Thoughts on the Digital Economy

Most modern economies have developed fairly robust methods of charging and collecting taxes however there’s one area that most are struggling with. That is of course, the digital economy which most experts agree is not dealt with even remotely well. It’s certainly fair to say both private and corporate tax rules are basically hugely ineffective when dealing with digital businesses.

One of the problems is that current tax legislation is often used to try and collect these taxes and it’s often completely inappropriate. First of all it does not capture many business models often for the simple fact that sometimes the company making money doesn’t even have a physical presence there.

Take for example a media streaming website or digital business which operates solely online. It provides service over the web in exchange for payment in the form of single charges or more commonly using a subscription model. The business has no physical buildings or employees in that country. Even identifying the fact that a profit is being made is difficult, even quite large companies can easily operate under the radar. Simply banking profits and only declaring them in some far flung low tax principality somewhere. This means that there is a huge disconnect between where the value is created and where that company pays taxes.

Many large economies are extremely concerned about this as it means they are losing out on literally billions in taxation revenue from these services. The European Commission has been at the forefront of this issue and is trying to develop new rules which tackle the subject fairly – you can see their initial report here.

Basically they are suggesting that corporate tax rules in all countries are modified to ensure that profits are registered and taxed in the countries where they are primarily created. This overall seems the ideal solution but it is a difficult one to achieve. The EU has proposed until this is implemented that there is an interim tax levied which covers any activities which are currently escaping any tax.

One of the problems is determining where the value and hence the profits are actually generated. For an example you could have a French company streaming US made films and content to customers in the UK for a subscription fee. Also the servers which are hosting this content and streaming it to the customers could be located somewhere completely different. Its relatively simple for a company to argue about where the value is created, and obviously they’ll generally pick somewhere with the lowest tax rate.

What happens is a country which has no involvement in any of the activities will benefit from the taxation for one single reason – they have low corporate tax rates. This is of course entirely unfair and means that money is being extracted from one country without any taxation benefit being applied at all.

Although large companies hit the news with these tax evasion scenarios all the time, there is also a problem in small business market. Many people are now making their livings online and are becoming harder and harder for the normal taxation system to capture.

For instance I know a huge group of people from all over the world who make their living online simply from buying and selling hard to obtain products. One example is the purchase of sneaker (trainers in the UK) where people buy them and resell them at a profit. This sounds like a tiny sideline but in fact for many people it’s actually a huge business. People invest in automated software and method to hide their IP addresses (known as sneaker proxies like this).  In fact many people make hundreds of thousands out of these online deals which are very difficult to bring into the taxation systems unless they are voluntarily declared but the individual.

It’s not a small industry either huge marketing companies have developed by buying and selling online and make thousands of pounds of profit every day.  Yet again there difficult to tax as they could literally be based anywhere, indeed the only physical location will be web servers which are unlikely to be in the target country anyway.

Whether it’s huge international companies or just ordinary individuals, more and more people are making their living online and can easily sidestep the traditional taxation system.  Even the more advanced countries  are struggling to keep up with this so it’s important that they try and lead an example.  Obviously smaller areas and self styled tax havens have less incentive to promote any sort of value based taxation rules so are unlikely to help much.  It also easy to appear to be in any country too, a company in Panama can simply have digital offices and use a UK VPN like this to appear very convincingly to be in the UK.

Ultimately though it’s important that the world comes up with a way to tax these digital enterprises fairly.   The corporate issues certainly need some sort of global, international solution, however taxing individuals and small businesses could become increasingly important due to the scale of people moving to these employment opportunities.

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