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 PERSONAL STATEMENT Regarding the Adv LLM Paper submitted to satisfy the requirements of the 'Master of Advanced Studies in International Tax Law' degree: 1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself without any assistance, (b) that this paper does not contain any materials from other sources unless these sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been properly marked as such while full attribution has been made to the authors thereof. 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In articles that I may publish on the basis of my Adv LLM Paper, I will include the following statement in a footnote to the article’s title or to the author’s name: “This article is based on the Adv LLM paper the author submitted in fulfillment of the requirements of the 'Master of Advanced Studies in International Tax Law' degree at the International Tax Center Leiden (Leiden University).” 4. I hereby certify that any material in this paper, which has been accepted for a degree or diploma by any other university or institution is identified in the text. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree. signature: name: Fabián Andrés Acosta Guevara1 date: 15 08 2016 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 ...................................................................................................................