The expected changes to international tax principles as a response to digitalisation

Tax

During the last few years, we have been accustomed to major developments to tax principles and legislation, whether as a result of EU Directives, OECD proposals or updates to local legislation. 2021 will be no different as we expect a number of changes, particularly from an international tax perspective. Transparency has been, and will continue to be, the order of the day, particularly in relation to amendments of existing Directives from the European Commission.

Apart from the deadlines relating to the first submissions for the mandatory disclosure requirements in relation to the Directive on Administrative Cooperation, the main topic of discussion will definitely be the expected changes to international tax principles as a response to digitalisation.

Digital Tax

We have already seen a number of countries take unilateral action by introducing some form of digital services tax. In March 2020, the European Commission stated that in order to avoid different systems at EC and OECD level, the EC stated that it is committed to support the work of the OECD, but if no solution is found by the end of 2020, it will again make a proposal for its own digital tax.

In October 2020, the OECD issued a Cover Statement to explain what the current status of the 2020 consensus-based solution is. In its statement, the OECD announced that the members of the OECD/ G20 Inclusive Framework (‘IF’) on BEPS have made substantial progress towards building consensus. The IF released a package consisting of the Reports on the Blueprints of Two Pillars.

Pillar One
Although no agreement has yet been reached, these pillars are meant to provide a solid foundation for future agreements. Pillar One tackles the issue that digital businesses are able to generate profits in a number of jurisdictions with or without having a physical presence. The solution, which is being presented in this pillar, would be to allocate a portion of residual profit to the market/user jurisdiction. A new multilateral convention would need to be developed to implement this solution.

Pillar Two
The Report on Pillar Two Blueprint is presented as a solution that would address remaining BEPS challenges and provides a right to jurisdictions to ‘tax back’ where other jurisdictions have not exercised their primary taxing right, or payment is otherwise subject to low level of taxation. One of the aims of this proposal is to ensure that all large internationally operating businesses pay at least a minimum level of tax.

Whilst the Report provides a solid foundation, there are a still a number of technical matters which would need to be agreed on, these include:

– The Income Inclusion Rule (IIR), the Undertaxed Payment Rule (UTPR), the Subject to Tax Rule (STTR), the rule order, the calculation of the effective tax rate and the allocation of the top-up tax for the IIR and UTPR, including the tax base, definition of covered taxes, mechanisms to address volatility, and the substance carve-out.

European Commission

From a European Commission perspective, we expect to see transparency maintaining its high status on the agenda. Following the implementation of DAC 6 (Directive on Administrative Cooperation), the Commission will be extending the Directive to DAC 7 and 8. DAC 7 brings digital platforms within the requirement of automatically exchanging information on revenues generated by sellers on such platforms, whilst DAC 8 will look to extend the scope of the Directive to include crypto-assets and e-money.

It will also be interesting to see what changes are implemented by the UK as a result of Brexit. We have already seen the UK effectively pulling-out of the DAC 6 requirements, and we expect further changes to come about. The UK’s status as a holding company jurisdiction could also be affected as a result of losing the Parent-Subsidiary and Interest and Royalties Directives benefits. How the EU reacts to these changes will also be an important factor, given the fact that the UK will be seen as a direct competitor of the EU-bloc.

The implications of Brexit will also bring about a number of changes from an indirect tax perspective in relation to the supply of goods from, or to, the UK. Businesses that move goods from the UK to the EU could be subject to VAT, with a possible cash flow implication. Other indirect tax concepts such as ‘Distance Sales’ and ‘Triangulation’ will no longer apply.

Local perspective

From a local perspective, we hope to see headway being made in relation to a gradual reduction in Malta’s corporate tax rate, as we have been proposing for the last couple of months. We believe it is an appropriate time for Government to reconsider reducing the standard income tax rate for companies especially in view of the fact that Malta’s tax rate is significantly higher than that chargeable in other countries, with the EU’s average corporate tax rate being 21.3%. Furthermore, whilst the effective rate in Malta, for the shareholder could be reduced by virtue of the full imputation system and the tax refund system, where applicable, this would only apply when a company distributes profits – in the coming months and years, we would expect companies to re-invest such profits in the company and not distribute them, also due to the current economic situation. Our proposal is for the corporate tax rate to be reduced to 25% over a period of 5 years with the first reduction as follows:

2021 will also bring about the changes mentioned in the November 2020 budget speech, which mainly relate to the extension of reduced tax rates on transfers of immovable property and assignments of promise of sale agreements.

This year will also see the first submission of the Tax Returns for Consolidated Tax Groups, which was a welcome change to Malta’s tax legislation in 2019, allowing group companies to form a fiscal unit for tax purposes with the various administrative and other benefits that this could bring.

Conclusion

What is certain is that during the next 12 months we will continue to see changes to international tax principles, and automatic exchange of information requirements. The tax challenges arising from digitalisation could result in a complete overhaul of the existing tax concepts, not to mention the disruption that this could lead to particularly with countries which have already taken unilateral action to tax such companies.

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