On 21 March 2018, the European Union (EU) Commission proposed the adoption of new rules on the imposition of Digital Service Tax (DST) to tax digital business activities in a fairer and more growth-friendly way within EU.
The proposal aims to identify and tax the new ways by which profits are generated in the digital world and more specifically the users' role in creating value for businesses engaging in such digital activities.
The need for a DST implementation was a result of identifying a disconnect between where value is created and where taxes are paid. In addressing the challenges and gaps of current taxation systems, the EU Commission issued legislative proposals in two areas.
1. Corporate tax rules reform
Profits generated in a territory, even without the businesses' physical presence there, to be taxed in the EU Member State within which companies engage in such digital activities.
Where to Tax:
A digital platform will be deemed to have a taxable 'digital presence' or a virtual permanent establishment in a Member State if it satisfies any of the following criteria:
- Revenues exceeding €7 million annually in a Member State;
- Users exceeding 100,000 in a Member State within a taxable year;
- Online business contracts for digital services exceeding 3000 in a taxable year.
The new rules are set to change how profits are allocated to Member States in a way which better reflects how companies can create value online (e.g. depending on where the user is based at the time of consumption).
What to Tax:
Profit attribution will take into account the market values of:
- Profits from user data
- Services connecting users (online marketplaces, 'sharing economy' platforms)
- Other digital services (subscription to streaming services)
2. Application of Interim Tax on certain revenues
A second proposal affecting indirect taxation is the application of interim tax on certain revenues arising from digital activities, currently escaping from current/traditional tax frameworks.
DST will apply on revenues created from activities where users are a vital part of value creation and which are the hardest to capture under current tax rules, such as revenues:
- From selling online advertising space;
- From digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them and
- Created from the sale of data generated from user-provided information.
Tax revenues would be collected by the Member States where the users are located and would only apply to entities with total annual worldwide revenues of €750 million out of which €50 million are EU-generated.
The proposed tax rate for revenues arising from such activities is 3%.
Certain EU Member States such as France, Italy, Spain, Austria and Poland have already implemented the above proposals and it is expected that other EU countries such as Cyprus, Slovenia, Czech Republic, Latvia and Norway will follow in the near future.
Although initial consultation regarding the adoption of DST in Cyprus has been initiated since 29 August 2019 it has yet to be implemented, since an international consensus-based solution is aimed without having unilateral measures.
Since then, the European Commission has further opened a four-week feedback period running from 14 January 2021 to 11 February 2021 on its inception impact assessment/roadmap (per below) for the introduction of a digital tax to address the issue of fair taxation of the digital economy. Responses will be taken into account in the further development and fine tuning of the initiative.
There is no fixed timescale for further action after this feedback period and the next steps are likely to be driven by what progress can be made.
As such digital businesses will need to put in place appropriate identification mechanisms of potential tax obligations in Member States which already adopted DST, and where potential obligations may arise.
The introduction of DST, goes hand in hand with other indirect tax changes in VAT for which developments are expected to be implemented in the summer of 2021. Such are the simplification rules in the e-services/commerce, through the introduction of One Stop Shop.
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