-Border Online Economy or “Google Tax”

Goals of Tax Administration in The Context of the Development of Cross-Border Online Economy

The development of international Internet business and the advancement of payment instruments are blurring the boundaries of entrepreneurial activity. To sell digital products and services around the world, it is unnecessary to be physically present in the country where the client is located. The Internet makes it possible to sell goods and services remotely through various advertising networks and marketplaces, receiving payment from abroad through international payment systems.

Technology is fast becoming an indispensable tool for tax authorities. Although technology can enable taxpayers to use more sophisticated methods to evade tax, it can also be a powerful tool for tax authorities to swiftly identify such methods.

A number of tax authorities have already achieved successes in preventing and detecting tax evasion and fraud through the use of technology solutions, which has led to the recovery of billions of Euros in tax revenue.

OECD[1]

How to organize taxation of cross-border online transactions? Non-residents may not register or declare their income in foreign jurisdictions, which results in tax losses in their territory. Customs control the movement of physical goods and the payment of duties, excise, and taxes when goods cross the state border. For digital goods and services there are no such means of control.

Large international corporations, including digital businesses, often register legal entities in countries with a gentle tax regime for export revenues, such as Ireland. The lack of tax burdens in the cross-border market makes the price offerings of non-residents more attractive than those of local companies.

A tax imbalance arises, which creates a significant preference for foreign businesses and significantly limits the competitive opportunities for local companies. Residents must pay taxes to the local budget, and this burden affects the final cost of goods and services. The amount of VAT or sales tax contributes to the significant difference in retail prices for local and similar global digital services.

Local “digital” revenues of international corporations can be a hefty sum. The lack of a regulatory framework governing this sector of the economy causes significant tax losses for the governments. For example, Google’s revenues in several developing countries exceed a billion dollars a year, and Netflix’s revenues exceed a hundred million dollars a year.

So, tax authorities face multinational corporations that offer digital goods and services and are not tax residents in the country. They have customers and users across the country who consume these goods and services. How national tax authorities can resolve this international corporation’s tax challenge and stop tax losses for the local budget?

Voluntary Income Reporting by International Corporations and Challenges of Tax Administration

The primary method of taxing the activities of international corporations in a foreign country is their voluntary legalization in the local market.

Tax authorities should create a simplified tax registration procedure for such companies. International suppliers must include local taxes in the end customer prices of digital services for citizens and legal entities of the country. To do this, they must update their information systems, specify the place of sale of the product/service and generate an invoice for the buyer with the allocation of the amount of local tax. At the end of the tax period, the corporation must file a tax return in the respective country and pay the tax.

The largest public corporations that cherish their reputation in the international market respond strongly to this approach because it is the easiest way to lower risks. It is not profitable for them to violate the legal requirements of foreign countries, especially in the case of presence in their territory. Local inspections can detect these violations and charge fines, which will lead not only to financial losses but also to the damage to their reputation.

The tax authorities will not incur extra costs by implementing this method of legalizing overseas business. They have no reliable data sources to check the correctness and completeness of the calculation of taxes. For this reason, they do not conduct control work and take the information received from the international company on faith.

Small international companies may continue to sell their digital goods and services without registering or declaring their operations in local markets. The tax authorities simply do not see them in this case, but there are solutions to this problem.

Solution 1: Payment Agents’ Reporting

Customers can pay for digital goods and services only by electronic means. The buyer and seller have physical presence in different countries. They cannot pay in cash and must use cards from international payment systems. Although, in some countries, they can also use payment surrogates, for example, mobile wallets or cell phone bills.

In this situation, it is possible to oblige payment agents, payment card issuers (banks) and owners of payment instruments (financial companies, mobile operators) to give information about payment recipients who are non-residents. Analysis of this information will help to form a register of all recipients of cross-border payments, calculate the amount of income received by them from local buyers, and compare this information with the data officially declared by international companies.

Also, the legislation of the country may introduce the requirement for international companies to register a local representative office, which will perform the function of a tax agent, for example, when reaching a certain threshold of received income.

A more radical method of forcing legalization in the local market and payment of taxes could be the blocking of internet access to the resources of international companies. This would require the creation of an appropriate technological and legislative framework, which is not always feasible.

Solution 2. Shifting the Obligation to Withhold Tax Charges to the Payment Agents

Instead of struggling to organize a complicated process of registration, tax declaration and monitoring by the tax authorities, it is possible to assign the function of paying taxes of international companies to payment agents, through which the customer (local consumer) makes payment for digital goods and services to a foreign company. When making payment, the agent can automatically withhold tax from the foreign company and pay it to the state at the end of the tax period. Here, payment agents function as tax agents.

We must separately consider the situation where the resident acts not as a buyer, but as a seller. For example, he rents an apartment through Airbnb or Booking.com. International online platform pays, and the resident citizen receives income from abroad. It is also necessary to tax the international platform (in terms of its commission) and the service provider through the platform (in terms of its income). In that case, the international platform can function as a tax agent for its suppliers.

Large online platforms are very reluctant to cooperate with foreign tax authorities. Disclosure of information about themselves and their suppliers can lead to customer churn to competitors or switch to classifieds, where the supplier can directly search for customers and work with buyers from other countries. Therefore, the method of voluntarily declaring their commission and income of platform suppliers will not work in most cases. Everyone will look at each other and be afraid to make the first step, so that they do not lose market share in a foreign country.

In such situations, we propose a working model by combining two methods. The tax authorities have no way to figure out platform’s commission amount on their own. To calculate income and the tax base, they should need foreign platforms to give access to the payment transactions made by platform sellers.

Conclusions

As the digital economy strengthens, it forces tax authorities to find new ways to combat income withholding and tax evasion by international corporations working from a foreign authority without registering a business in the local market.

At the same time, the digital nature of the online economy and the widespread use of electronic payments provide an opportunity to address these challenges with digital technologies.

Tax authorities should work with online platforms to localize their businesses within the state and get information about their customers and a taxable base.

At the national level, it is important to develop special tax regimes and digital tax administration for online platforms and their providers, including self-employed individuals. This will simplify tax administration, encourage transparent activities of online platforms and their suppliers in the local market and multiply the volume of tax revenues to the state budget.

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[1] Technology Tools to Tackle Tax Evasion and Tax Fraud // Organisation for Economic Co-operation and Development (OECD), 2017. URL: https://www.oecd.org/tax/crime/technology-tools-to-tackle-tax-evasion-and-tax-fraud.htm