Digital economy and BEPS: practical questions with practical answers?

Adv LLM paper submitted by

Fabián Acosta

in fulfillment of the requirements of the 'Master of Advanced Studies in International Tax Law' degree at the International Tax Center Leiden (Leiden University)

supervised by

Gábor Baranyai Fabián Acosta version 15 08 2016 II

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name: Fabián Andrés Acosta Guevara1

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1 Beneficiary COLFUTURO 2015 / Beneficiario COLFUTURO 2015 Fabián Acosta version 15 08 2016 III

Title and table of contents

Digital economy and BEPS: practical questions with practical answers?

Title and table of contents ...... III List of Abbreviations used ...... V Executive summary ...... VI Main Findings ...... VII 1. Introduction ...... 1 2. Historical background and development ...... 2 2.1. A brief history of the digital business practices and the digital economy ...... 2 2.2. Defining digital economy and e-commerce...... 5 2.3. Business models in the digital economy and e-commerce...... 6 2.4. Challenges of taxing the digital economy ...... 7 3. OECD BEPS final report and current framework ...... 8 3.1. Addressing the tax challenges of the digital economy ...... 8 3.1.1. Key features of the digital economy...... 9 3.1.2. Identifying tax planning opportunities in the context of direct taxation ...... 11 3.1.2.1. Eliminating or reducing tax in the source country ...... 11 3.1.2.2. Low or no withholding tax at source ...... 12 3.1.2.3. Low or no taxation at the level of the recipient ...... 12 3.1.2.4. Elimination of current taxation ...... 13 3.1.3. Tax policy concerns in the area of direct taxation ...... 14 3.1.3.1. Nexus ...... 14 3.1.3.2. Data ...... 15 3.1.3.3. Characterization ...... 16 3.2. Tackling BEPS in the digital economy and addressing alternatives ...... 16 3.2.1. Recommendations that will address BEPS issues in the source and ultimate parent jurisdictions ...... 16 3.2.1.1. CFC rules ...... 17 3.2.1.2. PE status ...... 18 3.2.1.3. Transfer Pricing ...... 20 3.2.2. Options to address the broader direct tax challenges in the digital economy ...... 21 3.2.2.1. A new nexus based on the concept of significant economic presence and its determination ...... 21 3.2.2.2. A withholding tax on digital transactions ...... 22 3.2.2.3. An introduction of an equalization key...... 23 3.3. Preliminary conclusions...... 23 4. Current framework, recent developments and implementations ...... 24 4.1. PE and nexus ...... 24 4.1.1. Current framework ...... 24 4.1.1.1. Treaty rules for taxing business profits...... 25 4.1.1.2. PE status ...... 25 4.1.1.3. Service PE ...... 26 Fabián Acosta version 15 08 2016 IV

4.1.1.4. Agency PE ...... 26 4.1.1.5. Artificial contractual arrangements to avoid PE status ...... 27 4.1.2. Recent developments and implementations ...... 27 4.1.2.1. Diverted profit tax (DPT) ...... 27 4.1.2.2. Bandwidth tax ...... 28 4.1.2.3. Indian equalization levy ...... 29 4.1.2.4. Israel circular on Internet activity of foreign companies ...... 29 4.2. Other direct tax related developments ...... 30 4.2.1. Formulary apportionment ...... 30 4.2.2. Destination based corporate income tax or cash flow tax ...... 30 4.2.3. Hungary advertising and telecommunications taxes ...... 31 4.3. Transfer Pricing ...... 32 4.3.1. Current framework ...... 32 4.3.1.1. Delineation of the transaction ...... 32 4.3.1.2. Preparation of the functional analysis ...... 32 4.3.1.3. Intangibles and hard to value intangibles ...... 33 4.3.1.4. Identification of the most appropriate transfer pricing method and comparable selection ...... 33 4.3.2. Recent developments and implementations ...... 34 4.3.2.1. Italian transfer pricing rules in the context of the digital economy ...... 34 4.3.2.2. APA programs and country-by-country reporting regulations ...... 34 4.4. Withholding tax ...... 35 4.4.1. Current framework ...... 35 4.4.1.1. Tax treaties abuse ...... 36 4.4.1.2. Cloud computing payments ...... 36 4.4.2. Recent developments and implementations ...... 37 4.5. Anti-tax avoidance EU Directive ...... 38 4.5.1. General anti-avoidance rules ...... 38 4.5.2. Switch-over clauses ...... 38 4.5.3. Exit taxation ...... 39 4.5.4. Final remarks and conclusions ...... 39 4.6. Preliminary conclusions...... 39 5. Proposals and technical advise related with the current cases considering business examples ...... 40 5.1. Online games ...... 40 5.1.1. Facts of the case...... 41 5.1.2. Analysis of the case ...... 42 5.1.2.1. Company A ...... 42 5.1.2.2. Company B ...... 43 5.1.2.3. Source state issues ...... 43 5.1.2.4. Low-tax jurisdiction issues ...... 44 5.1.3. Conclusion ...... 44 6. Conclusions and recommendations...... 44 Bibliography ...... 46

Fabián Acosta version 15 08 2016 V

List of Abbreviations used

(alphabetical list of abbreviations used in the Paper)

AG Advocate General ACE Allowance for Corporate Equity APA Advance Pricing Agreement Art., Arts. Article, Articles ATAD Anti-Tax Avoidance Directive BEPS Addressing Base Erosion and Profit Shifting CCA Cost Contribution Arrangements CbC Country-by-Country CCCTB Common Consolidated Corporate Tax Base CEGTDE Commission Expert Group on Taxation of the digital economy CFA Committee on Fiscal Affairs CFC Controlled foreign corporation Comm. Commentary CUP Cost-plus Method C- , T- Court Case Number DEMPE Development, Enhancement, Maintenance, Protection and Exploitation DPT Diverted Profit Tax EBITDA Earnings before interest, taxes, depreciation and amortization EU European Union GAAR General anti-avoidance rule GSM Goods and Services Tax HTVI Hard-to-Value Intangibles ICT Information and Communication Technologies IP Intellectual Property IoT Internet of Things ISP Internet service providers LOB Limitation on Benefits MNE(s) Multinational Enterprise(s) OECD Organisation for Economic Co-operation and Development PE Permanent Establishment PPT Principal Purposes Test R&D Research & Development Sec., Secs Sections TAG Technical Advisory Group TCP/IP Transmission control protocol/ Internet protocol TFDE Task Force on the digital economy UK United Kingdom UNCITRAL United Nations Commission on International Trade Law US United States VAT Value Added Tax Fabián Acosta version 15 08 2016 VI

Executive summary

This paper addresses the new framework and recent developments in the context of the digital economy. Although this paper describes in a general way the key concepts of the digital economy along with the recommendations and options suggested by the BEPS Action 1 Final Report, its main focus is to identify and analyze the main items related to direct taxes and Transfer Pricing. The paper concludes that further work should be done at an international and domestic level in order to effectively address all the tax challenges of the digital economy. Also notes that the conclusions may evolve as the digital economies continues to grow and develop, which means that countries should continue monitoring the daily advances and new business configurations that are uninterruptedly arising.

Following the introductory chapter, the paper in the second chapter briefly outlines the historical background and development of the digital economy and e-commerce. The main topic of the chapter will be to clarify how the digital economy has emerged as an economic driver that accelerated growth, transformation and value creation in the markets across the world. For this purposes this paper will demonstrate with practical examples that the businesses that are active in the context of the digital economy are not exclusively the retailers of goods and services online, but also all the traditional businesses in each industry of the economy (section 2.1 below). In addition, in the second chapter the concepts of digital economy and e-commerce will be defined (section 2.2 below); the current business models in the context of the digital economies will be identified (section 2.3 below); and the tax challenges of the digital economy will be described along with their historical context (section 2.4 below).

The third chapter is aimed to identify the main items and current framework put forward by the BEPS Action 1 Final Report in the digital economy context. First the tax challenges of the digital economy will be addressed in depth, for this purposes the potentially relevant key features from a tax perspective of the business models emerged in the digital economy will be described (section 3.2.1 below), the tax planning opportunities (section 3.2.2 below) and the tax policy concerns (section 3.2.3 below) in the context of direct taxation will be identified and analyzed. Then the recommendations (section 3.3.1 below) and options (section 3.3.2 below) proposed by the BEPS Final Report will be described and analyzed in depth.

The current framework, recent developments and implementations are dealt within the core fourth chapter. Particular attention is given to the Permanent Establishment status, nexus and attribution (section 4.2 below), considering that due to the key features and issues that the digital economy raises, the PE concept have a particular relevance. As is going to be discussed, the digital economies reduce the need to be physically present for business operations, relying heavily rely in intangibles and segregate the value creation chain. Also the fourth chapter aims to analyze and discuss the current framework and developments in Transfer Pricing (section 4.4 below) and withholding tax (section 4.5 below) matters, where particular conclusions are to be provided. At the end a brief mention is going to be given to the recently issue Anti-Tax Avoidance EU Directive (section 4.6 below), as some of its recommendations have a relation with the tax challenges of the digital economy.

In the fifth chapter some practical cases are going to be analyzed taking into consideration the existing and new framework in the context of the digital economy.

Finally, in the concluding part, the paper provides an opinion of the answers needed to tackle the tax challenges of the digital economy in the context of the recommendations and options put forward by the BEPS Action 1 Final Report. Also some conclusions are going to be provided in relation with some items and risks that the Report did not considered regarding new business configurations that are arising in the backdrop of the digital economy. Fabián Acosta version 15 08 2016 VII

Main Findings

The main policy concerns contained in the BEPS Action 1 Final Report raise questions as to whether the current international tax framework is still appropriate to deal with the businesses in the context of the digital economy. It has been analyzed and suggested that the lower costs of the digital economies combined with the increasing network effects generated by customer interactions may justify a change in tax policy. However, in considering a change in tax policy the potential impact on traditional business configurations must be taken into consideration in order to maintain coherence at an international level.

The OECD recommendations and options are based on the OECD aim to avoid ring fencing the digital economy from the traditional businesses, considering that this would be against the tax neutrality principle and because the digital economy is rapidly becoming the economy itself, as the traditional businesses are moving many of its activities to the countless digital possibilities. In the BEPS Report the OECD suggest some accurate short-term reforms such as the modification of the list of the exceptions of PE in Art. 5.4. OECD Model 2014 and its definition, together with the introduction of an anti-fragmentation rule to ensure that it is not possible to get a benefit from this exceptions. Also provide several far-reaching possibilities, including a new nexus test in the form of a significance economic presence requirement, withholding tax on digital transactions and an equalization levy. Now that the major BEPS risks have been identified (i.e. thin capitalization, transfer pricing, hybrid mismatches, circumvention of CFC rules, preferential tax regimes and artificial contractual agreements) immediate action is needed to advance in the BEPS aim to tackle the tax challenges of the digital economy.

Despite countries around the world are implementing new measures to tackle the digital economy. Some of the measures are impractical, fail to address the problem and have a temporary nature as the digital economy is growing and developing much faster that the measures itself. However interesting approaches are arising, such as the Israel measure on Internet activity of foreign companies, that uses the concept of a significant economic presence to address the tax challenges of the digital economies for treaty country residents and non-treaty country residents. Also more radical measures can be interesting to be considered at an international level, such as the DBCT where the traditional connecting factors of residence and source have to be replaced for a destination based cash flow. The measure can be easily adapted to the key features of the digital economy as it relies on the consumers.

The overall analysis on the current framework and the BEPS recommendations and options shows that some measures fail to address the core issues of the tax challenges of the digital economy. The limitation of the BEPS measures could be attributed to the fact that the digital economy is developing faster than the measures considered and implemented, and in some cases because the operators do not understand the broad scope and possibilities of the digital economies. What it seems to be happening is that the BEPS Report is trying to address the tax challenges of the digital economy by adapting the current system that dates back to the 1920s to issues that go beyond the scope of the old regulations. The reasons for this could be that the OECD being a soft-law organisation and the difficulties to reach a conclusion are restricting more fast-phased solutions. Immediate action is needed to advance in the post BEPS strategy to make it happen sooner than later. At the same time further measures to tackle the tax challenges of the digital economy must be discussed at an international level, such the new nexus method in the form of a significant economic presence test, the apportionment method and the DBCT.

An effective and definitive answer to the major issues requires an international, coordinated and harmonized solution that may be achieved through a multilateral agreement, as is already the intention of the BEPS Action 15. As this is a solution that may take a long time to be achieved, now that the major BEPS risks have been identified for now immediate action of the recommendations and options stated by the OECD is needed to advance in the aim to tackle the growing tax challenges of the digital economy. Fabián Acosta version 27 07 2016 1

1. Introduction

Globalization has changed and re-designed the way in which the world works. Trends such as the free movement of capital and labor, the gradual removal of trade barriers, the creation of new business models, the innovation of Information and Communication Technologies (ICT)2 and the rapidly growing of the digital economy, all have increase the complexity of the current business environment. The above mentioned trends have enable Multinationals Enterprises (MNEs) and domestic companies to optimize their production allowing to deliver products and services in less time or immediately, reducing costs of transactions and increasing profitability and margins. At the same time, these factors have been configuring a set of new interactions between users, companies and service providers that most of the times break the boundaries between conventional markets and jurisdictions.

The connectivity, based on Internet Service Providers (ISP’s)3 constitutes the essential infrastructure of the digital economy, which nowadays is present everywhere and anywhere: in public spaces, private establishments, personal computing devices and physical objects such as vehicles, buildings and appliances that are fixed with electronics, software and network connectivity. Such connectivity has allowed a drastic increase of the digital economy worldwide that caught more and more attention in the last years. Only in 2015 the number of Internet users was 3.17 billion, up from 2.94 billion in the previous year. 4 The revenue on the e-commerce has been growing at an accelerated ratio in the last 3 years and is expected to continue growing at a rate of 10.72 per cent (CAGR 2016-2020) resulting in a market volume of USD$1.777 billion in 2020. Up to 2016 the e-commerce markets amounts to USD$1.182 billion. 5

Today as never before, globalization along with the digital economy have caused the old business models to evolve, have made tax planning and tax compliance more complex and have created a growing need to align taxation with the new world. Since the digital economy “is rapidly becoming the economy itself”, political leaders, the media and the civil society have expressed the growing concern about the tax consequences of digital business practices that proven to have a high mobility, a global reach and a easily relocation of business functions. The increasing interaction of the national economies and markets around the world is challenging the current international tax rules that were designed decades ago and without considering the impact of the digital economy and its new business models.

Following the release of the final report Addressing Base Erosion and Profit Shifting (BEPS) in October 2015, the Organisation for Economic Co-operation and Development (OECD) issued a 15 point action project, dealing with the contests of cross-border activities and international taxation.

2 The term of information and communication technologies within this paper is an umbrella term, as encompasses any communication device, application of software (i.e. cellular phones, computers, network hardware and software), as well as the various services associated with them (i.e. videoconferencing and distance learning) in the context of the digital economies. 3 The term Internet service provider within this paper refers to any organization that provides services for accessing and using the Internet. 4 http://www.statista.com/statistics/273018/number-of-internet-users-worldwide/, accessed on June 24th of 2016. 5 https://www.statista.com/outlook/243/100/ecommerce/worldwide#market-revenue, accessed on June 24th of 2016. For the purposes of the statistics presented above, the E-commerce market encompasses the sale of physical goods via a digital channel to a private end user (B2C). Incorporated in this definition are purchases via desktop computer (including notebooks and laptops) as well as purchases via mobile devices such as smartphones and tablets. The following are not included in the eCommerce market: digitally distributed services (see instead: eServices), digitally distributed goods in B2B markets nor digital purchase or resale of used, defective or repaired goods (reCommerce and C2C). The eCommerce market considers the following product categories: “Clothes & shoes”, “Consumer electronics & physical media”, “Food, cosmetics & pharmaceuticals”, “Furniture & home appliances” and “Special Interest”. Fabián Acosta version 15 08 2016 2

Action 1 of the BEPS Report addresses the challenges of the digital economy and outline the options and recommendations made by the Task Force on the Digital Economy (TFDE), a subsidiary body of the Committee on Fiscal Affairs (CFA) in which non-OECD countries participate as Associates on an equal footing with OECD countries.

Despite Action 1 deal mostly with the issues of the digital economy, many of the actions are tangled and complement each other, as will be discussed further in this paper (section 3 below): i) Action 2 will deal with the neutralization of the effects on Hybrid Mismatch Arrangements; ii) Action 3 with the strengthening and implementation of CFC legislation; iii) Action 5 will set the grounds on the counteraction of the Harmful Tax Practices; iv) Action 7 will analyze the artificial avoidance of a Permanent Establishment (PE); and v) the Transfer Pricing concerns and reporting will be discussed in Actions 8-10 and 13.

While the BEPS Report options and recommendations appear to be infeasible to implement at the short-term, various countries have been trying to address the challenges of the digital economy within their own domestic legislation. Because there is not a generalized solution and the proposed legislation of these countries have international tax imbalances, it is necessary to find a solution to tackle issues of double taxation or double not taxation that arise from the new business models of the digital economy.

The main objective of this paper is to analyze the current framework related to digital business practices, identifying the main items in Direct Taxation and Transfer Pricing addressed by the OECD BEPS Report and the current worldwide practices and developments in digital economy. In order to test and assess the current framework the paper will analyze the current issues and the alternatives thereof specified by Action 1 of the OECD BEPS Report, making reference when necessary to the other Actions. Similarly, considering that multiple measures have been suggested and implemented by various countries during the last years, this paper intent to consider these unilateral proposals in order to have a complete approach to the discussion surrounding the digital economy.

Once the current framework is clearly delimitated, this paper intend to spot the potential cases that may arise with the current framework, studying possible challenges and risk areas in the future. In order to test and assess the potential cases that may arise, the paper will review with practical examples that contain high digital value how the current framework may affect the position of the tax authorities and the taxpayers.

As a result, the author intend to contribute from a tax and Transfer Pricing perspective to the current discussion on digital economy, identifying the most appropriate approaches to the current and future digital economy business model configurations. Likewise, the definition of the current framework, recent developments and case law will help to understand how to address the challenges of the digital economy and at the same time how to deal with the increasing importance of e-commerce and the migration of old business practices to the new and upcoming digital business practices.

2. Historical background and development

2.1. A brief history of the digital business practices and the digital economy The digital economy has emerged as an economic driver that accelerates growth, transformation and value creation. It is clear that it have a dramatic effect on the economy as a whole and is likely that this is going to be a growing tendency in the future years. With more and more people connecting to the Fabián Acosta version 15 08 2016 3

Internet6 and conducting their purchases trough the e-commerce, 7 the digital economy is becoming a broad phenomenon affecting all the spheres of our lives. The origin of this economy can be traced to the invention of the Internet and the advances put forward trough the ICT.

This chapter briefly outlines the historical background and development of the digital economy and e- commerce. The main topic of the chapter will be to clarify how the digital economy has emerged as an economic driver that accelerated growth, transformation and value creation in the markets across the world. In addition, the concepts of digital economy and e-commerce will be defined, the current business models in the context of the digital economies will be identified and the tax challenges of the digital economy will be described along with their historical context.

While the Internet once was a communication tool, nowadays has been transformed into a technology supporting all sectors of the economy. Despite in the beginning the Internet was used exclusively by academic institutions and governmental entities in the United States (US), the development of the transmission control protocol/ Internet protocol (TCP/IP)8, which is the pillar of the current state of the Internet, gave access to the technology to commercial service providers who extended its scope worldwide. 9

Figure 1: history of the digital economy •Development of ARPANET, first The first step in bringing the Internet to the public was 1960s - operational network the introduction of personal computers by IBM in 1970s •Used by academic institutions, handed to the Department of Defense of US 1981. This was followed in the 1990s by a high •ARPANET research and commercial use investment in intangibles, the implementation of the is restricted 1980s hypertext concept and the creation of the first Internet •Development of the TCP/IP, backbone of the current state of internet browsers that came along with the World Wide Web (www.). 10 By 1995 the Internet was still seen as a •Implementation of hypertext concept (jump through documents by clicking) useful tool, but its expensive and complicated 1990s •Creation of the first internet browsers infrastructure related to its use did not allow it to grow and the World Wide Web (www). 11 rapidly at that time.

With the commercialization of the Internet, by the mid 90s the businesses started witnessing a change in their operating mechanisms. By 1994 the e-commerce began to arise with the birth of companies such as eBay and Amazon, which started to form brands trough the Internet selling books, office supplies, music and electronics. In 1998 the e-commerce revenue amounted to around USD$26 billions, 12 which heavily contrast with the USD$1.182 billions in 201613 and the USD$1.777 billons that are expected for 2020. 14

After the “dot-com bubble burst” in 2000, the ITC triggered a revolution. The growth of the digital economy has been much more faster than former technologies. Nowadays the businesses active in the digital economy are not only the retailers of good and services online, but also all the traditional businesses in each industry and sector of the economy: from the telecommunications industry to the

6 See Statista, supra note 4. 7 See Statista, supra note 5. 8 The term transmission control protocol/ Internet protocol within this paper refers to the basic common communication language or protocol of the Internet. 9 Steef Huibregtse and Avisha Sood, digital economy Handbook 2016. Tax, Transfer Pricing and other Legal Aspects of Business configurations (Amsterdam: TPA Global, 2016), p. 36. 10 Neal Friedman, ‘The Legal Challenge of the Global Information Infrastructure’, 2 Cyberspace Law 10 (1998). 11 Ibid. 12 See Statista, supra note 7. 13 Ibid. 14 Ibid. Fabián Acosta version 15 08 2016 4 banking, travel, education and games industries, between others. 15 To illustrate these changes induced by ICTs we can put forward the following examples of new digital business practices: 16

 The Telecommunications Industry that through the 1980s and 1990s was focused on the needs of business enterprises soon changed its scope and began to pay attention to the users. While the operators in the traditional businesses owned the infrastructure, the virtual providers leased only the infrastructure to render the same services directly to the users. Following this, the virtual operators could provide the same or better services spending 3 or 4 times less than the traditional operators. Recently we can think in companies such Skype or Whatsapp that provide all types of telecommunication services (i.e. chat and voice call services). 17

 The Marketing industry that once was entirely focused in providing its services trough conventional communication media such as radio, television, newspapers and magazines, started to advertise through e-mails and websites. On the late 90s these advertisements took the form of online banners, but recently the companies have also started to merge the advertisements with editorial content, online social networking and mobile applications. 18

 The Retail and Manufacturing sectors undergone significant changes. Nowadays it is possible to easily and rapidly access through the Internet various online marketplaces selling clothes, food and electronic devices with high technological specifications. Also with the digital economy the companies are able to monitor the production process, offer costume made products, between other possibilities. These industries currently are using digital “cookies” 19 that allows them to track consumer needs more efficiently. 20

 The Transport and logistics Industries are implementing online applications that enable the user to request and pay the services online and track the vehicles and cargo. In these sectors its possible to put as examples FedEx that was the first company to allow their customers to track their packages online, or Uber that serves as a platform to provide taxi services in most of the major cities of the world. 21

 The games industry that traditionally offer physical products (i.e. monopoly or UNO), nowadays have expanded their possibilities to a world of countless possibilities. With the proper connectivity video games, mobile applications, consoles and massive multiplayer online games are available nowadays everywhere.

The digital economy through technologies such as cloud computing, participative platforms, digital payment systems or personal devices, has allowed new business models and traditional businesses to take advantages of the new technologies, making possible to conduct many types of services at a greater scale and with a world wide range than was previously impossible before.

In the future we can expect to have fully automated technologies and machines that can transfer between each other goods and services when needed, the “Internet of Things” (IoT) that comprises

15 See Huibregtse, supra note 9, at p. 42. 16 Ibid. 17 Ibid. 18 Ibid. 19 Cookies are small amounts of information that are sent back to the server from a user’s web browser whenever he visits it. Cookies were designed to be a reliable mechanism for websites to remember useful information (i.e. products and services added in the shopping cart) or to record the user's browsing activity. 20 Ibid. 21 See Huibregtse, supra note 9, at p. 43. Fabián Acosta version 15 08 2016 5 the plugging to the internet from automobiles, electronics and even entire houses, 22 3D printing, cloud-base processes and virtual currencies (i.e. Bit Coins). All of these new possibilities that are making obsolete the old business models give rise to several challenges from the tax perspective that will be discussed above. 23

2.2. Defining digital economy and e-commerce Defining what constitutes the digital economy is problematic, because of the constant innovation on new technologies and the implementation of new business models within the whole economy and markets. 24 The BEPS Report lacks a comprehensive definition of the digital economy. 25 Instead the Action 1 appears to analyze it putting forward the new business configurations that have been arising in this regard in the last years.

For this purposes the BEPS report states that the digital economy is “the result of a transformative process brought by information and communication technology (ICT), which has made technologies cheaper, more powerful, and widely standardised, improving business processes and bolstering innovation across all sectors of the economy”. 26 Furthermore the BEPS Report characterizes the digital economy through a set of key features which are potentially relevant from a tax perspective: mobility, reliance on data, network effects, the spread of multi-sided business models, a tendency toward monopoly or oligopoly and volatility. 27 In conclusion the term “digital economy” for the OECD comprehends all forms of business models relying mostly on the use of ICTs. 28

Alternatively, the European Commission in the Report of the Commission Expert Group on Taxation of the Digital Economy (CEGTDE) considers that the digital economy is the consequence of the widespread and transformative process brought trough ICT, impacting all sectors of the economy and society: retail, transport, financial services, manufacturing, education, healthcare, media, etc. 29

Before looking further into this matter it might be helpful to define what we mean exactly when using the term “e-commerce”. This term should not be confused with the concept of digital economy, because the former should be considered as comprising part of the latter. In this sense, the digital economy is more general and includes all the digitalization of businesses.

The OECD has defined the electronic commerce, or e-commerce, as “the sale or purchase of goods or services, conducted over computer networks by methods specifically designed for the purpose of receiving or placing of orders”. 30 In this way an e-commerce transaction can be hold between enterprises, individuals, governments or other public or private entities. 31 Therefore e-commerce can include electronic data interchange, online retail and electronic financial services.

22 Peter Friess and Francisco Ibanez, ‘Putting the Internet of Things Forward to the Next Level’, Internet of Things – From Research and Innovation to market Deployment (2014), pp. 3 – 6, at p. 3. 23 Organisation for Economic Co-operation and Development. OECD/G20 Base Erosion and Profit Shifting Project. Action 1: 2015 Final Report. Addressing the Tax Challenges of the digital economy. (Paris: OECD, 2015), p. 54. 24 Ibid. 25 Daniel W. Blum, ‘Permanent Establishments and Action 1 on the digital economy of the OECD Base Erosion and Profit Shifting Initiative – The Nexus Criterion Redefined?’, 69 Bulletin for international taxation 6 (June/July 2015), pp. 314-325, at p. 314. 26 See OECD BEPS Action 1, supra note 23, at p. 11. 27 Ibid. 28 See Huibregtse, supra note 9, at p. 315. 29 European Commision. Commission Expert Group on Taxation of the digital economy Report. (Brussels, 2014), p. 11. 30 See OECD BEPS Action 1, supra note 23, at p. 55. 31 Ibid. Fabián Acosta version 15 08 2016 6

Considering the above, it is the opinion of the author that nowadays it is not possible to define digital economy as a separate part of the conventional economies, but as the entire technologies trough which different markets are carrying their trade of goods and services.

2.3. Business models in the digital economy and e-commerce Businesses in the digital economy are more dependent on Intangibles than traditional business. The transactions are driven by content production and electronic services over the Internet. There are different forms in which the businesses can be configured; the main following distinction is made when discussing this kind of transactions: 32

 Business-to-Business (B2B): This configuration can include transactions where a wholesaler purchases consignments of goods online, which then it sells to consumers from retail outlets. Another configurations may be web-hosting or content management services.

 Business-to-Consumer (B2C): This configuration denotes the most traditional transactions between a business and a final consumer. The goods or services may include tangibles (i.e. DVDs or clothes) or intangibles (i.e. Music or images in electronic format).

 Consumer-to-Consumer (C2C): This configuration is trending in the last years, where businesses involved in C2C transactions play the role of intermediaries. For example peer-to-peer systems allowing sharing files between users or marketplaces allowing the negotiation between customers.

Although there can be new types of business configurations, most of the time are a combination of the above-mentioned traditional configurations. They are known as multi-sided businesses as they cover more than one segment of users. Multi-sided businesses create value by grouping multiple participants that work together in order to develop a project or intangible that is going to be useful for all the participants. These platforms are playing an important role in different industries such as online payments, advertising and transportation. 33 Multi-sided platforms create value by bringing two or more economic agents together facilitating interactions between them and by coordinating the multiple groups’ agents.

As an example we can mention Uber that is a platform for ride sharing, where passengers connect with taxi drivers trough an application and pay their rides online. In this multi-sided business no money change hands, Uber is in charge of the advertising and to provide incentives to the drivers (keeping a small percentage of each ride), while the taxi drivers provide the transportation services and owns the vehicles. 34

A unique feature of the above mentioned business models, is that they could offer free services and still has profits. For instance, customers can enjoy a free service (i.e. access to a web page) in exchange for personal data used by the company involved in the digital business to sell targeted advertisements to other businesses (i.e. banners placed in their web pages). In this way there is no profit collected from the users, but there is revenue gathered from the advertisements that other companies may use.

The unique nature of the digital economy business models allows companies to engage in tax planning and avoidance practices, which will be analyzed broadly in the next section and specifically in the next chapter (section 3.2 below).

32 Ibid. 33 See Huibregtse, supra note 9, at p. 66. 34 Ibid. Fabián Acosta version 15 08 2016 7

2.4. Challenges of taxing the digital economy

Already in the early stages of the e-commerce the governments, the media and the individuals realized about the tax issues related to the digital business practices that proven to have a high mobility, a global reach and a easily relocation of business functions. Initial work came from US that following several proposals for specific Internet taxes such as the “Bit Tax”35 or the “Clinton E-card proposal”, issued the Internet Tax Freedom Act of 1998 to ensure that no consumption tax can be introduce to the e-commerce. 36

Also in 1998 the OECD concluded the Ottawa Ministerial Conference, where was discussed how to deal with the tax issues related to e-commerce. 37 In the Conference the OECD set up a Technical Advisory Group (TAG) to monitor the application of existing treaty rules in the context of e-commerce. The conference turned out in the reconciliation of some principles in order to settle a common framework of conditions for the governments to sign, called the “Ottawa Taxation Framework Conditions”. The five conditions on the taxation of e-commerce are the following: i) neutrality; ii) efficiency; iii) certainty and simplicity; iv) effectiveness and fairness; and v) flexibility. In the following years the TAG issued several reports and discussion drafts focusing on achieving a common international consensus in the taxation of profits arising in e-commerce transactions. 38

After 13 years, when the digital economy is growing an accelerated rate and many businesses configurations are created every day, the OECD in July 2013 released the BEPS Action Plan containing 15 actions where the issues of the taxation of the digital economy were one of the main items to be examined. 39 Then a discussion Draft was released in 2014 where the OECD identified certain challenges and recommendations related to the digital economy in the ground of direct and indirect taxation. Finally in October of 2015 the OECD issued the final report regarding the digital economy (hereby the Final Report), the BEPS issues and its tax challenges.

In general, the Action 1 of the OECD BEPS Final Report identifies the following issues: i) Definition and exceptions related to the PE concept; ii) characterization of income; iii) jurisdiction of the taxable income; iv) relevant nexus in the form of a significant economic presence; v) the collection of Value Added Tax (VAT)/ Goods and Services Tax (GSM); and vi) Withholding Tax on certain types of digital transactions. The following chapter will discuss these issues in relation with the proposed solutions and recommendations address by BEPS in the digital economy (section 3.3 below).

As a final point it should me mentioned that various countries have been trying to solve the challenges of the digital economy using their own domestic law, what most of the times brings international repercussions due to the global reach of the digital economy. The solutions proposed unilaterally by these countries have consequences in both direct and indirect taxes. As an example we can mention the U.K. Diverted Profit Tax40, the Italian Web Tax 41 and the Bandwidth Tax 42 that are going to be

35 Arthur J. Cordell, ‘New Taxes for a New Economy’, 2 Government Information in Canada/Information gouvernementale au Canada 4 (May 1996). The “Bit Tax” applies to bits of electronic information being transferred. 36 Department of the Treasury, Selected Tax Policy Implications of Global Economic Commerce (United States, Washington, D.C. : Dept. of the Treasury, Office of Tax Policy, 1996). The proposal is that consumers can buy E-cards in physical retail stores or online to spend digitally via Internet. 37 Organisation for Economic Co-operation and Development, Comitte on Fiscal Affairs, Electronic Commerce Taxation Framework Conditions (Canada: OECD, 1998). 38 Discussion draft on “Attribution of Profit to a Permanent Establishment Involved in Electronic Commerce Transactions” released in 2001, “The Impact of the Communications Revolution on the Application of Place of Effective Management as a Tie Breaker Rule” released in 2001 and “Place of Effective Management Concept: Suggestions for Changes to the OECD Model Tax Convention”, released in 2003. 39 Organisation for Economic Co-operation and Development, Action Plan on Base Erosion and Profit Shifting (Paris: OECD, 2013), p. 13. 40 Introduced in the UK Finance Act of 2015, issued by the Commons of the United Kingdom in Parliament Fabián Acosta version 15 08 2016 8 analyzed in chapter four “Current framework, recent developments and implementations” below.

Despite some of the current trending initiatives deal with taxes over consumption (i.e. VAT/GSM), that are out of the scope of this paper, the states are also facing challenges related with significant digital presence, characterization of income and nexus that are related with direct taxation as we will see in the next chapter.

3. OECD BEPS final report and current framework

3.1. In general The society have criticized a number of huge MNEs and companies that have substantially reduced their taxes by shifting assets to tax havens or low tax jurisdictions and their losses to high tax jurisdictions43. As an answer to this unfairness and distortions caused by tax avoidance and with the intention to protect governmental revenue, the OECD issued on October 2015 the BEPS Final Report44. As mentioned before the BEPS Report contain 15 overlapping actions in order to introduce coherence in the domestic rules of all the OECD and non-OECD members that affect international transactions reinforcing mainly substance requirements, decreasing double-taxation, promoting transparency and trying to attain consensus to determine measures that diminish the BEPS of the tax base. 45

This chapter is aimed at identify the main items and current framework put forward by the BEPS Action 1 Final Report in the digital economy context. While section 3.2 addresses the tax challenges of the digital economy identifying the key features, the tax planning opportunities and the tax policy concerns of the digital economies. Section 3.3 addresses the recommendations and options proposed by the BEPS Final Report.

3.2. Addressing the tax challenges of the digital economy

Action 1 was released in order to deal with the challenges of the digital economy, considering that in the own words of the OECD its “increasingly becoming the economy itself”. 46 For this reason it is specified in this Report that it is impossible to alienate the digital economy from the rest of the economy for tax purposes. In this way the OECD instead of suggest options and a different tax system exclusively for the digital economies, identifies issues in both direct and indirect taxes and propose recommendations that address these challenges.

The Action 1 largely follows the initial public discussion draft released by the OECD on September of 2014. 47 The Final Report that exceeds the 2014 deliverable by 88 pages provides the OECD conclusions and recommendations regarding the next steps to address the digital economy challenges in the future.

The challenges of the digital economy discussed in the Action 1 Final Report are the consequence of

assembled. 41 Luigi Quaratino, ‘New Provisions Regarding the Taxation of the digital economy’, 54 European Taxation 5, (9 April 2014), pp. 211-217, at p. 211. 42 See Cordell, supra note 35. 43 Sean Rosenthal, ‘The OECD’s International Tax Proposal; The Action Plan’, 33 Review of Banking & Financial Law (2014), pp. 20 – 29, at p. 20. 44 Ibid. 45 See Rosenthal, supra note 42, at p. 23. 46 See OECD BEPS Action 1, supra note 23, at p. 11. 47 Organisation for Economic Co-operation and Development, Public Discussion Draft Addressing the Tax Challenges of the digital economy (Paris: OECD, 2014). Fabián Acosta version 15 08 2016 9 the vast and increasingly amounts of economic activity and cross-border commerce that is occurring beyond the reach of the local tax authorities. In the particular point the BEPS Project focuses on the current framework in order to make proposals and conclusions in the equitable allocation of profits by country and the possibility to reach profits that currently are not taxed (i.e. stateless income).

In general, the tax issues related to business activities in the digital economy arise from the following three aspects: i) the high reliance on data (information and communication technologies), which reduce the need to be physically present for business operations in the source country; ii) the importance of intangibles (such as IP rights); and iii) the segregation of the value creation chain. 48

Action 1 states in relation with the direct tax issues that these challenges should be effectively addressed within the scope of the recommendations of other BEPS Actions. The Report recognizes that while many strategies used by the taxpayers in the context of direct taxation are similar to those used by more traditional businesses, the key features of the digital economy increases the related BEPS risks. Therefore, the BEPS initiative in relation with direct taxation is intended to change the global environment to ensure the coherence of corporate income taxation (CIT) at the international level. 49

In relation with the indirect tax challenges the Final Report recommend to apply the principles of the OECD International VAT/GST Guidelines released in November 201550 as well as consider the introduction of the collection mechanisms included therein. 51

The Final Report acknowledges that the conclusions may evolve as the digital economy continues to grow in the future, which means for the OECD that the countries must continue monitoring the new developments in the area and analyzing the data that will become available with the evolution of the digital economies. It also states that the TFED will continue studying the completion of the work on the BEPS Project. For this purposes the TFED will consult a broad range of stakeholders and design an inclusive post-BEPS monitoring process, in order to provide in 2020 a report reflecting these outcomes. 52

3.2.1. Key features of the digital economy Action 1 identifies certain key features potentially relevant from a tax perspective of the business models emerged in the digital economy that can trigger risks addressed by BEPS. While all the key features may not be present at the same time in one transaction, they characterize overall the digital economies and the modern economy. 53 It should be noted that the emerging technologies such as the IoT, virtual currencies, robotics and·3-D printing are currently affecting these key features, making evolve rapidly the current business models. 54 These technologies are configuring additional challenges due to the difficulty to anticipate all potential issues55 and characterize the key features of the digital economy.

48 See Blum, supra note 25, at p. 315. 49 See Blum, supra note 25, at p. 314. 50 Organisation for Economic Co-operation and Development. International (VAT/GST) Guidelines (Paris: OECD, 2015). 51 Channing Flynn, Stephen Bates and Rob Thomas, ‘OECD issues final report on the tax challenges of the digital economy under Action 1’, Global Tax Policy and Controversy Briefing. Special edition: BEPS final recommendations 17 (March 2016), pp. 36-43, at 36. 52 See OECD BEPS Action 1, supra note 23, at p. 11. 53 The Report on digital economy of the European Union characterize the digital economy trough the key features of mobility, network effects and use of data, leading aside the multi-sided business models, tendency towards monopoly and oligopoly and volatility, discussed in Action 1 of the BEPS Report by the OECD. 54 See Flynn, Bates and Thomas, supra note 51, at p. 38. 55 Ibid. Fabián Acosta version 15 08 2016 10

The current key features of the digital economies discussed in the Action 1 of the BEPS Report are the following:

 Mobility: with respect to intangibles (on which the digital economy relies heavily), users (that could be situated anywhere around the world), and business functions (considering the huge flexibility of allocation of the local personnel to perform functions).

 Reliance on data: including collection (i.e. customers, users, suppliers and operations), analysis (i.e. identifying trends, quantity, performance, segmentation and prices) and storage (which create value due to the possibility to support decisions and mitigate risks).

 Network effects: related to the fact that decisions of users may have a direct impact (negative or positive) on the benefit received by other users56 (understood with reference to user participation, integration and synergies). 57

 Multi-sided business models: In accordance with the Action 1 Report is a configuration in which multiple distinct groups of persons interact through an intermediary or platform, increasing flexibility (facility to design and implement multi-sided business models) and reach (businesses in the digital economies can more easily connect two sides that are located far from the other). 58 In this business model, in accordance with the OECD, two sides of the market may be in different jurisdictions. 59

There are two categories: First, a business can operate several applications that provide complementary services (i.e. activities that put together in a package is more attractive for users). Second, a business can operate in vertical platform models, which make resources available for third-party developers60 (i.e. apple store).

 Monopoly or Oligopoly: the digital economies have the tendency towards these market structures due to the exclusive ownership of intangibles (i.e. platforms, applications and software) and the preference of users to the same provider (i.e. Google, Facebook and Uber).

 Volatility: low barriers and rapidly developing technology.

These key features lead to the possibility to create business structures to reduce or eliminate tax in jurisdictions in the whole supply chain. As an example the intangibles, combined with the mobility of the digital economies across jurisdictions, generates substantial BEPS opportunities in the area of direct taxation. These opportunities might take the form of minimization of functions, assets and risks, avoidance of the taxable presence or, if there is, of profit shifting and erosion of the taxable base.

Derived from the above, it should be noted that resulting from the key features of the digital goods and services, the physical presence of a company in the source country is often not needed. This is

56 Customers that join a particular platform, such as content-based movie sharing (i.e. Netflix) or games (i.e. World of Warcraft through battle.net) increase its value by joining it. In this way the current members can be positive affected from the next members without having to pay a compensation for it. In these platforms if there are more users in a specific region they can add more content or additional features depending on the new subscribers. 57 See OECD BEPS Action 1, supra note 23, at p. 65. 58 See OECD BEPS Action 1, supra note 23, at p. 72. 59 See Flynn, Bates and Thomas, supra note 51, at p. 38. 60 See OECD BEPS Action 1, supra note 23, at p. 72. Fabián Acosta version 15 08 2016 11 changing the traditional businesses configurations where some activities must be carried out in the source country in order to make profits (i.e. marketing, personnel selling the goods or rendering the services, equipment or facilities). This means that while the digital economy keep expanding its boundaries in the markets; the traditional businesses are being digitalized as a consequence of the low prices that can be achieved through the ICTs.

3.2.2. Identifying tax planning opportunities in the context of direct taxation Recently the Panama leaks in addition to other issues involving Swiss Leaks and Lux Leaks and the investigations against tech giants such us Google, Apple and Starbucks, have remind us the large scale of aggressive tax planning practices seeking to BEPS tax revenues. In particular the European Union (EU) Commission in 2015, opened an anti-trust investigation on Google for abuse of its dominant position and hindered its competitors from growing or entering the market.61 In 2014, the EU Commission launched a state aid investigation against Apple and Starbucks to examine whether Transfer Pricing arrangements on corporate taxation offered by Ireland and the Netherlands would violate the EU’s state aid rules. 62

These tax-planning strategies are leading to competitive disadvantages for companies that lack the opportunity to engage in sophisticated planning schemes, undermine the integrity of the tax system, and harms the revenue goals of the different jurisdictions. Action 1 underlines the concerns expressed in the BEPS Action Plan of 2013, related to the tax planning opportunities triggered by the digital economies. Despite many of the strategies are also used in the traditional business configurations; the digital economies may intensify the risks of BEPS due to its particular key features. 63

In the context of direct taxation, the Report specifies four core elements derived from the tax planning strategies associated with digital economy and BEPS. These goals in the framework for the analysis of the digital economies have a strong connection with the exercise of the tax sovereignty of the source country. Their exponential growth as consequence of tax planning strategies and the changes to the traditional business configurations require prompt action. 64

These four core elements can be described as follows:

3.2.2.1. Eliminating or reducing tax in the source country

This core element is derived from the: i) avoidance of the taxable presence in one jurisdiction, or in case there is, by ii) minimizing the income allocable to functions, assets and risks in the source jurisdiction or by iii) maximizing deductions thereto.

Avoiding the taxable presence is the consequence of the key features of the digital economy, which allows business configurations to be related with customers in a different jurisdictions thought a website, application or other technological source without a physical presence in that country. The tax planning opportunity arises because most of the domestic laws of the countries worldwide require

61 http://europa.eu/rapid/press-release_MEMO-15-4782_en.htm, accessed on 18 July 2016. European Commission. Antitrust: Commission opens formal investigation against Google in relation to Android mobile operating system (Brussels, EU Commission, 2015). 62 http://europa.eu/rapid/press-release_IP-14-663_en.htm, accessed on 18 July 2016. European Commission. Antitrust: State aid: Commission investigates transfer pricing arrangements on corporate taxation of Apple (Ireland) Starbucks (Netherlands) and Fiat Finance and Trade (Luxembourg) (Brussels, EU Commission, 2014). 63 See OECD BEPS Action 1, supra note 23, at p. 78. 64 Peter Hongler and Pasquale Pistone, Blueprints for a new PE nexus to tax business income in the era of the digital economy (Amsterdam: IBFD White papers, 2015), p. 9. Fabián Acosta version 15 08 2016 12 certain degree of physical presence in order to tax a specific activity. 65 Also due to the fact that Articles 5 and 7 of the OECD Model 2014 and of the UN Model 2011 gives the taxable power to the country of the source if there is a PE located therein.

When the taxable presence is already established taxpayers minimize income allocable to functions, assets and risks by structuring the business activities with a little taxable profit. The possibility to allocate income creates incentives to avoid the real intention of the parties’ trough contractual arrangements. For example allocate or transfer the ownership of intangibles or hard-to-value intangibles (HTVI) (i.e. servers, applications or websites) to other group members located in jurisdictions with low tax rates. Usually in this kind of structures the taxpayers use agents in the source country that don’t have the possibility to conclude contracts on behalf the company, but perform all other functions. 66

In the context of the digital economies when there is a significant presence in one jurisdiction, taxpayers use business structures that allow them to reduce the taxable income by maximizing the deductions. These deductions take the form of royalty and interest payments or service fees that are made to other group members located in different jurisdictions. 67 For example payments for the use of intangibles (i.e. servers, applications or websites) or intra group services (i.e. service desk or human resources management) that the subsidiary or the PE have to make to another affiliate company due to the ownership that the latter have on these assets.

3.2.2.2. Low or no withholding tax at source

The avoiding of withholding taxes in the digital economy can be achieved using the tax treaty network of the countries involved in a business transaction, under the form of interest or royalties. These payments can be exempt or reduced depending in the particular tax treaty and are usually made to low-tax jurisdictions. 68 These structures that involve treaty shopping by interposing shell companies in countries with a favorable treaty network, usually lack of sufficient anti avoidance mechanisms such as Limitation of Benefits (LOB) or Controlled foreign corporation (CFC) rules.

The digital economy also facilitates payments made by customers in a particular jurisdiction to taxpayers providing digital services in another jurisdiction through cloud platforms or digital currencies (i.e. Bit Coins). When the transaction is structured in this way the digital service provider can avoid more easily a significant physical presence in the source country. 69 Therefore without a taxable presence or nexus to the source country the Withholding Tax cannot be levied.

3.2.2.3. Low or no taxation at the level of the recipient

It is achieve by eliminating or reducing the tax in an intermediate country (i.e. Regional Hub) through low-tax jurisdictions, preferential domestic tax regimes, hybrid mismatch arrangements, or excessive deductible payments made to related entities. 70 In these structures the companies shift profits into low-tax jurisdictions or countries with preferential regimes, with entitlement to extensive non-routine profits often build-up via intra-group arrangements. 71

Within the framework of the digital economy the taxpayers can more easily shift profits related to the rights in intangibles with other associated enterprises. Due to the key features of the digital economies

65 See Huibregtse, supra note 9, at p. 99. 66 See OECD BEPS Action 1, supra note 23, at p. 80. 67 See OECD BEPS Action 1, supra note 23, at p. 80. 68 See OECD BEPS Action 1, supra note 23, at p. 81. 69 See Huibregtse, supra note 9, at p. 101. 70 See Flynn, Bates and Thomas, supra note 51, at p. 39. 71 See OECD BEPS Action 1, supra note 23, at p. 81. Fabián Acosta version 15 08 2016 13 the companies may allocate functions, assets and risks to related parties situated in favorable tax jurisdictions. As explain before, the taxpayers may also reduce tax by generating deductible payments in form of royalties, interest or services with other associated enterprises located in low or no-tax jurisdictions. 72 The same effect takes place by using hybrid mismatch arrangements to generate deductible payments without the corresponding inclusion in the country of the recipient. 73

3.2.2.4. Elimination of current taxation

The same tax planning opportunities are identified to eliminate or reduce tax in the country of residence of the ultimate parent company of the group. While group members situated in the source or market country are claimed to have a marginal remuneration, all the remaining profits are attributed to the legal owner of the intangibles or HTVI.

Furthermore the MNEs may avoid taxation in the resident country of the ultimate parent if that jurisdiction has an exemption or deferral system for foreign-source income, has a deficient CFC regime, 74 has a regime that does not cover certain categories of passive or highly mobile income (i.e. intangibles) or has some rules that can be easily avoided through hybrid mismatch arrangements. 75

In the following figure the tax planning opportunities in the digital economy that where described above, are summarized:

Figure 2: summary of the tax planning opportunities in the digital economy context

Considering the tax planning opportunities recognized by BEPS within the framework of the challenges of the digital economy (Action 1) have a correlation with other Actions, in order to restore taxation in the context of the digital businesses, the deliverables regarding the neutralization of the

72 Ibid. 73 See OECD BEPS Action 1, supra note 23, at p. 82. 74 Kimberly A. Clausing, ‘Who Pays the Corporate Tax in a Global Economy?’, 66 National Tax Journal 1 (March 2013), pp. 151-184, at p. 178. 75 Ibid. Fabián Acosta version 15 08 2016 14 effects on Hybrid Mismatch Arrangements (Action 2); the strengthening and implementation of CFC legislation (Action 3); the counteraction of the Harmful Tax Practices (Action 5); the artificial avoidance of a PE (Action 7); and the Transfer Pricing concerns and reporting (Actions 8-10 and 13) will be particularly relevant. The recommendations will be discussed in section 3.3.1 below.

3.2.3. Tax policy concerns in the area of direct taxation In the area of direct taxation, the Action 1 identifies that the digital economy gives rise to a number of challenges in tax policy concerns. The OECD states that these challenges are not limited to domestic law and international tax policy, but touches areas such international privacy law, data protection, accounting regimes and regulations. 76 The new business structures that come along with the digital economies allow the taxpayers to reduce or avoid taxation on profits that in the traditional business were taxed.

With the digital economy non-residents now are allowed to sell their products and provide their services without having a physical presence in the source country. Despite in the traditional businesses this was possible (i.e. through agents) with the advances of the ICTs, now than ever before, this possibility is being expanded to markets in all the corners of the world with the additional possibility to easily allocate functions, assets and risks across different jurisdictions. Currently the digital economies have allowed managing centrally and remotely many activities that used to require local presence, such as procurement, inventory management, local marketing, advertising, branding, customer support and other activities indispensably performed in the source country. 77

The fact that with the digital economies less or none physical presence is required in the source country, have amplified the challenges for international taxation. The challenges arise from nexus, data and characterization. In general these concepts are related to the difficulty to define tax jurisdiction, attribute value to data created by users and to characterize the nature of the transactions (i.e. royalties or services). As an example of the issues arising from the digital economy, the MNEs use the exceptions of Art. 5.4 OECD Model 2014 and UN Model 2011 to avoid the PE status, use preferential regimes such as patent boxes for tax purposes rather than for research and development (R&D), engage in treaty shopping to shift taxable revenue to low-tax jurisdictions or tax havens and exploit the beneficial restrictions of the tax treaties creating shell companies.

Following this, the main policy concerns raised by the digital economy, can be portrayed in three broad categories:

NEXUS DATA CHARACTERIZATION

Ability to have significant digital Attribution of value created from the Characterization of the income in presence without being liable to tax generation of data through digital the context in the new digital and rules for attribution of profits in products and services. business models. cross-boarder transactions. Determining the share of profit attributable to these values.

3.2.3.1. Nexus

The digital economy has enhanced the ability to carry out activities remotely and more efficiently due to the possibility that the new technologies bring when analyzing and using data. At the same time has reduced the barriers to trade between markets, increasing exponentially the number of potential customers. As a result, activities that used to demand physical presence, now are carried out by

76 See OECD BEPS Action 1, supra note 23, at p. 98. 77 Ibid. Fabián Acosta version 15 08 2016 15 automated technologies or personnel situated in a different country, what at the same time is lowering down the need for facilities, infrastructure and local staff in the source country. 78 Considering the new opportunities that the digital economy brings, businesses now are allowed to choose where substantial activities take place and how value creation chains are settled. 79

The continual increase in the potential of digital technologies and the reduced need in many cases for extensive physical presence are facts directly related with the definition of PE for treaty purposes and the rules for attribution of profits (Arts. 5 and 7 OECD Model 2014 and UN Model 2011). This raises questions regarding whether the existing definition of PE remains consistent with the purpose80 on which it was based and whether the preparatory and auxiliary activities as exceptions to the definition of PE (Art. 5.2 OECD Model 2014 and UN Model 2011) are justified under the key features of the digital economy. 81 Finally, another issue that must be analyzed is whether the current rules to determine nexus with a jurisdiction for tax purposes are appropriate both for tax treaties purposes and regarding the definition of nexus under domestic laws. 82

3.2.3.2. Data digital economy relies in the collection, storage and use of data. It is gathered from users, consumers and other sources of information remotely and from long distances. The growth in sophistication of ICTs has permitted now than ever before to gather and use the information across borders to an exceptional degree. Data in the context of the digital economy can be collected effortlessly and proactively through social networks, cloud computing and cookies83 stored in the user’s web browser. 84 Data is allowing the companies using ITCs to easily identify trends, quantity, performance, segmentation and prices.

This raises some issues regarding the attribution of value created from the generation of data through digital products and services, the determination of the share of profit attributable to these values and how to characterize for tax purposes a person or entity supplying data in a transaction. Additional issues are presented by the increasing prominence in the digital economy of multi-sided business models, where several companies may contribute for the collection of data depending on the others ability to attract customers. 85

Therefore the questions within the tax challenges arising from data in the digital economy, must be whether the remote collection of data should give rise to nexus for tax purposes? What is its value and how can be determined? And what impact this would have on the application of Transfer Pricing86 and profit attribution principles? 87

78 See Huibregtse, supra note 9, at p. 101. 79 See Blum, supra note 25, at p. 314. 80 Sec. 1 of OECD Comm. on Art. 5 establish that the purpose of the concept of a PE is to determine the right of a Contracting State to tax the profits of an Enterprise of the other Contracting State. It should be noted that under Art. 7.1 OECD 2014 a Contracting State cannot tax the profits of an enterprise of the other Contracting State unless it carries on its business through a PE situated therein. 81 See OECD BEPS Action 1, supra note 23, at p. 101. 82 See OECD BEPS Action 1, supra note 23, at p. 102. 83 Maya Bacache et al., Taxation and the digital economy: a survey of theoretical models (Paris: France Stratégie, 2015); Alan J. Auerbach and Michael P. Devereux, Consumption and Cash-Flow Taxes in an International Setting (Oxford: Oxford University Centre for Business Taxation, 2012), p. 18. Cookies are small amounts of information that are sent back to the server from a user’s web browser whenever a user visits it. Cookies were designed to be a reliable mechanism for websites to remember useful information (i.e. products and services added in the shopping cart in an online store) or to record the user's browsing activity. 84 Ibid. 85 See OECD BEPS Action 1, supra note 23, at p. 103. 86 Which in turn require an analysis of the functions performed, assets used and risks assumed. 87 The fact that the value of data can impact tax results places pressure on the valuation of data. Fabián Acosta version 15 08 2016 16

3.2.3.3. Characterization

Products and services can be provided to customers all around the world in new ways through digital technology. The development of new digital products or means of delivering services raises new questions about how to characterize income derived from new business models.

For example, the OECD commentary does not bring any consideration about the characterization for the activities of application hosting or cloud computing. Then the question for tax treaty purposes should be whether these payments should be royalties (under Art. 12.2 OECD Model 2014, includes payments for the use of, or the right to use, any copyright, patent, trade mark, design or model, plan, secret formula or process or for information concerning industrial, commercial or scientific expertise) business profits (under the scope of Art. 7 OECD Model 2014) or other type of payment (i.e. technical services). 88

Nowadays 3-D printing is also raising characterization questions. For example, when the companies are selling their products, they are at the same time providing the users with the license of their designs for the products purchased? Under what circumstances these payments can be classified as royalties? Or as it is in the traditional selling of goods, the payments should be business profits?89

Another interesting example will be the multiplayer online games90 were most of the time you do not have to pay to participate in the virtual worlds, but in the course of playing the participants need items (such as armor, weapons or virtual currency) that have value in and outside the game (considering that participants may accept real money for transferring such items). Then the question will be whether incomes from the transfer of such property, rights and items is taxable and if it is, which will be the jurisdiction where the user is liable to tax.

3.3. Tackling BEPS in the digital economy and addressing alternatives The BEPS Action Plan in order to put an end to the “stateless income” (income that is taxed nowhere or taxed at extremely low rates in a country in which the income is not earned), 91 sets out key recommendations and options in number of areas related to the challenges arising from the tax planning opportunities and tax policy concerns mentioned in the last sub-chapter (section 3.2 above). The recommendations relate other actions of the BEPS Report and are made at the level of both the source (market) country and the jurisdiction of the ultimate parent company. The options to address the broader direct tax challenges instead of target the nexus, data and characterization individually, are focused on the ability of businesses in the digital economy to i) derive sales income from a country without a physical presence, and ii) use contributions of users in the value chain. 92

3.3.1. Recommendations that will address BEPS issues in the source and ultimate parent jurisdictions As was discussed before, Action 1 states in relation with the direct tax issues that these challenges should be effectively addressed within the scope of the recommendations of other BEPS Actions. The report recognizes that while many strategies used by the taxpayers in the context of direct taxation are

88 See OECD BEPS Action 1, supra note 23, at p. 104. 89 See OECD BEPS Action 1, supra note 23, at p. 105. 90 Such as Word of Wardcraft (For PC), The Elder Scrolls (For Play Station), Star Wars Heroes (Mobile Application), between others. 91 Edward D. Kleinbard, ‘Stateless Income, 11 Florida Tax Review 9 (2011), pp. 700-770, at p. 701. “Income derived by a multinational group from business activities in a country other than the domicile (however defined) of the group’s ultimate parent company, but which is subject to tax only in a jurisdiction that is not the location of the customers or the factors of production through which the income was derived, and is not the domicile of the group’s parent company” 92 See OECD BEPS Action 1, supra note 23, at p. 106. Fabián Acosta version 15 08 2016 17 similar to those used by more traditional businesses, the key features of the digital economy increases the related BEPS risks. The measures recommended by BEPS can be illustrated in summary in the following table:

ULTIMATE RESIDENCE SOURCE (MARKET) JURISDICTION JURISDICTION N/A  Strengthening and incorporating CFC Rules  Implement CFC rules addressing CFC Rules (Action 3) taxation of mobile income (digital goods and services provided remotely)  Model rules (LOB and PPT) to tackle N/A tax treaties abuse  Minimum standard to address treaty shopping Treaty Abuse (Action 6)  Rules preventing structures involving dual resident companies  Denial of treaty benefits in cases of double non-taxation  Modification of PE definition N/A  Modification of the list of exceptions to PE Status (Action 7) the PE definition  Introduction of anti-fragmentation rule Hybrid Mismatch  Neutralization of the effects of hybrid mismatch arrangements Arrangements (Action 2)  Rules to prevent double non-taxation, long-term deferral and income-stripping Deductions and Other  Limit base erosion via interest deductions and other financial payments Financial Payments  Agreed framework for best practices in the design of domestic rules (Action 4)  Fixed ratio rule that limits a percentage of its earnings before EBITDA Harmful tax practices  Requirement for substantial activity for any preferential regime (Action 5)  Counter harmful tax practices more effectively  Bring the allocation of income within a MNE more directly in line with the location of the economic activity that gives rise to that income, through the evaluation of: i) the transfer and use of intangibles including HTVI and cost contribution Transfer Pricing (Actions arrangements; ii) the delineation of the actual transaction; and iii) global value 8-10 and 13) chains and transactional profit split methods.  Through the CbC reporting BEPS calls on MNEs to report financial information, regarding their Transfer Pricing in every country they operate.

Considering that some of the recommendations provided by BEPS tackle broadly the tax challenges of the traditional businesses and indirectly the issues of the digital economy, following the author selected the recommendations that are more related with the tax planning opportunities and tax policy concerns in the context of the digital economies. For these purposes first a brief explanation will be provided and then the recommendation will be analyzed using for discussion purposes examples in the context of the digital economy.

3.3.1.1. CFC rules

The OECD on Action 3 provides recommendations in the form of six building blocks, including a definition of the CFC income and a non-exhaustive list of approaches that could be used in order to define it. In the context of digital economy importance is given to the mobility of such income due to the importance of intangibles in the provision of goods and services in the digital economies and the Fabián Acosta version 15 08 2016 18 relatively few people required to carry out most of the activities.

For example a MNE involved in the digital economy can earn income in a CFC located in a low-tax jurisdiction by allocating key intangibles or HTVI therein. In this way the intangibles can be used by the MNE to sell digital goods and services without the necessity that the income generated in the CFC jurisdiction is subject to income tax, as the CFC usually does not perform any significant activity therein. In addition, in this kind of structures due to the huge mobility of the digital economies it is possible to undertake the selling of goods and services in the source country without the necessity of having significant people functions to carry out most of the activities, what leads to the absence of a physical presence in this market country. Therefore, in the digital economy a MNE may pay little or no tax in the CFC jurisdiction and avoid tax in the source country and in the ultimate parent jurisdiction.

In order to tackle the above-mentioned issues, the BEPS Report recommends taxing income derived from the digital economy in the jurisdiction of the ultimate parent company. For these purposes countries could use the categorical analysis approach, including types of revenue generated in the digital economies transactions (i.e. license fees and income from sales of digital goods and services rendered remotely) in the definition of CFC income. Alternatively, countries adopting the excess profits approach, could characterize any excess generated in low-tax jurisdictions as CFC income. In the last approach the indefinite deferral structures of foreign source income in the country of the residence of the taxpayer can be avoided. 93 The Report recommend use a substantial economical test in combination with the above approaches. 94

3.3.1.2. PE status

The PE concept represents the source state’s threshold for the right to tax and is decisive to determine whether a state has the right to tax income generated by a non-resident. It is a key concept at an international level and for the digital economy, as realign taxation and the nexus for business transactions. 95 The OECD Actions 1 and 7 propose the following recommendations to address the challenges introduced by the digital economy in relation with the PE status:

Changes to the Exceptions to the Definition of PE One of the options to address the tax challenges of the digital economy is to modify the existing list of exceptions to the definition of PE stated in Art. 5.4 OECD Model 2014, related to the fixed premises of a preparatory and auxiliary nature. The recommendation96 is that the modification includes specifically in the article of the Model Treaty that the exceptions must be in fact preparatory or auxiliary. 97 The proposal arises due to the evolution of the new business and value creation models that in the context of the digital economies can easily circumvent core functions trough the list of exceptions. 98

For a company involved in the digital economy the activities that used to be relevant in the traditional

93 See OECD BEPS Action 1, supra note 23, at p. 93. 94 See Flynn, Bates and Thomas, supra note 51, at p. 41. 95 See Blum, supra note 25, at p. 315. 96 One of the options stated in the Action 1 discussion draft was to remove the list of exceptions, however this drastic measure could not be found in the proposal of Action 7 and probably was going beyond what was necessary to secure the intended policy objective. A second option was to delete the exceptions (a) to (d) of the OECD Model, as they were the targets of the businesses in the digital economy. None of these options was considered at the end. 97 Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Action 7: 2015 Final Report, Preventing the Artificial Avoidance of Permanent Establishment Status (Paris: OECD, 2015), p. 29. The modification is drafted at the end of the list of exceptions of Art. 5.4 OECD Model 2014, in the following way: “provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character” 98 See Blum, supra note 25, at p. 316. Fabián Acosta version 15 08 2016 19 business configurations in order to determine the existence of a physical presence in the source country may be different. For instance, the use of facilities solely for the purpose of storage or delivery of goods or merchandise that is contemplated within the exceptions for the existence of a PE of Art. 5.4. OECD Model 2014, do not have the same importance in the traditional business configurations than in the digital economy. In the context of the digital economy a warehouse is more relevant, as the digital companies usually does not have any stores in the source country because the entire activity is conducted through the Internet. Therefore for these companies some core businesses are easily circumvented through the exceptions contemplated in Art. 5.4. OECD Model 2014, avoiding in this way the existence of a PE in the source country.

For this purposes the BEPS Report recommends to modify the exceptions to the definition of PE including that they must be in fact preparatory or auxiliary. Thus the companies involved in the digital economy are not going to be able to circumvent core activities through the exceptions contemplated in Art. 5.4. OECD Model 2014 as they must evidence that the activities are preparatory or auxiliary in nature.

New Anti-Fragmentation Rule A second option that could be implemented together with the modification to the exceptions to the definition of PE is to include an anti-fragmentation rule to ensure that it is not possible to benefit from these exceptions through the fragmentation of business activities among related parties. 99 The expected result is that significant components of transactions in the digital economy, which are part of the core business of these new configurations, cannot be entitled to get a benefit from these exceptions. 100

Taking into consideration the example described above, the maintenance of a warehouse with the intention of storing and delivering goods sold online by an online seller whose business relies on the proximity to customers and the efficiency of delivery would constitute a PE for the latter company under the new standard, even though the activity is solely performed by a related party.

Modifying the PE Definition In addition to the above options, the OECD agreed to modify the definition of PE to address the cases in which artificial arrangements related to the sales of goods and services of one company in a MNE effectively result in the conclusion of contracts. In this way the sales should be treated as if they had been actually made by that company.

The Final Report provides an example describing a case where the sales force of a local subsidiary of an online seller of tangible products usually plays the principal role in the conclusion of the contracts and the these contracts are routinely concluded without material modification by the parent company. This will result after the modification intended by BEPS in the configuration of a PE of the parent

99 See OECD BEPS Action 7, supra note 97, at p. 39. The new anti fragmentation rule will be a new paragraph 4.1, drafted as follows: “4.1 Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and a) that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or b) the overall activity resulting from the combination of the activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character, provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, constitute complementary functions that are part of a cohesive business operation”. 100 See OECD BEPS Action 1, supra note 23, at p. 88. Fabián Acosta version 15 08 2016 20 company even though the subsidiary does not conclude the contracts. 101

For instance, where the employees of a subsidiary located in the source country of an online seller of physical goods habitually plays the principal role in the conclusion of contracts with clients for those products, and these contracts are habitually concluded without material modification by the parent company, this activity would result in a PE for the parent company.

3.3.1.3. Transfer Pricing

In the context of Actions 8-10 it was noted that the new business configurations in the digital economy rely heavily in intangibles when creating value and producing income and that many BEPS structures involve the transfer of these assets and its related rights to low-tax jurisdictions or jurisdictions with preferential regimes. It was recognized that the taxpayers in order to justify large allocations of income use contractual arrangements, even if there is little or no business activity. The Report also recognize that the ICTs have accelerated the spread of global value chains, enabling MNEs to become more integrated and better able to maximize opportunities in the digital economy. 102

As the OECD Actions 1 and 8-10 provide extended guidelines in several aspects that are related directly or indirectly with the digital economy, the author have selected the following relevant items driven by BEPS that tackle the tax challenges of the digital economies:

Intangibles, Hard-to-Value Intangibles and Cost Contribution Agreements (CCA) Because a key feature of many BEPS structures in the context of the digital economy involves the transfer of intangibles or the rights derived from these assets to low-tax jurisdictions or countries with a preferential regime, the BEPS work start by providing a clear definition of intangibles for Transfer Pricing purposes, and explain that any transference of an intangible must be compensated at arm’s length between enterprises. 103

Also as in the context of the digital economy the business configurations rely heavily on intangibles in order to create value and produce income, the Report also ensures that related parties performing the important functions, contributing important assets or assuming economically significant risks related to the Development, Enhancement, Maintenance, Protection and Exploitation (DEMPE) of intangibles have to receive an appropriated return in accordance with these activities. 104 In this way it can be ensured that the related parties that contribute value to the intangibles are appropriately rewarded for doing so.

In relation with he HTVI (i.e. intangibles that are partly developed or not yet commercially exploited at the time of the transfer; intangibles where financial projections are highly uncertain and intangibles where reliable comparisons are not available) the BEPS work states that valuation techniques can be used to determine the arm’s length transfer prices when them cannot be determined through other Transfer Pricing methods. Following the guidelines stated in the BEPS Final Report the OECD consider that it can be ensured that post-transfer profitability of an intangible can be taken into

101 See OECD BEPS Action 1, supra note 23, at p. 88. 102 See Flynn, Bates and Thomas, supra note 51, at p. 40. 103 Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Actions 8-10: 2015 Final Report, Aligning Transfer Pricing Outcomes with Value Creation (Paris: OECD, 2015), p. 67. In the guidelines of Actions 8-10 the OECD states that the word “Intangible” is intended to “address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances” (emphasis and underlining added). 104 See OECD BEPS Actions 8-10, supra note 103, at p. 73. Fabián Acosta version 15 08 2016 21 consideration in the valuation in circumstances when there is availability of information. 105

Finally, in relation with the CCA the OECD ensures that the same guidance for valuing and pricing intangibles, including HTVI is applicable to CCAs as to other kinds of similar contractual arrangements. 106

Delineating the Actual Transaction and Allocating Business Risks In order to tackle BEPS structures the guidelines of Actions 8-10 mandate to supplement, where necessary, the terms of the arrangements with the characteristics of the transaction reflected in the actual conduct of the parties. In combination with the application of the Transfer Pricing methods in a way that prevents the allocation of profits to related parties that do not contribute to make the profits, the guidance intend to allocate an appropriate return to related parties performing the important functions, contributing important assets or assuming economically significant risks. 107

The guidance also establishes the necessity to have control over the risks, understanding this concept as the capability and authority to decide to take on the risk, and to decide whether and how to respond to the risk. In this way it can be assured that the appropriate return is given to the related party that in fact is assuming, controlling and have financial capacity over the risk. 108

Global Value Chains and Transactional Profit Split Methods The Report notes that attention should be devoted to the implications of the growing integration of MNEs and to profit spitting factors that show strong correlation with value creation. In the context of the digital economy these points are important considering that the developments in ICTs are one of the biggest factors that are changing global value chains. 109

It should be noted that the OECD on July 4th of 2016 released a Discussion Draft providing guidance on Profit Splits. In the particular, the Discussion Draft aims at clarifying and strengthening the guidance on the transactional profits split method in the context of global value chains. 110

3.3.2. Options to address the broader direct tax challenges in the digital economy Action 1 besides of the recommendations developed before, considered three options to address the broader tax challenges of nexus, data and characterization raised by the digital economy. While none of these options where recommended at this stage, the OECD establish that countries could introduce any of them in their domestic law in order to tackle BEPS. However the Final Report alerts that if the options are going to be implemented, adaptation is needed to ensure consistency with respect of the current tax treaties and other bilateral or multilateral obligations. 111 The options instead of address the broader tax challenges individually, are focused broadly in the ability of business in the digital economy to generate sales without physical presence and to use and monetize the contributions of users in the value chain of these transactions. 112

3.3.2.1. A new nexus based on the concept of significant economic presence and its determination

Based on the existence of a significant economic presence that evidence a purposeful and sustained

105 See OECD BEPS Actions 8-10, supra note 103, at p. 109. 106 See OECD BEPS Actions 8-10, supra note 103, at p. 161. 107 See OECD BEPS Actions 8-10, supra note 103, at p. 39. 108 See OECD BEPS Actions 8-10, supra note 103, at p. 24. 109 See OECD BEPS Action 1, supra note 23, at p. 92. 110 Organisation for Economic Co-operation and Development, Base Erosion and Profit Shifting, Public Discussion Draft, BEPS Actions 8-10, Revised Guidance on Profit Splits (Paris: OECD, 2016). 111 See Flynn, Bates and Thomas, supra note 51, at p. 41. 112 Ibid. Fabián Acosta version 15 08 2016 22 interaction trough the digital economies between a company and a particular jurisdiction, this option creates a taxable presence for non-resident companies. In doing so, the option will take into consideration the following potential relevant factors that indicate the existence of a significant economic presence for attributing income to the new concept of nexus. The factors can be used individually or in combination with the others.

Revenue-Based Factors Under this factor the revenues earned from customers in a country are a potential feature that allows establishing of a nexus in the form of a significant economic presence of a company. This factor is based in the assumption that user data translated into a strong network is useful to enhance the value of the goods and services offered by a company. For this purpose in order to delimitate the transactions covered, it is possible to include only the gross revenues generated from digital transactions concluded with customers located in the source country thought a digital platform. The functionality of this option would depend on the ability of the country to identify and measure remote sales activities of the non-resident enterprise (that can be achieved for example with a mandatory registration system). 113

Digital- Based Factors This factor relies on a range of characteristics to determine a purposeful and sustained interaction with users and costumer in a specific country. For example, local domain names, local digital platforms or local payments are options that could help to indicate the existence of a significant economic presence of a company. 114

User-Based Factors Considering the importance of a strong network to sell goods or provide services in the digital economy, this factor relies in the size of the user base and associated data to determine the existence of a significant economic presence. Monthly active users, online contract conclusion and data collected could be good indicators to do so. 115

Once is determined the existence of a significant economic presence, the Report underlines that the form of the attribution of profits is a key consideration. To achieve a fair attribution method the OECD states that adjustments should be made to the existing principles for attribution of profits. In any case these adjustments will require departures from existing standards for allocating profits such as an analysis of the functions, assets and risks of a particular enterprise. Alternatively, the Action 1 also considers apportioning profits of the whole enterprise through a predetermined formula, a variable allocation key established in a case-by-case basis or a deemed profit method. 116

3.3.2.2. A withholding tax on digital transactions

The Report suggests a gross-basis final Withholding Tax on certain payments made to non-residents or, instead, use it as a primary collection mechanism and enforcement tool of the significant economic presence test describe above. For this purpose it is advised a general definition in order to determine the transactions that will be covered (i.e. transactions for goods or services ordered online). Alternatively, it is also possible to enumerate specific types of transactions to be subjected to withholding tax. However due to the rapid development of the ICT the latter option could arise future challenges. 117

113 See OECD BEPS Action 1, supra note 23, at p. 107. 114 See OECD BEPS Action 1, supra note 23, at p. 109. 115 See OECD BEPS Action 1, supra note 23, at p. 110. 116 See OECD BEPS Action 1, supra note 23, at p. 111. 117 See OECD BEPS Action 1, supra note 23, at p. 114. Fabián Acosta version 15 08 2016 23

In addition, the OECD alerts that the application of the Withholding Tax on digital transactions could raise challenges regarding the current trade obligations and EU law. For this reason the Report suggest as more viable approach to use the Withholding Tax as a back-up mechanism to enforce net- basis taxation on the basis of a significant economic presence nexus, rather than as a standalone option. 118

3.3.2.3. An introduction of an equalization key

The last option mentioned in the Action 1 Final Report is the introduction of an equalization levy (i.e. a tax to equalize the tax burden on remote and domestic suppliers of similar goods and services), that my help to avoid some of the difficulties arising from creating new attribution rules. The equalization levy suggested by the OECD will tax non-residents with significant economic presence in a country and at the same time is intended to provide clarity, certainty and equity to all stakeholders. 119

Finally, the Report states that elements of the three potential options discussed above to address the broader tax challenges raised by the digital economy could be combined into a new concept of nexus based in a significant economic presence. In this way it can be possible to better reflect the real effect that the new business configurations of the digital economy are having in the economy. 120

3.4. Preliminary conclusions Through the tax panning opportunities and main policy concerns we can now determine several BEPS risks in the area of direct taxation, commonly used for BEPS by MNEs, such as the abuse of preferential tax regimes (i.e. patent boxes or IP preferential regimes), artificial internal trading of intangibles (i.e. trading of internal property licensing), thin capitalisation (i.e. local subsidiary of an online retailer with a warehouse with limited earnings), internal debt shifting (i.e. decrease of the tax base through deductions), transfer price allocation (i.e. selling of goods at high prices to make subsidiaries artificially erode or increase its tax base), artificial contractual arrangements and the circumvention of CFC rules.

These BEPS risks raise questions as to whether the current international tax framework continues to be appropriate to deal with the businesses in the context of the digital economy. It has been analyzed121 and suggested122 by the academia that the lower costs of the digital economies combined with the increasing network effects generated by customer interactions may justify a change in tax policy. However, in considering a change in tax policy it is agreed by most authors123 that the potential impact on traditional business configurations must be taken into consideration in order to maintain coherence at an international level.

The OECD recommendations and options are based on the OECD aim to avoid ring fencing the digital economy from the traditional businesses, considering that this would be against the tax neutrality principle and because the digital economy is rapidly becoming the economy itself, as the traditional businesses are moving many of its activities to the countless digital possibilities. In the BEPS Report the OECD suggest some accurate short-term reforms such as the modification of the list of the

118 See OECD BEPS Action 1, supra note 23, at p. 115. 119 See OECD BEPS Action 1, supra note 23, at p. 116. 120 See OECD BEPS Action 1, supra note 23, at p. 107. 121 Francis Bloch and Gabrielle Demange, Taxation and Privacy Protection on Internet Platforms (Paris: Paris School of Economics, 2015, loose-leaf). 122 Jaques Crémer, ‘Taxing network externalities’, 26 Taxation and the digital economy: A survey of theoretical models Final Report (26 February 2015), pp. 59-75. Peter Hongler and Pasquale Pistone, Blueprints for a new PE nexus to tax business income in the era of the digital economy (Amsterdam: IBFD White papers, 2015) 123 Ibid Fabián Acosta version 15 08 2016 24 exceptions of PE in Art. 5.4. OECD Model 2014 and its definition, together with the introduction of an anti-fragmentation rule to ensure that it is not possible to get a benefit from this exceptions. Also provide several far-reaching possibilities, including a new nexus test in the form of a significance economic presence requirement, withholding tax on digital transactions and an equalization levy.

In this authors view, the current recommendations and options proposed by the BEPS Report are limited to address some of the tax challenges of the digital economy but not all the issues that arise from the new business configurations (i.e. nexus and attribution of income rules). Some of the major risks are not dealt in the BEPS Report, as the intention of the OECD is to achieve a solution with the traditional taxation rules that are useless to tackle the key features of the digital economy. Following this, risks related to the source country ability to tax digital income generated in its territory under the current attribution rules is still pending. If the general policy objective is in fact to ensure the source jurisdiction ability to tax, the recommendations and option of a narrow significant digital presence test does not sound as long-term solutions, as these measures does not achieve this intention, does not ensure an equal treatment of the market participants and ring-fence companies engaged in fully dematerialized activities.

An effective and definitive answer to the major issues requires an international, coordinated and harmonized solution that may be achieved through a multilateral agreement, as is already the intention of the BEPS Action 15. As this is a solution that may take a long time to be achieved, now that the major BEPS risks have been identified for now immediate action of the recommendations and options stated by the OECD is needed to advance in the aim to tackle the growing tax challenges of the digital economy.

4. Current framework, recent developments and implementations

4.1. In general Since only until October of 2015 the BEPS Final Report was issued and there is no agreement on a multilateral solution yet, countries all over the world have been implementing their own solutions and interpretations to the tax challenges raised by the digital economy. National governments moved by the necessity of collecting public revenue began implementing new digital tax policy even before the Final Report was issued. Some of these solutions go beyond the OECD guidelines as does not follow the recommendations and options stated in the BEPS Final Report, and, alternatively, some of the recent developments are aligned with the Report, as is going to be noted in this chapter. 124

With the purpose of illustrate the current framework, recent developments and implementations in the context of the digital economy, the following subchapters provide a general overview by tax measure.

4.2. PE and nexus

4.2.1. Current framework As noted in section 3.3.1 above, due to the key features and issues that the digital economy raises, the PE concept have a particular relevance. The main question in the context of the digital economies is, whether and to what extent the digital businesses establish sufficient presence for the source state to derive a right to tax, and as a consequence of the latter question, whether the existing rules can ensure the attribution of taxing rights reflecting the underlying value creation. 125 Under this framework

124 Valère Moutarlier, ‘Global warming: the heat is rising on digital taxation’, 16 Tax Insights for business leaders (2016), pp. 46-47, at p. 46. 125 See Blum, supra note 25, at p. 315. Fabián Acosta version 15 08 2016 25 in this authors view the current main concerns related to the PE in the digital economy, are the following:

4.2.1.1. Treaty rules for taxing business profits

Under the current tax treaties regulations provided by the OECD the companies that operate their businesses solely through websites, do not trigger a PE in the source country because of the lack of a fixed place of business therein. Following this, section 42.2 of the OECD Commentary on article 5126 recognizes that an Internet website does not constitute tangible property and therefore does not constitute by itself a place of business. Alternatively, the server through which the website operates, understanding it as a piece of equipment, constitutes a fixed place of business as it have a physical location. 127

Therefore the OECD Commentary leads to the conclusion that in the case where the enterprise owns the website but not the server, the enterprise does not have a physical presence at that location and, thus, does not trigger a PE in the source country. The fact that the digital companies conducting their activities solely through websites do not trigger a PE in the source country makes that these business configurations of the digital economy are not going to be taxed therein, as the PE concept represents the source state’s threshold for the right to tax and is decisive to determine whether a state has the right to tax income generated by a non-resident.

Because the tax treaty rules for taxing business profits rejected the view that a website could be regarded as a PE, this is imposing an additional challenge in the context of the digital economy, as under the current tax treaty framework a webpage its not enough to trigger a physical presence in the source country. In order to tackle this issue a possibility could be the option suggested by BEPS of a new nexus based on the concept of significant economic presence based on revenue, digital and user-based factors described in section 3.3.2 above. However as noted before, this option at this stage was not recommended and only was suggested as an option to be freely adopted by each country. If the measure wants to be successful a multilateral agreement must be implemented containing this option.

4.2.1.2. PE status

The OECD commentary and BEPS Report recognize that activities of a preparatory or auxiliary character would not constitute a PE, even if there are conducted through a fixed place of business. Under the current framework Article 5.4 OECD Model 2014 states that the PE shall be deemed not to include some activities listed as exemptions. This can give rise to several practices of MNEs to avoid the PE Status in the context of the digital economy, such as: i) fragmenting functions with related parties to be covered by the exceptions, as the digital economies does not require the same level of significant people functions than in the traditional businesses; and ii) use the exemptions to cover core business functions of the digital economies.

As discussed in section 3.3.1 above, for this purposes the BEPS Report recommended to amend the

126 The UN Model Tax Convention also included the rules of section 42.2 of the OECD Commentary on Article 5. For this purposes see sections 36-37 of the UN Commentary on Article 5. 127 Sec. 42.2 of OECD Comm. on Art. 5. “Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” (Emphasis and underlining added). Fabián Acosta version 15 08 2016 26 existing PE provision and limit the scope of the set of exemptions provided in Article 5.4 OECD Model 2014. The OECD’s intention to limit the scope of the exemptions to solely preparatory and auxiliary activities is valid and in line with the underlying policy objective, as all the companies will have to examine and evidence (if required) that the activities performed does not constitute core activities.128 Also the anti-fragmentation rule may ensure that is not possible to benefit from the exceptions through the fragmentation of business activities among related parties.

For example, if a representation office is used in a particular location where the server and the webpage are operated in order to advertise, display a catalogue of products or provide information to potential customers, the representation office will not constitute a PE at that location as the activity is preparatory and auxiliary in nature and falls under Article 5.4.a. OECD Model 2014. Alternatively if the representation office is performing sales through the webpage hosted in the server owned by that company, a PE will arise.

It should be noted that most of the tax avoidance practices of the digital economy related to the PE status still do not have a proper solution, as the main tax challenges of the digital economy in this matter are related directly with the key features of the digital economies and not only with the “preparatory or auxiliary” character or the possibility to fragment business activities. We can mention the following business practices related to the PE Status and its nexus that still does not have a proper answer: i) Migration of services to the Internet that could be provided in person; ii) shifting royalties into services fees and avoid withholding tax by transforming technical services into services delivered online; and iii) monetizing location relevant data created by local users without compensation. 129

4.2.1.3. Service PE

Article 5.3.b UN Model 2011 provides the configuration of a PE when a person is furnishing services including consultancy services, when the activities are carried for a period or periods aggregating more than 183 days in any 12 months period commencing or ending in the fiscal year concerned. The application of the service PE face problems in the context of the digital economy, considering that the person rendering the services can provide remotely the services without the need to be physically present in the source country. 130 The problems that arise within the concept of service PE allow to demonstrate that further work must be undertaken in order to address the tax challenges of the digital economy, as the current framework is not enough to solve the issues that are arising from the key features of the digital economies. In this sense as noted in section 3.3.1 above issues related to the source country ability to tax digital income generated in its territory under the current attribution rules still need to be answered.

4.2.1.4. Agency PE Under the scope of the Article 5.5 OECD Model 2014, a foreign enterprise is considered to have a PE when the company has a dependent agent who has the authority to conclude contracts for or on behalf of the foreign enterprise. Article 5.5. UN Model 2011, in addition to this provides an agency PE where the agent habitually maintains a stock of goods or merchandise from which he regularly delivers goods on behalf of the enterprise. In the context of the digital economy this provisions have become useless in some cases considering that the ITCs have transformed the manner in which the customers are identified, business solicited, marketing made and the contracts concluded. Nowadays the agents have been replaced with software available in the Internet through webpages and applications.

For example, the customers by checking the box to the statement “I Agree to The Terms of Service”

128 European Parliament, Tax Challenges in the digital economy (Brussels: European Parliament, 2016), at p. 28. 129 Ibid. 130 See Huibregtse, supra note 9, at p. 111. Fabián Acosta version 15 08 2016 27 are digitally signing contracts without the need of an agent in the source country. 131 In this way the current regulations of the agent PE every day are becoming more useless and need to be reshaped as the source jurisdiction is losing once again ability to tax income that was attributable to it under the traditional business configurations.

4.2.1.5. Artificial contractual arrangements to avoid PE status

Companies motivated to minimize taxation through the allocation of functions, assets and risks artificially avoid the PE status through contractual arrangements that does not reflect the real conduct of the parties. For these purposes the modification of the definition of PE proposed by BEPS Report may be useful, as the intention is to address the cases in which artificial arrangements related to the sales of goods and services of one company in a MNE effectively result in the conclusion of contracts for the parent company.

For example, where the employees of a subsidiary located in the source country of an online seller of tangible goods or provider of advertising services habitually play the role in the conclusion of contracts with the customers, and these contracts are concluded without any material modification by the parent company, this activity under the BEPS recommendations would trigger a PE for the parent company even if the contractual arrangement between the parties indicate otherwise.

It should be briefly mentioned that Section 37 of UN Commentary on article 5 suggests that entities trying to avoid creating a PE through contractual arrangements may fall under the application of legislative or judicial anti-avoidance rules. This seems to be in line with Action 1 BEPS Report, when discussing precisely the artificial contractual arrangements to avoid PE Status.

4.2.2. Recent developments and implementations Considering that the recommendations and options brought by BEPS Final Report do not answer all the tax challenges raised by the PE status in the context of the digital economy, it is important to consider the different alternatives that many countries in the world are taking in this area. For this purpose the following section will discuss briefly the most recent approaches and some conclusions are going to be make at the end of each measure.

4.2.2.1. Diverted profit tax (DPT)

With effect from April 2015, the United Kingdom (UK) introduced a DPT, which can be considered as a unilateral anti-abuse rule due to the fact that operates through two rules: i) counteract arrangements by which foreign companies132 avoid the PE rules; and ii) prevent companies from creating tax advantages by using transactions or entities that lack economic substance. 133 The measure is imposed on the profits that are artificially diverted from the UK, under the scope of the rules described above.134 The measure was call by the government “Google Tax”, as the intention was to target MNEs making profits in the digital economy but shifting them to low-tax jurisdictions. However, the measure more than a tax can be considered as an anti-abuse measure that counteracts tax planning and tax avoidance practices by MNEs.

Australia in May 2016 released a Discussion Draft in order to implement a DPT with a similar reach of

131 See Huibregtse, supra note 9, at p. 112. 132 Considering that the measure is intended to increase corporate tax compliance by MNEs, it include only enterprises with an annual turnover of more than EUR$50 million or an annual balance sheet not exceeding EUR$43 million. 133 Oana Popa, ‘Taxation of the digital economy in Selected Countries – Early Echoes of BEPS and EU Initiatives’, 55 European Taxation 1 (2016), pp. 38-42, at p. 40. 134 Ibid. Fabián Acosta version 15 08 2016 28 the one introduced in United Kingdom. The proposal is to impose a penalty tax on the profits that are considered to be artificially diverted and reduce the tax paid on the profits generated in. As in the diverted profit tax of UK, an arrangement with a related party may be subject to the measure if the transaction gives rise to an effective tax mismatch and has insufficient economic substance. The measure is enacted as an answer to the tax challenges arising from the digital economies and MNEs135 that carry sales activities in Australia without the creation of a PE therein. 136

The DPT more than a measure to tackle the tax challenges of the digital economy it can be considered as an anti-abuse measure that counteracts tax planning and tax avoidance practices by MNEs. Currently it is not clear if the DPT can interfere with the treaty obligations and other regulations, such as the EU laws (i.e. anti-tax avoidance directive) and case law that have their own definitions and principles of tax related abusive situations. A flaw of the DPT is that does not take into consideration that some business configurations in the digital economy do not need physical presence and therefore they do not trigger a PE under its current definition (i.e. companies involved in the selling of goods and rendering of services online that do not have any kind of facilities and personnel in the market country). Then these business structures will not fall under the scope of the DPT, because they are not intentionally avoiding the PE status.

4.2.2.2. Bandwidth tax

Some countries such as France and Hungary137 have been trying to address the tax challenges of the digital economy by redefining the PE concept. Under the proposal, a PE is deemed to exist when Internet user data is collected in the domestic market. 138 Furthermore France also suggested attributing profits to jurisdictions, where the users are located according to the destination principle instead of the origin principle. In this sense income corporate tax could move towards this principle in a similar way as VAT/GSM operates. 139

In the last report published by the French government in 2015, 140 two specific digital taxes where proposed. The first proposal is an ad valorem tax based on revenues from sales and advertising. And the second is a tax based on activity such as number of users, flow of data or number of advertisers and overall in collection of data. 141

The above-mentioned proposals have been criticized for ring-fencing the digital economy, by creating taxes exclusively to tackle its tax challenges instead of taking into consideration the current framework of the income corporate tax. 142 The Commission of the European Parliament, making the same consideration stated by the OECD in the Action 1 Final Report, while arguing that the use of Internet and toll of Internet is not a practical idea for taxation matters, suggests finding solutions in the framework of existing rules. 143

135 The DPT applies to significant global entities that are Australian residents or are foreign residents with Australian permanent establishments. A significant global entity is: an entity with annual global income of AU$1 billion or more; or an entity that is a member of a group of entities, consolidated for accounting purposes, which has annual global income of AU$1 billion or more. 136 Australian Government, Implementing a Diverted Profits Tax (Australia, Australian Government, 2016). 137 See Popa, supra note 133, at p. 40. 138 See Popa, supra note 133, at p. 39. 139 See European Parliament, supra note 128, at p. 39. 140 https://ec.europa.eu/futurium/en/system/files/ged/ficalite_du_numerique_9_mars_13_h.pdf, accessed on July 15th of 2016. (France Stratégie, Taxation and the digital economy. A survey of theoretical models (2015)) 141 See European Parliament, supra note 128, at p. 39. 142 See Popa, supra note 133, at p. 39; and, See European Parliament, supra note 128, at p. 39. 143 See European Parliament, supra note 128, at p. 39. Fabián Acosta version 15 08 2016 29

4.2.2.3. Indian equalization levy

The Indian government following the options stated in BEPS Action 1 introduced an equalization levy144 at a rate of 6 per cent, effective from June of 2016, on amounts paid to non-residents that do not have a PE in India. The equalization levy would apply on a gross basis for payments related to services of online advertising, any provision for digital advertising, services for the purpose of online advertisement and any other service that may be notified later by the central government. The levy would not be applicable to non-residents having a PE in India, as they will be subject to regular PE- basis taxation. Indian residents conducting business or non-residents with a PE in India must withhold the equalization levy. 145

The measure is the first significant step taken by India to tax digital economy transactions and one of the firsts in the world to follow the options of the BEPS Action 1 Final Report. Despite the measure would apply on B2B businesses only, it is expected that tax neutrality between MNEs and domestic enterprises can be achieved. 146 It seems that the initiative of the equalization levy it is going to bring good results in the Indian context and also it is expected that further development is going to be made at least in the B2C businesses. At this point it is not possible to know the future impact of the levy, however the measure as affects only the advertising industry could create an increased burden on companies operating in these industries. Finally, restrictions regarding the current tax treaty network should be considered, as the measure is affecting taxpayers that may be covered by a particular tax treaty rule, limiting in this way the scope of the measure.

4.2.2.4. Israel circular on Internet activity of foreign companies The circular of April of 2015 focuses on the attribution of income of a foreign company to a PE in Israel in the context of the digital economy. Acknowledging BEPS Action 1, the circular uses the concept of a significant economic presence to address the tax challenges of the digital economies for treaty country residents and non-treaty country residents. For the first group, the circular mandates that a company that has significant digital presence in Israel and conducts activity in that jurisdiction can be considered to have a PE even if the activity is of a preparatory or auxiliary character. For the second group, if the activity of a foreign company has significant digital presence in Israel, it could be considered as conducting taxable activity in that jurisdiction even without any physical presence therein. 147

The circular provides some criteria to determine when a company have significant economic presence, such as: i) Significant amount of contracts for Internet services with Israeli residents; ii) large number of Israeli customers utilizing the digital service; iii) the online service is adjusted for Israeli users (i.e. language, style or currency); iv) High web traffic by Israel users; and v) Close correlation between the consideration paid to the foreign company and the level of internet usage of Israeli users. 148

Once the existence of the PE is concluded, the Circular stipulates that the approach of the 2010 OECD Report on the Attribution of profits to a PE should be adopted.

It has been criticized that the measure is far reaching and touches upon issues, which cover much

144 The equalization levy has been defined as “tax leviable on consideration received or receivable for any specified service under the provisions of this chapter”. 145 Sudhir Kapadia et al., India introduces new equalization levy on online advertising revenue (United States, PWC, loose-leaf), Tax Insights from International Tax Services, at p. 1. 146 Ibid. 147 Ranni Gilady, Israel Tax Authorities publish oficial circular on Internet activity of foreign companies in Israel (New York, EY, loose-leaf), International Tax Alert, at p. 1. 148 Ibid. Fabián Acosta version 15 08 2016 30 more than the Internet economy aspect. 149 However the measure seems to reflect a broadening of the BEPS intent within Action 1 Final Report. The measure tackles the digital businesses that do not have need a physical presence in Israel (i.e. online selling of goods and rendering of services) what can be a good first step to address the tax challenges of the digital economy. It is too soon to know the effects of the measure, nevertheless the measure seems well structured and goods results are expected. Lastly, restrictions regarding the current tax treaty network should be considered, as the measure is affecting taxpayers that may be covered by a particular tax treaty rule, limiting in this way the scope of the measure.

4.3. Other direct tax related developments

4.3.1. Formulary apportionment An alternative to the options provided by the BEPS Final Report, is the formulary apportionment method proposed by the academia150 and suggested by the Commission of the European Parliament. Under this system the global profit of a MNE will be calculated by consolidating all profits of the subsidiaries, after which an apportionment is made among different countries following a formula based on sales, salaries, number of employees. 151

The apportionment factor has been criticized when is solely based on property or payroll, as can incentive the allocation of assets and people through jurisdictions. Therefore the academia has suggested that the apportionment factor must be based in sales. 152

In accordance with the Commission of the European Parliament the EU should start considering measures to shift to the formulary apportionment model and unitary taxation. In their opinion the global formulary apportionment could be the only viable solution in the long-term to address the challenges of the digital economy.153 The measure seems to be really effective tackling the tax challenges of the digital economy, however this approach need to be implemented around the world in order to work, what it appears to be far away in the current worldwide context. 154

4.3.2. Destination based corporate income tax or cash flow tax In order to address the tax challenges of the digital economy, scholars have suggested implementing a Destination Based Corporate Income Tax (DBCIT) or Cash Flow Tax. 155 The proposed approach is an alternative to income taxation as it is a consumption-type tax. The DBCIT allocates the right to tax based on the net cash flow that a company has in each country and then apply the respective tax rate. 156 Similar to the new VAT rules for e-commerce in the EU (OECD VAT/GSM Guidelines), 157 under the DBCIT the taxpayers have to pay taxes on the goods and services provided in the jurisdiction where

149 Yedidya Rosensweig, ‘Tax Authorities Publish Draft Circular on Internet Activity of Foreign Companies’, 22 International Transfer Pricing Journal 4 (2015), pp. 261-262, at p. 261. 150 See Maya, supra note 83, at p. 18. 151 See European Parliament, supra note 128, at p. 34. 152 Alan J. Auerbach and Michael P. Devereux, Consumption and Cash-Flow Taxes in an International Setting (Oxford: Oxford University Centre for Business Taxation, 2012), at p. 17. 153 See European Parliament, supra note 128, at p. 34. 154 Ibid. 155 Maya Bacache et al., Taxation and the digital economy: a survey of theoretical models (Paris: France Stratégie, 2015); Michael P. Devereux, ‘Issues in the Design of Taxes on Corporate Profit’, 65 National Tax Journal 3 (September 2012), pp. 709-730; Alan J. Auerbach and Michael P. Devereux, Consumption and Cash-Flow Taxes in an International Setting (Oxford: Oxford University Centre for Business Taxation, 2012). 156 Maya Bacache et al., Taxation and the digital economy: a survey of theoretical models (Paris: France Stratégie, 2015), at p. 55. 157 Organisation for Economic Co-operation and Development, International (VAT/GST) Guidelines (Paris: OECD, 2015). Fabián Acosta version 15 08 2016 31 the customers are located. 158

There are two systems for defining the taxable base. The first is the origin-based DBCIT that identifies the value created in a country after deducting the normal cost of capital. Under this system to the total income from the sale of goods or rendering of services in a country, whether produced domestically or imported, the total cost associated with those goods and services it is deducted, whether produced domestically or imported. The result is that in an origin-based system the DBCIT reaches only domestic production. The second is the destination-based BCIT that identifies the value consumed by a nation after excluding the normal cost of capital. Under this system to the total income from the sale of goods or rendering of services in a country, all the sales of exported goods and services are excluded. Then the cost of all goods and services produced in the country it is deducted. The result is that in a destination-based system the DBCIT reaches only domestic consumption. 159

The taxable base will be influenced by taxable inflows (i.e. revenues from the sale of goods and services) and deductible outflows (i.e. amounts paid for equipment, inventory, supplies and labour). Whereas the DBCIT provides for the immediate deduction of capital expenditures, usually the corporate income tax denies the immediate deduction of capital expenditures through depreciation. The DBCIT measures what is available for consumption after accounting for all expenditures. Alternatively, under an income tax system all expenditures for assets are normally capitalized.

The measure is a promising approach to tackle the tax challenges of the digital economy. However implement the DBCT would mean a radical change because in order to work, the current connecting factors of source and residence established in the tax treaties worldwide must be abolished. There is an interesting question that may arise in connection with this approach, because if a company does not have sales and customers there would no be taxable base and therefore no tax can arise. If the measure its going to be implemented an international, coordinated and harmonized solution that may be achieved through a multilateral agreement, as is already the intention of the BEPS Action 15. In any case the measure seems to be a long-term solution rather than a short-term possibility.

4.3.3. Hungary advertising and telecommunications taxes Hungary is imposing an Advertisement tax that applies in relation with publishing and advertising activities including Internet portals and websites. The tax is levied at a progressive rate ranging from 0% to 50% of the net sales revenue. 160The advertising tax is imposed independently of the residence of the provider of the service.

Hungary also levies a tax on telecommunications service providers in relation with the activities of public telecommunication services rendered through ICT located in the country. The tax is charged at a fixed amount based on the minutes spoken and number of messages. 161

The above-mentioned taxes only affect the advertising and telecommunication sectors within the digital economy. This creates an increased burden on companies operating in these industries and does not tackle broadly the tax challenges of the digital economy or the BEPS issues. Taxing the transactions in the context of the digital economy should not create competitive disadvantages, in this way these taxes does not seem to be a good example for future initiatives in the area. As the measure is a different tax than the corporate income tax, the measure is not restricted by the double tax

158 See Bacache, supra note 156, at p. 55. 159 William B. Barker,, ‘A Common Sense Corporate Tax: The Case for a Destination-Based, Cash Flow Tax on Corporations’, 61 Catholic University Law Review 4 (2012), pp. 958-1010, at p. 976. 160 See Popa, supra note 133, at p. 40. 161 Ibid. Fabián Acosta version 15 08 2016 32 conventions subscribed by Hungary.

4.4. Transfer Pricing

4.4.1. Current framework As noted in section 3.3 above, in the context of the digital Economies MNEs have been criticized because of their practices to attribute income to lower-tax jurisdictions and tax havens by arbitrarily inflating and deflating prices of intangibles and HTVI. 162 Also, they have been criticized because the implementation of structures that use subsidiaries based in high-tax jurisdictions that pay royalties, which can be deducted from the taxable basis as operating expenses. 163

In this framework the following challenges can be identified in applying the current Transfer Pricing guidelines to transactions within the digital economy:164

4.4.1.1. Delineation of the transaction

In the digital economy the international transactions of related parties are closely integrated, meaning that is harder to apply a separate transaction analysis. In the digital economies several interactions between various layers in the ICT have to participate in order to provide value to the clients: i) Infrastructure (i.e. cables or data centres); ii) software resources (i.e. data or digital content); iii) Accessibility (i.e. operating systems as HTTP protocol, web services, application programming interfaces); iv) Applications (i.e. web browser or applications available in the app store); v) interface (i.e. web page or an online store); and vi) users. 165 All of these layers represent at the same time different functions that could be allocated between related parties or rendered by third parties, such as: Strategic direction, intangibles development, data storage, customer service, marketing, selling and manufacturing, between others. 166

For this purposes the current guidelines permit an aggregation of the transactions since they are so closely linked that cannot be evaluated in a separate basis. For this purposes the guidance on group synergies states that if synergistic benefits arise from a deliberate concerted action, them must be shared between the group members in proportion to their contribution. 167 Having this in mind in the Discussion Draft on the revised guidance on profit splits released in 2016, it is noted that there is no need to combine all the profits of the parties and apply a transactional profit split, but is only necessary to apply an appropriate allocation key to the marginal system profits arising from those synergies. 168

In this regards it is also important to note that the guidelines of Actions 8-10 mandate to supplement, where necessary, the terms of the arrangements with the characteristics of the transaction reflected in the actual conduct of the parties.

4.4.1.2. Preparation of the functional analysis In order to analyse the transaction between two independent parties, compensation must reflect the functions that each entity is performing, assets used and risks assumed. In the context of the digital economy this delineation may be problematic, complex and some times unique. 169 For example, with the development of the ICT online retailers in a B2B configuration may collect valuable information for

162 See European Parliament, supra note 128, at p. 28. 163 Ibid. 164 See Huibregtse, supra note 9, at p. 116. 165 See Huibregtse, supra note 9, at p. 120. 166 Ibid. 167 See OECD BEPS Actions 8-10, supra note 103, at p. 58. 168 See OECD BEPS Discussion Draft on Profit Splits, supra note 110, at p. 11. 169 See Huibregtse, supra note 9, at p. 120. Fabián Acosta version 15 08 2016 33 the manufacturer through automated software that do not need the help of any personnel, these services can be part of a free-service agreement, due to the fact that for the online retailer collecting such data does not have a cost. However for the manufacturer the information may be valuable because it allows making decisions about their products, customers’ needs, stock, etc.

The issue here is how to allocate functions, assets and risks in the digital economy, for instance how much of these economically significant activities can be attributed to the online retailer in the previous example. Should be for instance related with the ownership of the software or with its development and adaptation. In this backdrop, BEPS report and the OECD guidelines put special emphasis in the reliance of value chain analyses and transactional profit split methods. Also in the necessity to have control over the risks, understanding this concept as the capability and authority to decide to take on the risk, and to decide whether and how to respond to the risk. In this way it can be assured that the appropriate return is given to the related party that in fact is assuming, controlling and have financial capacity over the risk. 170

4.4.1.3. Intangibles and hard to value intangibles In section 3.3.1.3 above it was mentioned that the BEPS work provides a clear definition of intangibles for Transfer Pricing purposes, and explain that any transference of an intangible must be compensated at arm’s length between enterprises. In this backdrop, the Report also ensures that related parties owning intangibles and parties involved in DEMPE functions in regards intangibles are appropriately compensated. 171 Currently, with the guidelines set out in BEPS Actions 8 to 10 the entities that have only legal ownership of assets, or only a contractual allocation of risks, should only receive a risk-free return. Alternatively, with the supply chain correctly delineated the entities undertaking economically significant activities (align with DEMPE), should receive a proper allocation of profit.

Under the current framework it seems that regarding intangibles the BEPS Report provides extensive guidelines. It is too soon to know the effects of the guidelines, nevertheless they seem to be well structured and goods results are expected. What we currently can affirm is that in order to avoid adjustments and controversies, structures using intangibles should either re-design their Transfer Pricing policies to allocate profits to jurisdictions where the economically significant activities take place, or redesign their operating models to align economically significant decision-making and control functions with intangible ownership.

4.4.1.4. Identification of the most appropriate transfer pricing method and comparable selection

When the transaction is identified and accurately delineated through a functional analysis, the next step is to determine the most appropriate method to determine the arm’s length price. In the context of the digital economy all the factors described previously are challenging the suitability of the methods as well. Challenges such as net profits methods when the company is highly integrated or when the enterprise is in the early stages of functioning set questions regarding the application of the methods and the availability of comparable companies when needed. 172 For example, if the profit split method is to be applied, issues of determining the correct ratio in relation with the functional analysis arise. Alternatively, if the Transactional Net Profit Method is to be applied, issues in determining the differences in products, services, assets and functions being performed may arise. 173

Under the current framework in the absence of clear guidance on the application of the arm’s length

170 See OECD BEPS Actions 8-10, supra note 103, at p. 92. 171 See OECD BEPS Actions 8-10, supra note 103, at p. 73. 172 See Huibregtse, supra note 9, at p. 122. 173 Ibid. Fabián Acosta version 15 08 2016 34 principle to transactions within the digital economy may result in the arbitrary allocation of the tax base or, in the contrary, in controversies with the tax authorities.

Under the current guidelines the analysis of group synergies, value chain creation and the development of better profit split methods weighting functions performed by the respective group entities could help in the determination of the arm’s length principle of the transactions of the digital economy. 174 In this way, we can expect that companies that do not align their Transfer Pricing policies with economically significant activities, decision-making and value creation rather than a formal approach through intra-group agreements, will likely need to face the tax authorities.

4.4.2. Recent developments and implementations

4.4.2.1. Italian transfer pricing rules in the context of the digital economy

On December 27th of 2013, the Italian parliament issued the Finance Act for fiscal year 2014 (Law no. 147/2013), introducing new rules related to the determination of the transfer price of intercompany transactions for companies that operate in on-line advertising services and related ancillary services. The regulations mandate that taxable income deriving from transactions among related parties concerning the mentioned services shall be verified using profit indicators other than the cost-plus method, unless the taxpayer applies for an Advance Pricing Agreement (APA). 175

While the cost-plus method leads to a compensation using an arm’s length mark-up, the other methods, such as the transactional profit methods, are able to asses the remuneration on an arm’s length net margin, representing a better approach in the context of the digital economy to the actual value generated by the company and contributed within the group. 176

The proposal makes an APA potentially more attractive for companies operating in online advertising and provides a good opportunity to achieve clarity in the existence of a PE. 177 However, the measure partially covers specific businesses (on-line advertising services and ancillary) and address limited aspects of the tax challenges of the digital economy. In addition, it seems that the method exclusion is unjustified as all the Transfer Pricing methods in accordance with the OECD guidelines have the same weight. Similar result could be achieved through an accurate Transfer Pricing policy that is transparent and reflects the actual group business structure. Finally, it should be mentioned that the impact on the budgetary revenue of the Italian initiative did not prove to be significant. 178

4.4.2.2. APA programs and country-by-country reporting regulations

In the context of Transfer Pricing, after the issuance of the BEPS Final Report various countries have been releasing APA programs and country-by-country (CbC) reporting regulations. Even though these measures are not exclusively related with the digital economy, they address indirectly some of the issues of the digital businesses.

Regarding APA measures, Ireland recently released a program launched in response to Action 14 of the BEPS Final Report related to dispute resolution mechanisms. The program will apply from July of 2016 to Transfer Pricing issues (including the attribution of profits to a PE). Further, it is intended to transactions that involve complex Transfer Pricing challenges, such as cases where there is: i) a significant doubt over the applicable methodology; ii) lack of reliable comparables and/or the necessity

174 See Huibregtse, supra note 9, at p. 125. 175 See Quaratino, supra note 41, at p. 211. 176 Ibid. 177 Ibid. 178 See Popa, supra note 133, at p. 39. Fabián Acosta version 15 08 2016 35 to make significant adjustments; iii) tailored Transfer Pricing analysis; and iv) complex calculations (i.e. applicability of profit split indicators). 179

Regarding CbC reporting, after the BEPS Report many countries such as Germany, 180 Austria, 181 Portugal, 182 Italy, 183 UK, 184 Denmark185, Japan186 and US187 are drafting and releasing regulations following the OECD recommendations for BEPS Action 13 related to Transfer Pricing documentation. Similar measures are being discussed in Belgium, where it was published a plan to address BEPS and combat fraud, including topics such as APA’s and CbC reporting. In relation with Action 1 Belgium intends to support any initiatives issued at the EU level relating to the digital economy. 188

Regarding the CbC there is much criticism on the recommendation regarding the threshold of the companies that would be obliged to provide information (minimum of USD$750 million). Finding in this area show that this would exclude more than 85 per cent of the MNEs restricting the tax authorities powers189.

4.5. Withholding tax

4.5.1. Current framework When is determined that income derived by the payee is taxable in the source jurisdiction (i.e. by means of a PE therein), it is necessary to determine the characterization of the payments. Under the current OECD Model 2014 and UN Model 2011 in general terms they can be dividends, interests, royalties, technical fees or business profits. Usually when the payments are regarded as a royalty or interest in accordance with the domestic law of the source country, a withholding tax is levied. 190

In accordance with the OECD Commentary the royalties are related to rights or property constituting the different forms of literary and artistic property, the elements of IP specified in the text and information concerning industrial, commercial or scientific experience. Therefore the definition of royalties encompasses payments or the use of, or the entitlement to use, rights of any copyright of literary, artistic or scientific work including cinematographic films, any patent, trade mark, design or model, plan, secret formula or process, whether or not they have been, or are required to be, registered in a public register. 191 These payments then generally fall under the scope of article 12 of

179 Ronan Finn and Kevin Norton, Ireland introduces bilateral APA program (Dublin, PwC, loose-leaf), Tax Insights from Transfer Pricing, at p. 1. 180 Stefan Grube, Axel Kroniger and Andreas Maywald, Germany’s draft tax law includes CbC measures (Dusseldorf, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-019, at p. 1. 181 Andrea Lahodny and Gabriele Holzinger, Austria plans introduction of standardized transfer pricing documentation (Vienna, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-018, at p. 2. 182 Rosa Soares and Patricia Matos, Portugal introduces country-by-country reporting requirement (Lisbon, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-014, at p. 1. 183 Aldo Casoldi, Immacolata Abbamondi and Stefano Lavore, Italy introduces country-by-country reporting requirement (Italy, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-008, at p. 1. 184 Bill Dodwell et al., UK issues country-by-country reporting regulations (United Kingdom, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-007, at p. 1. 185 Asger Mosegaard et al., Denmark finalizes implementation of OECD three-tiered approach to transfer pricing documentation (Denmark, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-017, at p. 1. 186 Gary Thomas and Timothy Obrien, Japan’s proposed adoption of BEPS Action 13 includes new perspective transfer pricing documentation rules (Japan, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-2, at p. 1. 187 David Varley et al., United States issues final country-by-country reporting regulations (United States, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-024, at p. 1. 188 https://tax.thomsonreuters.com/blog/checkpoint/belgium-publishes-plan-to-address-beps-and-combat-tax- fraud/, accessed on July 16th of 2016. Jessica Silbering-Meyer, Belgium Publishes Plan to Address BEPS and Combat Tax Fraud (Thomson Reuters, 2016). 189 See European Parliament, supra note 128, at p. 44. 190 See European Parliament, supra note 128, at p. 23. 191 Sec. 8 of OECD Comm. On Art. 12. Fabián Acosta version 15 08 2016 36 the OECD Model of 2014, as royalties.

Royalties differ from contracts for the provision of services, in which customary skills are executed by one the parties by himself. As examples of payments constituting services we can mention: after sales services, technical assistance services, opinion given by an engineer, an advocate or an accountant, and advice provided electronically such as communications with technicians or trouble-shooting database for frequently asked questions. 192 These payments then generally fall under the scope of article 7 of the OECD Model of 2014, as business profits.

In the backdrop of withholding taxes two areas are being affected by the digital economy, in general, by the abuse of tax treaty networks by taxpayers, and in particular, in the characterization of payments under the new developments of cloud-computing.

4.5.1.1. Tax treaties abuse

In general, as discussed in 3.2.2 above, tax treaties between jurisdictions may be abused by treaty shopping to avoid the payment of withholding taxes, usually by using shell companies in low-tax jurisdictions, preferential regimes or tax havens. 193 Due to the key features of the digital economy when these tax planning or tax avoidance mechanisms are implemented through digital businesses, the risks of BEPS are increased.

Taking the above mentioned tax challenges into consideration; the Action 1 Final Report suggested a gross-basis final withholding tax on certain payments made to non-residents (i.e. transactions for goods or services ordered online) or, alternatively, propose to use it as a primary collection mechanism and enforcement tool of the significant economic presence test also proposed by the Report (see section 3.3.2.1 above). Despite the measures appear to be strong mechanisms to address the tax challenges in the digital economy, because they could raise issues regarding the current trade obligations and EU law, the measures where suggested as options but not officially recommended at this stage. Therefore under the current framework the tax challenges in the digital economy regarding withholding taxes, still unclear and still do not have a proper answer.

4.5.1.2. Cloud computing payments

In particular, the digital economies have enabled the delivery of goods and rendering of services over the cloud (i.e. platform services or software services). Due to the characteristics of these transactions, it is hard to know whether the payments are for example royalties or technical services and, therefore, under the current framework it is also hard to know whether to raise a withholding tax.

The features of the cloud computing technologies are the following: i) A third party provides the cloud services; ii) This third party provides hardware, software and processing tools where data is stored, applications are created and by which is possible to access everywhere; and iii) data and intangibles (i.e. applications and software) are the primary property in the value chain. 194

In general terms, the cloud computing usually involves the following services:

Infrastructure as a Service (LaaS) LaaS involves the provision of computer servers, network infrastructure and other resources (i.e. Amazon Web Services and Google Drive). Because the customer only have the right to access the

192 See Huibregtse, supra note 9, at p. 106. 193 See European Parliament, supra note 128, at p. 24. 194 See Huibregtse, supra note 9, at p. 105. Fabián Acosta version 15 08 2016 37 server or network remotely and upload data into the provider infrastructure, no royalties may arise as the substance of the arrangement is to obtain an over-the-counter service. 195

Software as a Service (SaaS) Involves the provision services by means of software that is made available over the cloud (i.e. Google Docs). As the arrangement is the provision of a service (such as telephone or internet) rather than software licensing, no royalties may arise. 196

Platform as a Service (PaaS) Involves services in the form of platforms, typically including an operating system, database and web server (i.e. Beanstalk and Heroku). Under this arrangements taxpayers may argue that the payments are not for the use or right to use any IP, as does not involve the use or right to use any industrial, commercial or scientific equipment, rather as in the cases of LaaS and SaaS, the payments are made to receive a service to access a platform. 197

The application of income tax rules to cloud computing structures is not as developed as the sales tax issues. Several questions still unanswered, such as which jurisdiction can tax the remote use of software? Where the server is located? Where the user is located? The same happens with the characterisation of the services, they are royalties? Or services? All of these questions have an impact in the context of digital economy, which until this moment is still unclear at an international level how to answer them.

4.5.2. Recent developments and implementations Around the world tax authorities are having problems dealing with the tax challenges related with the withholding taxes in the context of the digital economy in cross-border situations. Despite the complexity, governments are actively investigating and writing tax laws in this area, increasing the risk that taxpayers will be caught unprepared in some countries. 198

For example, under German regulations a cross-border payment characterized as royalty, should give rise to withholding taxes in a B2B situation. Based on the current regulations B2C transactions should not give rise to withholding taxes. However, taxpayers engaged in digital economy transactions are facing considerable uncertainties, derived from the controversial tax technical classification of the payment and the arising or not of a withholding tax. Despite some uncertainties can be addressed by the BEPS Report, a practical solution is still needed in relation with the transactions with a digital content.

Also, the Indian Authority for Advance Rulings characterized as a royalty a payment made by a resident for the use of software on the platform of a non-resident. The decision was made on the ground that for the Indian tax authorities this transaction was based on the use of scientific equipment. A similar reasoning was made when the Indian Authority for Advance Rulings concluded that payments made to non-residents for providing a password to access and use a cargo booking portal hosted from outside India constituted royalty subject to withholding tax. 199

These examples can provide a brief example of the current framework in relation with the

195 See Huibregtse, supra note 9, at p. 107. 196 Ibid. 197 Ibid. 198 http://www.ey.com/GL/en/Services/Tax/Worldwide-Cloud-Computing-Tax-Guide---Country-list, accessed on 17 July 2016. 2015 Worldwide Cloud Computing Tax Guide (EY, 2015). 199 See Huibregtse, supra note 9, at p. 107. Fabián Acosta version 15 08 2016 38 characterization of payments, issue related with the imposition of withholding taxes. At the moment it seems that there is not a practical solution worldwide to tackle this issue. Rather the governments and tax authorities around the world are trying to issue their own rules in the matter. However the rules appear to be confusing and tend to create conflicts with the taxpayers that due to the uncertainty in the tax challenges of the digital economy may end paying high penalties due to different interpretations in the subject.

4.6. Anti-tax avoidance EU Directive On January 28th of 2016, the EU issued the Anti-Tax Avoidance Directive (ATAD) that contains measures to prevent “aggressive” tax planning, promote tax transparency, intend to create an balanced level for all businesses in the EU and tries to harmonize direct taxation. 200 In general terms the ATAD transposed most of the BEPS recommendations and even went beyond BEPS by introducing some additional measures. The Directive suggests the following BEPS Actions: i) Action 2 that deals with the neutralization of the effects on Hybrid Mismatch Arrangements; ii) Action 4 that deals with interest limitations; and iii) Action 3 that strengthen and implement CFC legislation. In addition, the ATAD proposes: i) General anti-avoidance rules (GAAR); ii) switch-over clauses where income and gains are regarded as taxable and not as tax-exempt; and iii) exit taxation.

Considering that the actions that the ATAD transposed from BEPS where already discussed in the last chapter, in the following sections a brief description would be provided for the additional three actions followed by a general conclusion that will outline the main critics of the Directive. It should be noted that the ATAD does not intend to tackle directly the tax challenges of the digital economy, but when is addressing the other actions some features will be related with the digital issues. In fact, as stated in the Fact Sheet of the ATAD prepared by the European Commission “The EU agrees that no special action needed but will monitor the situation to see if general anti-avoidance measures are enough to address digital risks”. 201

4.6.1. General anti-avoidance rules The General anti-avoidance rules (GAAR) is designed to allow the tax authorities to ignore arrangements that do not reflect the real intention and behaviour of the parties or agreements where the essential purpose is obtaining a tax advantage that goes beyond the object and purpose of the tax provisions and tax treaties. 202 The GAAR would operate if no other anti-avoidance measure specifically covers the particular arrangement.

4.6.2. Switch-over clauses The measure is intended to prevent double non-taxation of dividends, capital gains and PE Profits coming from third countries, which are often exempt in the EU in order to prevent double taxation. The switch-over clause operate if the tax rate paid in the third country is lower than 40 per cent in comparison with the corporate rate of the Member State. If the rule is fulfilled the foreign income entering the EU will be regarded as taxable and not as tax-exempt. 203 This measure that applies on distributed or realized income should be distinguish from the CFC rules that applies on non-distributed income.

200 http://europa.eu/rapid/press-release_MEMO-16-160_en.htm, accessed on July 16th of 2016. European Commission, Fact Sheet The Anti-Avoidance Package-Questions and Answers (Brussels, European Commission, 2016). 201 Ibid. 202 See European Parliament, supra note 128, at p. 56. 203 See European Parliament, supra note 128, at p. 55. Fabián Acosta version 15 08 2016 39

4.6.3. Exit taxation Exit taxation is intended to stop the transfer of assets with potential gains out of the taxable jurisdictions without a change of ownership. In this way the ATAD proposes that all EU member States can apply an exit tax on assets moved from their jurisdiction. 204 This measure can be more effective is its complemented by an anti-inversion rule in order to tackle companies changing the parent company from one jurisdiction to another. However, the introduction of this measure in the context of the EU rules can be a problem as a merger issue does not exist and only few EU companies have their headquarters abroad. 205

4.6.4. Final remarks and conclusions The ATAD has been criticised for lack of ambition in some measures. First the minimum range of 30 per cent on interest limitations has been considered as a low threshold to address the base erosion via interest deductions and other financial payments. Second, the tax authorities have considered that the with the CFC threshold some foreign based subsidiaries cannot be taxed, as only works if the tax rate paid there is lower than 40 per cent of the home country tax rate. Third, it is consider that the witch-over clause is useful as it might lead to double non-taxation if it is not well designed. Fourth, the minimum threshold set at EUR$750 million concerning the Common Consolidated Corporate Tax Base (CCCTB), would exclude 85 to 90 per cent of the MNEs. 206 Finally, the fact that the ATAD is not dealing directly with the tax challenges of the digital economy is indeed unfortunate, as the digital economies nowadays are “the economy itself”.

4.7. Preliminary conclusions Despite countries around the world are implementing new measures to tackle the digital economy. Some of the measures are impractical (i.e. limitation of the CUP method for on-line advertising services only), fail to address the problem (i.e. the DPT that more than an approach to tackle the digital economies is an anti-avoidance measure) and have a temporary nature as the digital economy is growing and developing much faster that the measures itself (i.e. put restrictions in the on-line advertising market only). Because of these problems many economist and activists are putting forward options such as the formulary apportionment method, the DBCIT or Cash Flow Tax to change the current system, starting with the current concept of nexus and the OECD arm’s length principle.

However interesting approaches are arising, such as the Israel measure on Internet activity of foreign companies, that uses the concept of a significant economic presence to address the tax challenges of the digital economies for treaty country residents and non-treaty country residents. Under the measure a company that has significant digital presence in Israel and conducts activity in that jurisdiction can be considered to have a PE even if the activity is of a preparatory or auxiliary character.

Also more radical measures can be interesting to be considered at an international level, such as the DBCT where the traditional connecting factors of residence and source have to be replaced for a destination based cash flow. The measure can be easily adapted to the key features of the digital economy as it relies on the consumers. In this way similar to the new VAT rules for e-commerce in the EU (OECD VAT/GSM Guidelines), under the DBCIT the taxpayers have to pay taxes on the goods and services provided in the jurisdiction where the customers are located. The DBCT shall apply to all enterprises ensuring tax neutrality, as it affects both traditional business models and the new business configurations. The key to determine the jurisdiction would be the benefits that an enterprise receives from a state.

204 See European Commission, supra note 200, at p. 53. 205 See European Parliament, supra note 128, at p. 56. 206 See European Parliament, supra note 128, at p. 50. Fabián Acosta version 15 08 2016 40

The overall analysis on the current framework and the BEPS recommendations and options shows that some measures fail to address some of the core issues of the tax challenges of the digital economy such as the current treaty rules for taxing business profits, business practices related to the PE Status and its nexus, issues arising from the service and agency PE and some of the transfer pricing and withholding tax challenges. The reasons for this could be that the OECD being a soft-law organisation and the difficulties to reach an international, coordinated and harmonized conclusion are restricting more fast-phased solutions.

In this author view the lower costs of the digital economy combined with the increasing network effects generated by customer interactions may justify a change in tax policy. For this purpose in order to avoid ring fencing the digital economy from the traditional businesses a consensus on the modification of the connecting factors of source and residence, through the concepts of origin and destination is becoming a pressing issue due to the absence of a physical presence or a taxable nexus of the business configurations in the digital economy. In order to achieve this we can consider different systems such as the formulary apportionment method and the DBCT, measures hat seems to be really effective tackling the tax challenges of the digital economy. However these systems will require an international, coordinated and harmonized solution that may be achieved through a multilateral agreement, as is already the intention of the BEPS Action 15.

5. Proposals and technical advise related with the current cases considering business examples

5.1. In general In the following sections case studies related to the taxation of the digital economy will be discussed. At the beginning the facts are going to be settled and then the possible tax challenges in the context of the digital economy are going to be studied under the current framework and also considering the recommendations and options addressed by the BEPS Report.

5.2. Online games The on-line games market is one of the fastest growing markets in recent years and it is expected to growth further. The overall digital games market for 2016 made USD$99.6 billions in revenues with a total of 2.1 billon gamers around the globe. 207 As an interesting fact to show the impressive numbers derived from the on-line games industry, recently Nintendo shares in Japan closed up 24.42 per cent in the stock market. Reuters reported that the company had added USD$7.5 billion to its market value just with the release of the beta version of the online game Pokémon Go. 208

Under the current international rules the business profits of a non-resident enterprise should be taxed in the source country only if there is a PE. In this regard the OECD and UN Model treaty defines it as a fixed place of business through which the business is wholly or partly carried on. 209 Then, the current rules contemplate that for income to be taxed in the source country, a physical location in that jurisdiction must be identified. However these rules appear to ignore the increasing importance of virtual worlds or the importance of virtual property and its increasing monetization through placements of ads on such sites.

207 https://newzoo.com/insights/markets/games/, accessed on 19 July 2016. Newzoo, Global Games Market Report (2016) 208 http://www.cnbc.com/2016/07/10/nintendo-shares-surge-20-pct-on-hopes-for-pokemon-go-smartphone- game.html, accessed on 19 July 2016. Saheli Roy Choudhury, Nintendo leaps 25% on Pokemon Go but the hurdle to killer profits is high (CNBC, 2016) 209 Art. 5.1 OECD Model 2014 and UN Model 2011. Fabián Acosta version 15 08 2016 41

The BEPS Action 1 Final Report the OECD delivers an example of a MNE providing cloud-computing services, 210 for purposes of discussion in the following case we are going to take some of the facts stated therein.

5.2.1. Facts of the case In the case two related companies are involved: i) Company A that provides cloud computing services and web based IT systems for various enterprises worldwide; and ii) Company B that sells on-line games worldwide. For purposes of this example assume that there is a tax treaty in force between the countries that is following the OECD Model 2014.

The facts are summarized in the table below.

COMPANY A COMPANY B

Residence State Based in State A. Based in State B Functions Provides cloud servers and platforms for Developer and publisher of software and website hosting, file back-ups and content in particular games. various other B2B cloud services. Leader in the subscription-based massively multi-player online role-playing game. Operation Operates through a subscription-based In the games that are offered for free, players business model, then customers pay a can purchase virtual items. recurring fee. Some games are subject to monthly subscription fees. Other activities 25% of the revenue comes from outside Had 300 million average monthly unique users State A, however, has R&D operations in and does not provide physical support services State B and C. The support services are to its customers. mainly rendered online but Company A does also send personnel to its customers.

Lets assume also that Company B it is selling its games to a jurisdiction different from State A and State B and that there is a subsidiary that is doing in State S limited routine marketing and customer care services.

Finally, lets also assume that Company A performs R&D and that the company transferred for tax purposes the IP of the MNE to a subsidiary of the company located in a low tax jurisdiction that licence to the related parties the IP rights and that there is an agreement between company A as parent company and the subsidiary, stating that the latter entity is going to make all the IP management for the group.

Following the facts from the case the structure used by the group can be depicted as shown in the next figure:

210 See OECD BEPS Action 1, supra note 23, at p. 175. Fabián Acosta version 15 08 2016 42

5.2.2. Analysis of the case

5.2.2.1. Company A

Under the current framework as Company A have servers and platforms for website hosting, this server through which the website operates, understanding it as a piece of equipment, have a fixed place of business as it have a physical location. Following this, Section 42.2 of the OECD Commentary on article 5, mandates that the company is going to have a PE at the location where the server is operated. Also in this case due to the personnel that is send to the customers, a possible Agency PE could be triggered as under the scope of the Article 5.5 OECD Model 2014, a foreign enterprise is considered to have a PE when the company has a dependent agent who has the authority to conclude contracts for or on behalf of the foreign enterprise.

Taking into consideration the new nexus in the form of a significant economic presence test, Company A indeed offers access to an on-line database and is therefore within the scope of this measure and in any case the company will trigger a PE. This conclusion is based on the existence of a significant economic presence that evidences a purposeful and sustained interaction trough the digital economies between Company A and the particular jurisdiction where their clients are located, in this case States B and C.

As Company A have operations in different jurisdictions, the question of how to count the number of users is going to be relevant under the new nexus approach. Also as the entity is offering IT support services, consideration must be provided to the users of these services, because they may also count as users overall. A good indicator could be weather or not these services are being charged at stand alone basis or whether or not Company A is receiving a compensation for them within the price received for its core services. Fabián Acosta version 15 08 2016 43

5.2.2.2. Company B

Under the current framework Section 42.2 of the OECD Commentary on article 5 leads to the conclusion that in a case where the enterprise owns the website but not the server, the enterprise does not have a physical presence at the location of the server. What is more critical is that even though there is not a PE in the source jurisdiction, in the residence country it is possible that Company B is not paying direct taxes for users not located in State B. This can happen if we consider that the payments that the Company is receiving for allowing the users play on-line are service fees. In this way in some jurisdictions no withholding tax should arise, as services rendered abroad do not trigger taxes in the residence country. 211

Under the new nexus option suggested by BEPS Action 1 Final Report, as Company B is clearly providing an access to electronic applications and games online, is within the scope of the significant economic presence test and therefore a PE should arise in the jurisdictions where the users are situated. Also it should be noted that some characterisation issues might arise that can lead to double non-taxation if there is not a clear implementation of the nexus test. For example State B could consider that in State A there is a PE in the form of a significant economical presence, while State A may consider that there is not a PE in their jurisdiction under the traditional rules.

Considering the underlying benefit theory as the potential rational for the allocation of income in the new nexus method, it seems appropriate to refer to the amount of users. However in the present case there are paying and non-paying users. This could be a problem under the new nexus option, because questions such as whether the free users have to be contemplated for assessing the significant economic presence test and whether the free users have to be contemplated for allocating income to a particular jurisdiction, should be taken into consideration.

It should be noted also that in the course of playing games on-line, participant often receive items, such as armour, weapons and virtual currency. These digital goods that are sold in the course of the game if they were sold in the real life they should have a value in a physical currency and the company will have to pay direct taxes over the revenues that are generating. An example of this is the role-playing games such as Dungeons and Dragons, where the same armours and weapons are sold physically in order to improve the actions figures that have to be bought in order to play the game.

In this framework the question that should arise is whether income from the transfer of such digital property, rights and items is taxable and, if they are, which could be the jurisdiction to tax it. Similar questions should arise if we consider that the websites themselves constitute property, as in the course of the games the companies usually display ads and banners offering goods and services of other companies. 212 However, the present rules do not explicitly contemplate the above situations

5.2.2.3. Source state issues

Under the current framework as Company B does not have a physical presence, all the revenues from the sales of cloud computing services in State S are treated as income of Company B, due to its role as the counterparty to the transactions with local customers and administrator of the websites. 213 Following this State S its not going not tax the profits derived from these activities because it has no right to do so under its domestic law or because the tax treaties in force restrict its taxing power.

Under the new nexus option as Company B is clearly providing an access to electronic applications

211 Sections 24 and 25 of the Colombian Tax Code, Sub-section e) of Article 9 of the Tax Code of Peru. Where income derived from the offering of services outside the country is not taxable income therein. 212 See Huibregtse, supra note 9, at p. 99. 213 See OECD BEPS Action 1, supra note 23, at p. 176. Fabián Acosta version 15 08 2016 44 and games online, is within the scope of the significant economic presence test and therefore a PE should arise in State S.

5.2.2.4. Low-tax jurisdiction issues

It should be noted that the subsidiary located in State S would have to deal principally with the recommendations to address the challenges introduced by the digital economy in relation with Transfer Pricing. In the case the intangible was transferred by the parent company to the subsidiary located in the low-tax jurisdiction motivated by tax purposes. However in accordance to the BEPS guidelines even though the subsidiary have the legal title of the assets, this does not mean that the legal agreements correspond with the reality of the transaction. In order to determine the appropriated return attention should be provided to the related parties performing the important functions, contributing important assets or assuming economically significant risks related to the DEMPE of intangibles.

In the case both companies A and B have R&D activities and the subsidiary have the management of the Intangible. In this way the company will have to evaluate and determine through a profit split method the contribution of each company to the intangible in order to find the correspondent return. As this case is the typical example of a multi-sided business where several companies create value by working together in order to develop a project or intangible that is going to be useful for all the participants, the guidance on group synergies should be considered.

5.2.3. Conclusion The new nexus option is more likely to solve most of the issues arising from this particular case. However there are more tax challenges that should be considered in order to tackle all the issues of the digital economy through this option. Following this, the OECD should provide further guidance in the characterisation and implementation problems of the new nexus option. Also, as the significant economical presence test in this moment was suggested as an option and not as a recommendation by the BEPS report, it should be noted that under the current framework several tax challenges are going to keep arising even if we consider the changes to article 5 OECD Model 2014 proposed by the BEPS Action 1 Final Report.

6. Conclusions and recommendations

The previous analysis has shown that there are many aspects that must be considered in order to tackle all the spectrum of the tax challenges of the digital economy. Despite the OECD put forward most commonly used methods for BEPS such as the abuse of preferential tax regimes, 214 artificial internal trading of intangibles,215 thin capitalisation,216 internal debt shifting217, transfer price allocation,218 artificial contractual arrangements and the circumvention of CFC rules; there are more aspects to take into consideration such as multi-sided businesses, characterisation of payments under the cloud computing economy and 3-D printers regulations, aspects that need to be addressed in the discussion of the tax challenges of the digital economy.

Therefore, in this authors view, the existing recommendations and options proposed by the BEPS Report are restricted to tackle some of the tax challenges of the digital economy but not all the issues that arise from the new business configurations (i.e. nexus and attribution of income rules). The

214 i.e. patent boxes or IP preferential regimes 215 i.e. trading of internal property licensing 216 i.e. local subsidiary of an online retailer with a warehouse with limited earnings 217 i.e. decrease of the tax base through deductions 218 i.e. selling of goods at high prices to make subsidiaries artificially erode or increase its tax base Fabián Acosta version 15 08 2016 45 limitation of the BEPS measures could be attributed to the fact that the digital economy is developing faster than the measures considered and implemented, and in some cases because the operators do not understand the broad scope and possibilities of the digital economies.

What it seems to be happening is that the BEPS Report is trying to address the tax challenges of the digital economy by adapting the current system that dates back to the 1920s to issues that go beyond the scope of the old regulations. In addition, despite the BEPS Report is trying to modify the old system through modification of the list of the exceptions of PE in Art. 5.4. OECD Model 2014 and its definition, together with the introduction of an anti-fragmentation rule to ensure that it is not possible to get a benefit from this exceptions, most interesting options have not been recommended such as the new nexus in the form of a significant economic presence test.

This latter test was implemented successfully by Israel. However it has been criticized that the measure is far reaching and touches upon issues, which cover much more than the Internet economy aspect, the measure tackles the digital businesses that do not have need a physical presence in Israel (i.e. online selling of goods and rendering of services) what can be a good first step to address the tax challenges of the digital economy. It is too soon to know the effects of the measure, nevertheless the measure seems well structured and goods results are expected. Attention to taxpayers that are covered by tax treaty regulations should be considered, as the measure could be limited by these tax treaty restrictions in some cases.

Some of the major risks are not dealt in the BEPS Report, as the intention of the OECD is to achieve a solution with the traditional taxation rules that are useless to tackle some of the key features of the digital economy (i.e. mobility and data). Following this, risks related to the source country ability to tax digital income generated in its territory under the current attribution rules is still pending. If the general policy objective is in fact to ensure the source jurisdiction ability to tax, the recommendations and option of a narrow significant digital presence test does not sound as long-term solutions, as these measures does not achieve this intention, does not ensure an equal treatment of the market participants and ring-fence companies engaged in fully dematerialized activities.

A consensus on the modification of the connecting factors of source and residence, through the concepts of origin and destination is becoming a pressing issue due to world wide challenges posed by e-commerce such as the absence of a physical presence or a taxable nexus. In this sense one can observe a gradual trend towards the implementation of different systems such as the formulary apportionment method and the DBCT where the traditional connecting factors of residence and source have to be replaced for a destination based cash flow. Under the DBCIT the taxpayers have to pay taxes on the goods and services provided in the jurisdiction where the customers are located.

An effective and definitive answer to the major issues requires an international, coordinated and harmonized solution that may be achieved through a multilateral agreement, as is already the intention of the BEPS Action 15. As this is a solution that may take a long time to be achieved, now that the major BEPS risks have been identified for now immediate action of the recommendations and options stated by the OECD is needed to advance in the aim to tackle the growing tax challenges of the digital economy. Fabián Acosta version 15 08 2016 46

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retail stores or online to spend digitally via Internet. With this mechanism the authors intend to impose taxes at the moment of the acquisition of the E-cards. 12. Devereux, Michael P, ‘Issues in the Design of Taxes on Corporate Profit’, 65 National Tax Journal 3 (September 2012), pp. 709-730. The author proposes to introduce an Allowance for Corporate Equity (ACE) in the taxation systems of companies. In this sense, the article studies how an ACE can affect various dimensions of corporate decision-making. The author states that the ACE would introduce neutrality in decisions such as the scale of investment and the source of finance. However it notes that can lead to distortions related to location and profit shifting. The paper discusses some evidence on the possible impact of introducing an ACE, which depends on how the government makes decisions in the context of corporation tax revenue. The author also considers briefly more radical options such as a DBCT. 13. Dodwell, Dodwell, et al., UK issues country-by-country reporting regulations (United Kingdom, Deloitte, loose- leaf), Global Transfer Pricing Alert 2016-007. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 14. European Commission. Commission Expert Group on Taxation of the digital economy Report. (Brussels, 2014). The Report analyses the best ways of impose taxes within the context of the digital economy in the EU. Also focuses on identifying the key problems with digital taxation from a EU perspective, and presenting a range of possible solutions. 15. European Parliament, Tax Challenges in the digital economy (Brussels: European Parliament, 2016). The Report analyses tax challenges related to direct and indirect taxation in the context of the digital economy. The paper studies the conclusions of the OECD BEPS Project and the recent reforms in the area of taxation in the EU and third countries. The Report propose some policy recommendations considering the current framework of the digital economies and taking into consideration the recent scandals involving big MNEs and aggressive tax planning practices in the EU and third countries. The recommendations are intended to address the tax avoidance and harmful competition practices of MNEs and companies involved in the digital economy. 16. Finn, Ronan, and Norton, Kevin, Ireland introduces bilateral APA program (Dublin, PwC, loose-leaf), Tax Insights from Transfer Pricing. The article provides a brief description of the implementation in Ireland of the new APA program in the context of transfer pricing transactions that involve this country. 17. Friess, Peter and Ibanez, Francisco, ‘Putting the Internet of Things Forward to the Next Level’, Internet of Things – From Research and Innovation to market Deployment (2014), pp. 3 – 6. The article provides a brief description of what is the IoT in the current world. It establishes that the IoT has moved from being a futuristic vision to an increasing market reality that is affecting our day-to-day activities. 18. Flynn, Channing, Bates, Stephen, and Thomas, Rob, ‘OECD issues final report on the tax challenges of the digital economy under Action 1’, Global Tax Policy and Controversy Briefing. Special edition: BEPS final recommendations 17 (March 2016), pp. 36-43. The article intend to summarize the OECD BEPS Report Action 1, describing what is discussed in the Report, the fundamental principles of taxation, the emerging of new business models and the tax planning opportunities in the context of the digital economy. The article in analyzing the above-mentioned items, state the indirect and direct tax challenges of the digital economies and identify the next steps to address them. 19. Grube, Stefan; Axel, Kroniger and Maywald, Andreas, Germany’s draft tax law includes CbC measures (Dusseldorf, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-019. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 20. Hongler, Peter and Pistone, Pasquale, Blueprints for a new PE nexus to tax business income in the era of the digital economy (Amsterdam: IBFD White papers, 2015). The authors taking into consideration the OECD BEPS Action 1 Project identify the core issues of the introduction of a new PE nexus based on digital presence. In doing so the article describe the essential features of the new nexus and reconsider the basis of the concept of sourcing for income tax purposes in the global economy. The authors conclude that an implementation of a new PE nexus is needed in the context of the digital economy, based on a significant economic presence in the market country. For this purposes the article support its conclusions by a theoretical reconstruction in the light of a new dimension for the benefit theory. 21. Huibregtse, Steef and Sood, Avisha, digital economy Handbook 2016. Tax, Transfer Pricing and other Legal Aspects of Business configurations (Amsterdam: TPA Global, 2016). The book deals with the digital economy and its relation with the BEPS Project. The book is divided in three parts: i) the history and trends of the Internet; ii) the new and upcoming digital economy business model configurations; and iii) the legal, tax and Transfer Pricing considerations. The book discusses the history of the Internet and focuses particularly on new business models linked with the growth of the Internet. Explains the modern business configurations and illustrate them with practical examples. The final part of the book explains the international tax framework, including the tax treaty principles, particularly the application of the permanent establishment concept. Finally, in a last chapter the book contain some case studies. 22. Kapadia, Sudhir, et al., India introduces new equalization levy on online advertising revenue (United States, PWC, loose-leaf), Tax Insights from International Tax Services. The article summarizes the key provisions related to the equalization levy on digital E-commerce issued in the Indian fiscal budget presented on February 29 of 2016. 23. Kleinbard, Edward D., ‘Stateless Income, 11 Florida Tax Review 9 (2011), pp. 700-770. The article discusses the tax consequences and policy implications related to the stateless income. The author shows that the current US regulations governing tax income from foreign direct investments often are misunderstood, as in a tax planning scenario the US rules operates as a variant on territorial systems, with hidden benefits and special regimes that allow tax avoidance practices and hybrid mismatch agreements. In this sense the current US tax rules may lead to BEPS practices in an international setting. Fabián Acosta version 15 08 2016 48

24. Lahodny, Andrea and Holzinger, Gabriele, Austria plans introduction of standardized transfer pricing documentation (Vienna, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-018. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 25. Mosegaard, Asger, et al., Denmark finalizes implementation of OECD three-tiered approach to transfer pricing documentation (Denmark, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-017. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 26. Moutarlier, Valère ‘Global warming: the heat is rising on digital taxation’, 16 Tax Insights for business leaders (2016), pp. 46-47. The article provides insights in the recent developments related to the BEPS Action 1 Report about the tax challenges in the digital economy. For this purpose the article brings some country-by-country examples within the context of digital business configurations. 27. Neal Friedman, ‘The Legal Challenge of the Global Information Infrastructure’, 2 Cyberspace Law 10 (1998). The book provides a general historical background of the Global Information Infrastructure and the Internet, along with some facts about the e- commerce. 28. Organisation for Economic Co-operation and Development, Base Erosion and Profit Shifting, Public Discussion Draft, BEPS Actions 8-10, Revised Guidance on Profit Splits (Paris: OECD, 2016). The Discussion Draft is issued to clarify and strengthen the current guidance on the transactional profit split method in the context of global value chains, unique and valuable contributions and group synergies. The Report elaborates two different approaches to undertake the profit split method: i) transactional profit splits of actual profits; and ii) transactional profit splits of anticipated profits. Finally, the Discussion Draft proposes further guidance on the application of the transactional profit split methods. 29. Organisation for Economic Co-operation and Development, Base Erosion and Profit Shifting, Public Discussion Draft, BEPS Action 7, Additional Guidance on the Attribution of Profits to Permanent Establishments (Paris: OECD, 2016). The Discussion Draft is issued to clarify and provide guidance on the application of the rules of Art. 7 OECD Model 2014 to the PE resulting from the changes included in the OECD BEPS Final Report. Also the Report takes into consideration the results of the BEPS Project in relation with Transfer Pricing, in particular the work related to intangibles, risk and capital. The Discussion Draft focuses in two particular items: i) dependent agency PE, including commissionaire and similar agreements; and ii) warehouses as fixed place of business PEs. 30. Organisation for Economic Co-operation and Development, International (VAT/GST) Guidelines (Paris: OECD, 2015). The international VAT/GSM guidelines set forth the principles for the VAT treatment in an international setting. The guidelines are focused on trade in services an intangibles in order to reduce risks of double taxation and double non-taxation that result from inconsistencies in the application of VAT/GSM in a cross—border context. Despite the guidelines do not intend to modify the domestic law, they seek to identify objectives and suggest recommendations for achieving them. 31. Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Action 1: 2015 Final Report, Addressing the Tax Challenges of the digital economy. (Paris: OECD, 2015). The objective of the OECD BEPS Action 1 Final Report is to address the tax challenges of the digital economy. The Final Report instead of suggest recommendations and a different tax system exclusively for the digital economy, identifies issues in both direct and indirect taxes and propose solutions in order to address these challenges. The Report in order to address the issues that arise from the digital economy identifies the Key features of the digital economies, the tax planning opportunities in the context of direct and indirect taxation and the related tax policy concerns. Alternatively with the purpose of tackle these issues, the Report makes some recommendations and state some options. Despite the options do not where recommended at this stage, the OECD establishes that countries could introduce any of them in their domestic law in order to tackle BEPS. 32. Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Action 6: 2015 Final Report, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (Paris: OECD, 2015). The Report aims to include changes of the OECD Model Tax Convention in order to prevent treaty abuse. In doing so the Report provides recommendations to implement rules including a minimum standard to address treaty-shopping arrangements and to prevent the use of dual resident companies for tax planning purposes in the traditional and digital economy transactions. These rules intend to prevent cases of abuse of treaty networks (without carrying business activities in that country) and double non-taxation. For the above-mentioned purpose the Report addresses treaty shopping through different provisions that form part of a minimum standard. Also the Report includes rules to ensure that tax treaties do not inadvertently prevent the application of domestic anti-abuse rules. Finally, the Report includes some changes to the OECD Model Tax Convention in order to clarify that double tax treaties in any case aims to trigger double non-taxation, tax avoidance or tax evasion. 33. Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Action 7: 2015 Final Report, Preventing the Artificial Avoidance of Permanent Establishment Status (Paris: OECD, 2015). OECD BEPS Action 7 Final Report analyses the artificial avoidance of a PE. For this purposes in the context of the digital economy the Report include changes to the exceptions to the definition of PE put forward by Art. 5 OECD Model 2014, recommend a new anti-fragmentation rule to ensure that it is not possible to benefit from these exceptions through the fragmentation of business activities among related parties and a modification of the PE definition. The changes have as an objective ensuring that circumvent cases of tax planning, tax avoidance or tax evasion in relation with the PE status. 34. Organisation for Economic Co-operation and Development, OECD/G20 Base Erosion and Profit Shifting Project. Actions 8-10: 2015 Final Report, Aligning Transfer Pricing Outcomes with Value Creation (Paris: OECD, 2015). OECD BEPS Actions 8-10 Final Report modify and clarify the Transfer Pricing Guidelines in order to align Transfer Pricing outcomes with value Fabián Acosta version 15 08 2016 49

creation. The new guidance focuses on the following key areas: i) Issues relating to transactions involving intangibles and HTVI, including significant control over risk and DEMPE functions; ii) substance of the contractual arrangements and real behavior of the related parties; iii) contractual allocation of risks and profits; iv) funding return provided by a parent company or other related party, when the return does not correspond to the reality of the operation; v) further explanation of valuation techniques and the transactional profit split method; vi) guidance in intragroup services; and vii) other high risks areas. 35. Organisation for Economic Co-operation and Development, Public Discussion Draft Addressing the Tax Challenges of the digital economy (Paris: OECD, 2014). The purpose of the public discussion draft is to receive comments from stakeholders about the draft on the tax challenges of the digital economy. The Draft Identify the main issues that the digital economy triggers for the application of existing international tax rules. 36. Organisation for Economic Co-operation and Development, Action Plan on Base Erosion and Profit Shifting (Paris: OECD, 2013). In general the Action Plan identifies 15 actions to address BEPS in a comprehensive manner and sets deadlines to implement these actions. The Action Plan calls for fundamental changes to the current mechanisms and the adoption of new consensus-based approaches, including anti-abuse provisions, designed to prevent and counter BEPS, tax planning opportunities, tax avoidance and tax evasion. 37. Organisation for Economic Co-operation and Development, Committee on Fiscal Affairs, Electronic Commerce Taxation Framework Conditions (Paris: OECD, 1998). Set the principles that should apply to E-Commerce, namely: Neutrality, Efficiency, Certainty and simplicity, Effectiveness and fairness and flexibility. 38. Popa, Oana, ‘Taxation of the digital economy in Selected Countries – Early Echoes of BEPS and EU Initiatives’, 55 European Taxation 1 (2016), pp. 38-42. The article describes and provides some conclusions related to several initiatives of number of EU and third countries to address the tax challenges of the digital economy, after the release of the OECD BEPS Project. The article is based on information available up to 1 October 2015. 39. Quaratino, Luigi, ‘New Provisions Regarding the Taxation of the digital economy’, 54 European Taxation 5, (9 April 2014), pp. 211-217. An article that summarizes recently enacted provisions that attempt to address the problem of the taxation of the digital economy in Italy, including a VAT provision in the form of a web tax (that was subsequently repealed) and some transfer pricing provisions. 40. Rosensweig, Yedidya, ‘Tax Authorities Publish Draft Circular on Internet Activity of Foreign Companies’, 22 International Transfer Pricing Journal 4 (2015), pp. 261-262. The article explains the circular issued by the Israeli tax authorities sets forth to address the problem of the taxation of the digital economy in Israel. The article focuses on the attribution of income of a foreign company to a PE in Israel in the context of the digital economy. Acknowledging BEPS Action 1, the circular uses the concept of a significant economic presence to address the tax challenges of the digital economies for treaty country residents and non-treaty country residents. 41. Rosenthal, Sean, ‘The OECD’s International Tax Proposal; The Action Plan’, 33 Review of Banking & Financial Law (2014), pp. 20 – 29. Article contained in the book “Review of Banking & Financial Law” published by the Boston University School of Law. In the article the author reviews the OECD BEPS Action Plan, explaining the purpose, goals, policy and recommendations. The article also examine the potential effects of the Action Plan and the likelihood of its realization, describe the public events leading to the Action Plan’s publication and endorsement, explain the fifteen actions recommended by the Action Plan, consider the possible beneficial and harmful effects of the Action Plan on developing countries and analyze the political difficulties with fully implementing the Action Plan. 42. Soares, Rosa, and Matos, Patricia, Portugal introduces country-by-country reporting requirement (Lisbon, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-014. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 43. Thomas, Gary, and Obrien, Timothy, Japan’s proposed adoption of BEPS Action 13 includes new perspective transfer pricing documentation rules (Japan, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-002. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing. 44. Varley, David, et al., United States issues final country-by-country reporting regulations (United States, Deloitte, loose-leaf), Global Transfer Pricing Alert 2016-024. The article summarizes the regulations issued by the country mentioned in the title of the article, in relation with the standardized country-by- country reporting requirements identified in the BEPS Final Report in the context of Transfer Pricing.