International Taxation in the Digital Economy: 
Challenge Accepted?
Introduction
The phenomenon of digitalization is considered the most important development of the economy since the industrial revolution and one of the major drivers of growth and innovation. At the same time, the digital  economy is associated with major challenges for the international  tax  system . Traditional tax laws are governing new ways of conducting business, but current international tax law and its underlying principles may not have kept pace with changes in global business practices. With regards to digital business models, the main tax challenges in the digital economy are the decrease in physical  presence  in customers market, the increase in the importance and mobility of intangibles and the high degree of integration of the value chain. Although these developments are not entirely new, they have triggered a political and academic discussion about how international taxation can be reformed to provide a reasonable and stable system for taxing the profits of multinational companies in the 21 st century.
Question 1: What is the relation between the digital economy and the fourth industrial revolution?

The rise of the digital economy must be seen in relation
to the  F ourth Industrial R evolution. The First Industrial Revolution used mechanization, water power, and steam powe r; the Second Industrial Revolution used mass production through assembly lines and electricity; the Third Industrial Revolution focused on electronics, computers, and automatio n. Now the Fourth Industrial Revolution is using physical cyber systems, focusing on end-to-end digitalization of all physical assets, fusing technologies, and in the procedure hiding the lines between the physical, digital, and biological spheres. This shift has resulted in the rise of the digital economy in which data and information have become the new oil . The Organization for Economic Cooperation and Development (OECD) describes the digital economy as:
  • The result of a transformative process brought by information and communication technology (ICT), which has made technologies cheaper, more powerful, widely standardized, improving business processes and boosting innovation across all sectors of the economy.
  • The key word in this definition is called "transformative," as the digital economy is evolving an unprecedented speed, growing exponentially, and disrupting every industry across the globe.
  • The digital economy comprises e-commerce, app stores, online advertising, online payment services, cloud computing, and participative networked platforms, among others.
 
Question 2: What are the benefits and risks of the digital economy?


Question 3: What is the value chain of the digital economy?

Question 4: How should internet sales and consumption of digital goods be taxed?

Internet Sales:
Consumers pay sales taxes at the time of purchasing a good based on the location of the physical store at which the consumption is conducted. However, governments find it difficult to tax Internet sales because there is no retail address. In theory, the consum er is required to  pay the tax to the government authority where he resides. Some countries, such as Swi tzerland , have been successful at implementing this. However, this is not always the case. While the volume of e-commerce as a proportion of retail trade continues to increase around the world, sales taxes on goods purchased on the Internet are not paid in many cases. Some governments are trying to redress this imbalance by taxing e-commerce sales.


Consumption of digital goods:

The issue raised in the point above could be extended to the purchasing of digital g oods (such as the payment of a monthly fee for video streaming services). In most cases, payment of video streaming subscriptions from providers like Netflix or Apple TV  does not include taxes. In a recent case, the municipal government of Buenos Aires, Argentina imposed a tax on Netflix subscriptions to be collected on the basis of monitoring of relevant credit card transactions. The purpose of the tax was to protect local providers of competing services.
 
Question 5: What are the major challenges for taxing digital goods?

1- For the time being, there is no agreement among policy makers as to what category should digital goods fall, or whether a digital good should be taxed at all.

2- Video and audio streaming presents policy makers with an interesting dilemma when it comes to taxation. In order to deal with this issue, some governments determined that streaming video and music content should be subject to a tax similar to the sale of a cable TV subscription.

3- Another layer of complexity in taxing digital goods has to do with the physical location of purchasing .
For example, the acquisition of the digital good may be conducted at one location, while the property exists on a server located at another location, and the user consuming the good is resident in yet a third site. Under these conditions, which location should apply the sales tax? The source one, the one where purchasing took place or the one where consumption actually occurs? To make things even more complex, what happens if the good (say, a Netflix subscription) is consumed by more than one individual located in a different site?

4- Part of the inconsistency in the taxation treatment of digital goods relates to the fact that policy makers are trying to fit video streaming, as a new service, within pre-existing frameworks and classifications.
This problem is starting to be addressed in countries like the United States, where the Streamlined Sales Tax Project was created to standardize definitions of digital products with the purpose to adapt sales and use taxes to the new era. In this context, some local jurisdictions in the United States have imposed a 9% tax on cloud services .

5- European VAT Rules
  • The issue of taxation of digital goods, particularly video streaming services, was raised in other geographies beyond the United States. In Europe, in order to respond to a significant loss of cable television customers to streaming services, regional tax authorities are implementing VAT to be imposed on subscribers rather than providers. Implementing such measures could prove highly difficult given the range of local VAT rates across locations. The French government introduced a 2% tax on video on demand from foreign operators. Since January 2015, international online video streaming services were liable to payment. 
  • In a similar move, the South Africa Government imposed a 14%VAT on foreign services who sell digital goods and services. Moreover, The Brazil movie authority has required Netflix and Apple TV to pay a fee equivalent to 1400 USD for each movie, and 340 USD for each episode of a TV show distributed in Brazil. Considering the size of the catalog of both operators, the tax would amount to approximately 5.5 MM USD.
6- Distortive taxation regimes in the digital economy
In principle, taxation should attempt to be neutral and equitable across all sectors of the economy. A distortion occurs when a change in the price of a good resulting from taxation triggers different changes in supply and demand from what would occur in  the absence of taxes. The deviation in supply/demand equilibrium is defined as the  dead weight  loss (cost of taxation over and above the taxes paid to the government). In this sense, taxation regimes should seek to minimize discrimination for any particular choice .
  • Dimensions of distortion: Taxes can create distortions if they affect the choices made by market agents, which in the digital space could be as follows:
    • Consumers, particularly those that are price sensitive, limit the adoption of technology.
    • Telecommunications operators reduce their rate of investment in infrastructure.
    • Global digital technology providers adapt their deployment footprint according to a minimization of tax burden.
    • Different tax regimes within the digital eco-system create asymmetries.
  • The design of an efficient tax structure in the digital space needs to consider several somewhat contradicting requirements:
    • Ensure proper collection of taxes for income generated at source.
    • Avoid over taxation of digital activities when compared to other industries.
    • Selectively provide exemptions to facilitate investment in infrastructure and promote adoption by end-users.
 
Question 6: Taxation regimes of global players with no local presence: is it possible?

The delivery of Over-the-top players content refers to the distribution of audio, video and other media over the Internet without the involvement of a distributor, such as a cable TV operator, in the control or management of the material. Additionally, OTT platforms enable the distribution of targeted advertising, which have the capability of leveraging their deep understanding of customer demographics. Finally, OTT platforms include merchants capable of conducting all commercial transactions online leading to the purchasing of a physical good. The table below presents global revenues of several operators providing services operating over-the-top.

The growth in business of OTT players raises the issue of how to tax the distribution of digital goods . For the time being; however, those have been largely untaxed . This situation applies not only when they are provided by foreign operators, but also in many cases, within a given country.
  • The discussion above of tax rules for players operating in the digital space becomes quite complex for global players. It is worthy to mention that the Egyptian government is considering a tax on social media and search engine advertisements. It might also apply a tax on goods sold via electronic trade websites, given that the VAT does not apply to such goods.
  • The following part presents Netflix as a case study, assessing how it deals with taxation issues and what is the net impact of these arrangements in terms of tax collections for host country governments.  
  • Netflix:  The US-based company Netflix has a total 125 million worldwide subscribers, of which 80% are located outside the United States. Netflix offers video streaming service in Europe, Latin America, the Caribbean and Asia.  The co mpany's objective is to generate  80% of revenues from  international  subscribers , which forces it to aggressively expand in all continents. In its ongoing international expansion, the company is facing some taxation challenges, based on complaints of unfair competition on the part of local streaming providers and cable operators.  For example, the city of  Buenos  Aires  imposed a  3% gross  income  tax  on all  foreign  online  subscription  services , including video, music and games. The tax, known as the " Netflix  tax ", is  targeted  directly  at streaming services and relies on credit card companies acting as tax withholding agents. Rather than taxing consumers, the  objective  is to collect taxes from  digital  content  distributors  that do not pay any corporate taxes in Argentina. Beyond Netflix, the measure also affects services such as  Amazon  Instant Video and iTunes.
 
Conclusion
Because digital technologies have an impact on the economy, increasing the efficiency of production processes, facilitating the circulation of goods, and creating new businesses, the taxation of digital goods and services should be approached with care, preventing any erosion of their spill-over contribution to GDP growth. Furthermore, because of the economic  impact , it has been shown that excessive taxing of digital goods and services could limit adoption, restricting the positive contribution to GDP . Thus, the tax collected is outweighed by tax foregone on " lost " GDP. However, the evidence regarding the economic impact of digital industries continues to grow, ranging from fixed broadband to computing, the Internet, and mobile broadband. From that perspective, the argument to reduce potential distortions emerging from over-taxation of the sector is gaining ground. As others have argued, though, the reduction in digital sector taxes needs to be weighed in terms of the potential reduction in revenues. Having said so, establishing a balanced view of tax policy across sectors in order to eliminate distortions is a tall order .
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