TAXATION POSED BY THE DIGITALISED ECONOMY
i. INTRODUCTION
In addition to the finding of the inadequacy of the South African source rules in their application to the digitalised economy, it is commonly asserted that the international framework for taxation is also inadequate. This is evidenced by the urgency from all over the globe, and spurred on by the OECD, to reach a consensus-based solution to the challenges addressed in Chapter II. Moreover, Action Plan 7 – published by the OECD – identifies how the digitalised economy is able to inappropriately benefit from the exceptions to the concept of a permanent establishment through artificial arrangements.315
Digitalisation provides multinational enterprises with the opportunity to carry on their business endeavours in a country with little, or even no, physical presence. Thus, a business can derive substantial benefit from having access to a market and a market’s population without necessitating a physical presence which would give rise to a taxable presence in terms of the permanent establishment concept encapsulated in the DTAs. ATAF attributes the inability of many countries to establish taxing rights over these businesses to the current framework for taxation at the international level.316 The international framework only allocates taxing rights to a country where the non-resident enterprise creates sufficient physical presence in the form of a permanent establishment. This is the only nexus present in the current international framework.317 Therefore, the digitalised economy and the business models proliferated therein pose considerable risk to the proper allocation of taxing rights to contracting states.
Therefore, it is submitted that the challenges posed to the framework for taxation at the international level will persist indefinitely without intervention. These problems were identified in Chapter II as the ability of digitalised business models to derive sales income from a country sans physical presence, and the ability to use contributions of users in the value chain and monetise such contributions.318
315 Horak op cit note 15 at §18.1.
316 African Tax Administration Forum Technical Note ‘The tax challenges arising in Africa from the digitalisation of the economy’ (2019) at §1.2.
317 Horak op cit 15 at §18.1.
318 DTC op cit note 18 at 56.
There is a strong similarity in the challenges faced at the international and domestic levels.
Given the finding of inadequacy of the existing South African framework for source-based taxation and the recommendation of the enactment of a statutory source rule, the project at the international level toward addressing these challenges may present useful guidance to South Africa. Therefore, the revenue souring rules identified by the OECD, ATAF and the UN in relation to digitalised business models may provide some necessary guidance in the construction of a comprehensive South African statutory framework for the determination of source as applied to digitalised business models.
ii. THE REVENUE SOURCING RULES CONTAINED IN THE OECD’S UNIFIED PILLAR APPROACH
The Unified Pillar approach has been recognised as the first step of the process which intends lead to the gradual departure from the permanent establishment concept as the single international nexus for the taxation of business profits.319 At first glance the approach is commendable as the reliance on sales as an income tax nexus appears to be a pragmatic solution, as it allows for the realisation of fairness in the allocation of taxing power and inter- nation equity under the presupposition that profits will eventually be derived from such sales.320
The Unified Pillar approach is comprised of two pillars. Pillar One is focused on the introduction of new nexus and profit allocation rules to ensure that the allocation of taxing rights is reflective of the digitalised reality and that allocation is no longer exclusively determined with reference to physical presence.321 Broadly, Pillar One seeks to expand the taxing rights of market jurisdictions in situations where certain business are able to ensure sustained participation in the market jurisdiction’s economy.322
The revenue sourcing rules determine the market jurisdiction in which the revenue in question was derived and attempt to balance the need for the accurate determination of source while
319 Pasquale Pistone, Joao Felix Pinto Nogueira, Betty Andrade & Allessandro Turina ‘The OECD public consultation document ‘secretariat proposal for a “unified approach’ under pillar one”: an assessment’ (2020) Bulletin for International Taxation 14.
320 Ibid.
321 Organisation for Economic Co-operation and Development (2020), Tax Challenges Arising from
Digitalisation – Report on Pillar One Blueprint: Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, https://doi.org/10.1787/beba0634-3en at 11.
322 Ibid.
ensuring minimal compliance costs for multi-national enterprises (MNE).323 In terms of the adopted approach, there is an identification of a sourcing principle designated to the type of revenue in question. Following which, there is a hierarchal list of acceptable specific indicators to make the determination as to the source.324 The first indicator – which is considered the most accurate – may only be departed from where the indicator is not reasonably available or the first indicator is not reliable.325
It is evident that the adoption of this approach illustrates the OECD’s cognisance of the varying modalities of business adopted by digitalised multi-national business models. Thus, the approach identifies a revenue sourcing principle for a type of revenue, but allows flexibility in that the factors that may be used are catered to the specific revenue generating activity being undertaken by the taxpayer.326
The information for the indicator would be considered unavailable where it is not within the digitalised MNE’s possession, in addition to the fact that unsuccessful reasonable steps were undertaken to obtain the information.327 Moreover, the information would be considered unreliable where the MNE is able to justify that the information is not a true representation of the sourcing rule.328
While the OECD admits that it may be ideal to have revenue sourcing rules which are based on one indicator, the varying modalities of business make certain indicators more reliable than others.329 Moreover, certain businesses may only have access to certain sets of data from which the source of the revenue can be determined.
Subsequently, the indictors identified by the OECD rely on various data points. Geolocation data, users’ or viewers’ IP addresses, user profile information, billing addresses and other available information is employed by the indicators to determine the source of the revenue in question.330 This is all somewhat personal and invasive information that is collected on viewers
323 Ibid at 71.
324 Ibid.
325 Ibid.
326 Ibid.
327 Ibid.
328 Ibid.
329 Ibid at 83.
330 Ibid at 84-88.
and users. Unfortunately, due to the limited scope of this thesis, the full implications regarding privacy, constitutional law and the feasibility of domestic implementation – in light of our robust privacy and constitutional law – cannot be fully addressed.
This approach is advantageous in that the interests of tax authorities and MNE’s align regarding the collection of data, as new digitalised business models often rely on the information regarding the location of the end user or viewer as part of the revenue generating activities and value creation processes.331 Therefore, both taxing authorities and digitalised MNEs have a vested interest in the collection of accurate information regarding the viewer and end user.
The process identified by the OECD places an onus on the would-be digitalised MNE taxpayer to collect accurate data. Pillar One requires that the MNE retain documentation explaining the functioning of its internal control framework as it relates to revenue sourcing.332 Moreover, the MNE must retain documentation of the aggregate and period information on the results of applying the indicators identified by the OECD, the specific indictor implemented for a given category of revenue, and finally, the circumstances and justification for the departure from the higher ranked indicators included in the hierarchal list.333
Consequently, this onus invokes concerns regarding the privacy of information. In order for the efficient operation of this approach, the nature of the information required and the extent of the information required contends with global privacy regulation. South Africa has a robust and broad framework for the protection of private information, intimated by the Protection of Personal Information Act (POPIA).334 The definition of personal information contained in s1 provides a very wide definition including in paragraph (c); ‘any identifying number, symbol, email address, physical address, telephone number, location information, online identifier or other particular assignment to the person’.335 Moreover, the definition of ‘processing’ in s1, is given an equally wide definition that includes the collection, receipt, recording, storage, dissemination and transmission of personal information.336
331 Ibid at 83.
332 Ibid at 82-83.
333 Ibid.
334 Protection of Personal Information Act 4 of 2013.
335 Ibid at s1.
336 Ibid.
The OECD’s inclusion of the requirement to retain documentation relating to the functioning of its internal control framework related to revenue sourcing is a recognition of the stresses placed on global privacy and administration limitations.337 As such, the OECD notes that MNE’s should not be expected to keep record of every data point provided for by the indictors, if the MNE can provide a robust internal control framework on which tax authorities may rely.338 However, this does not appear to be compelling at all. It is submitted that despite the fact that the MNE will not be required to retain the data for presentation, they are nevertheless required to have knowledge of, collect, process and have access to the data in order to determine the source of the income.
Hence, it is submitted that despite the alignment of interest regarding the collection of accurate user and viewer information, between tax authorities and MNEs, the processing of this data must be done in accordance with domestic and global personal and private information laws.
This could seriously hamper the efficacy of this proposed approach. In South Africa, the requirement of lawful processing of data will be an obstacle hindering the full implementation of this approach to the determination of source. What is certain is that the collection of such data by digitalised MNE’s must always stay within the affordances of domestic and global privacy laws.339 Conferring a greater authority to collect such personal information for tax purposes, is worrying given the reliance on and value of intangible assets in the generation of revenue and the creation of value for the new digitalised business models.
iii. ATAF’S SUGGESTED APPROACH TO DRAFTING DIGITAL SERVICE TAX LEGISLATION
Similarly to the approach outlined by the OECD, the guidance provided by ATAF for the drafting of a Digital Services Tax (DST) makes provision for the determination of the source of revenue. Therefore, despite the fact that the source is determined for the imposition of a DST, the source rules nevertheless provide guidance for the enactment of statutory rules for the determination of source in South Africa.
337 OECD op cit note 321 at 96.
338 Ibid at 97.
339 Ibid at 72.
The DST proposed legislation is representative of ATAF’s recognition of the fact that challenges to international taxation posed by MNEs and increasingly digitalised businesses models are attributable to the international tax rules which only allocate rights to the source state upon sufficient physical presence.340 It also recognises the inability of the OECD to obtain consensus despite their concerted efforts. Ultimately, ATAF concludes that there exists sufficient taxation risks for African countries to justify their departure from passively waiting for an international consensus-based solution.341 Domestic passiveness could delay the much- needed enactment and implementation of legislation to ensure an appropriate allocation of taxing rights levied on highly digitalised business models. It is against this background that ATAF published their guide to the drafting of DST legislation. Many countries who have enacted similar DST legislation have made it express that the legislation will apply until such time as there is an international consensus-based solution.342 South Africa can consider taking the same approach.
Section 2 of the DST provides clarity regarding the quantum of digital services revenue and recognises two potential revenue streams.343 Firstly, revenue directly or indirectly paid from a country and secondly revenue that may be attributed to a country as a result of user participation.344 For the purpose of the DST, section 3 provides for what constitutes a digital service. The section provides a very broad scope, encompassing any service delivered over the internet or via electronic networks including through an online platform.345
Additionally, section 5 provides clarity regarding the term ‘user’ for the purposes of the DST legislation. It is defined as ‘any person who uses, views or otherwise engages with an online platform’ and goes on to give a non-exhaustive list of examples.346 The term is defined widely to entrench the broad scope of the proposed DST legislation.347 This is an attempt by ATAF to encompass the nature of the digitalised economy, whereby businesses are able to provide standardised digital services to a large population sans local infrastructure.348 The reality is that
340 African Tax Administration Forum ‘Suggested approach to drafting digital services tax legislation’ (2020) at 1.
341 Ibid.
342 Ibid.
343 Ibid at 10.
344 Ibid.
345 Ibid.
346 Ibid.
347 Ibid.
348 Ibid.
digitalised business models are able to generate income and value from large consumer or user bases and the concurrent network effects from consumer interactions.349 User content contributions and data collected from intensive monitoring of the users are integral to the value creation models implemented by highly digitalised business models. The term user is defined broadly enough to include all of this value derived from the user or customer base, thereby being cognisant of the phenomenon of ‘prosumption’.
Section 6 sets out the manner in which the MNE company or group’s revenue from the provision of online advertising services is to be attributed to the country who seeks to charge the DST.350 The section takes into account the contributions of the user’s in the country through the governance of indirect attribution of revenue rules set out therein. Data which a business is able to collect helps the business provide targeted advertisements, which would provide significant revenue streams allowing business to efficiently drive-up sales and brand value in substantial markets without a concomitant physical presence. Therefore, users viewing the advertisements can act as a proxy for determining whether the users of the country contributed to the generation of the relevant value stream.351
Moreover, ATAF recognises that the data of users is becoming increasingly valuable and may be monetised by businesses, thus, section 6 includes rules relating to the attribution of revenue relating to the data services. Therefore, the proposed legislation seeks to ensure the alignment of taxing rights and value creation. It does so by ensuring that in cases where there is no direct payment by the users of a country, some revenue relating to the monetisation transaction is allocated to the country of the users.352
Importantly, section 7 sets out the determination of the location of the user, which will vary according to the digital services being provided. Therefore, ATAF provides for a hierarchy of rules to determine the location of the user.353 In respect of online advertising services, data services and other digital services, the location is determined in accordance with the user’s online profile. The profile records information regarding the ordinary location of the user
349 Ibid.
350 Ibid at 11.
351 Ibid at 12.
352 Ibid.
353 Ibid.
through the engagement with the user.354 Failing the existence of a user profile, the location is determined in accordance with the geolocation associated with the device at the time the user engaged with the online platform. Where the above two options fail, the location is determined by the user’s internet protocol (IP) address associated with the device at the time that the user engaged with the online profile.355
In respect of online marketplace services, the location of the user who purchases goods and services through the online platform shall be the user’s physical address if the purchase is of physical goods and services.356 In all other cases it will be the geolocation associated with the device at the time of entering the relevant transaction.357 Failing this, the location of the user will be determined in accordance with the user’s IP address associated with the device at the time of entering into the relevant transaction.358
In respect of online marketplace services, the location of the users who sell goods or services through an online platform shall be the registered address associated with the account through which the transaction took place.359 Alternatively, the billing address associated with the account will determine the location of the user. If that fails, the geolocation associated with the device at the time of entering into the transaction will be the location.360 As a final resort, where none of the above options are available, the location will be the user’s IP address associated with the device at the time of entering into the transaction.361
In respect of digital content services, online gaming services and cloud computing services, the location will be determined according to registered business address of the user receiving the services.362 Where the user is not a business, the location will be determined according to the user’s billing address. Alternatively, if the above options are not available, resort will be had to the address of the user’s bank or financial account used to pay for the services received.363 Where this address is not available, the geolocation of the device at the time of purchasing the
354 Ibid.
355 Ibid.
356 Ibid.
357 Ibid.
358 Ibid.
359 Ibid.
360 Ibid.
361 Ibid.
362 Ibid.
363 Ibid at 13.
service will be used to determine the user’s location. Failing the availability of the geolocation, the user’s IP address associated with the device with be determinative.364
Aside, it is noted that while the geolocation information is often easy to find, obtaining the IP address is often more difficult. While certain ranges of IP addresses are assigned to specific countries, which would aid the determination of location, often users use a virtual private Network (VPN) which could effectively hide the IP address of the device.365
iv. THE APPROACH ADOPTED BY THE UN – DRAFT ARTICLE 12B
The complexities of the OECD’s proposed solution under the Unified Pillar approach stand in direct contrast with the approach adopted by the UN. The draft article 12B contains a concise and far simpler opponent to the Unified Pillar approach. Article 12B broadly mirrors the recommendation by the DTC of the construction of a statutory source rule, aimed at digitalised business models, on the basis of the ‘payer principle’. Article 12B presents a far narrower scope than the Unified Pillar approach, as it merely focuses on automated digital services (ADS), whereas the OECD includes Consumer Facing Businesses (CFB) within their scope.366
Paragraph 4 provides content as to what constitutes an automated digital service (ADS) and it is comprised of two key features. Firstly, services must be provided via the internet or electronic network and secondly human intervention in the provision of the services should be minimal.367 The commentary goes further to pronounce on a set of general principles which can be applied to determine whether the activity in question constitutes an ADS.368 The commentary goes further to apply these general principles to establish a list that identifies services which constitute ADS and a list of services that do not.369
364 Ibid at 13.
365 Ibid.
366 Radhakishan Rawal ‘Taxation of the digitalized economy – proposed UN solution’ (2020) 26 Asia-Pacific Tax Bulletin 3.
367 United Nations Model Double Taxation Convention between Developed and Developing Countries Draft Article 12(B) Income from Automated Digital Services. Available at:
https://www.un.org/development/desa/financing/sites/www.un.org.development.desa.financing/files/2020- 08/TAX%20TREATY%20PROVISION%20ON%20PAYMENTS%20FOR%20DIGITAL%20SERVICES.pdf
368 Ibid at 31-33.
369 Ibid 34 to 36.