Arijit Ghosh

The last two years have witnessed a large-scale collaborative effort by the international community, under the umbrella of the OECD, towards finding a consensus-based solution for the problem of taxation within the digitalized economy. The digitized modus operandi has allowed for a shift in the concept of ‘value creation’ and the requisite of ‘physical presence’ itself, within businesses, thereby leaving traditional concepts of ‘profit allocation’ and ‘nexus rules’ redundant within this context, and in desperate need of adaptation. This led to the creation of the ‘International Framework’ that has facilitated the body of work amalgamating the versatility of proposals, to reach a mutually acceptable change to the international taxation regime. With the final report of the TFDE (Task Force for Digital Economy), previously anticipated to be completed by the end of 2020 putting forth a viable solution, now seeming rather improbable; the onset of the Covid-19 pandemic, along with a general fallout and lack of consensus in the international dynamic, visible from the recent withdrawal from negotiations by the USA, have made the actuality of realizing a unified answer seem a little further today, than it did a few months ago. This article particularly focuses on the inherent political dichotomy existent within this process, in between sovereign states that that currently possess these taxing rights, and those that believe equitable redistribution will redirect a share of the corporate revenues towards them.

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Last week, the Treasure Secretary of the USA, addressed a letter to the European finance ministers putting a halt, by recusing themselves from negotiations towards finding a ‘unified approach’ as proposed under pillar 1. The ‘safe harbor’ provisions suggested by the USA during this process, allowing companies to choose whether they want to be subject to the new regime (specifically crafted to save giant corporations incorporated in America from taxation in source countries where they have no physical presence), has faced a reasonable amount of resistance from the rest of the world. On the other hand, incompetence of the current legal regime does not allow the taxation of such digital businesses in source countries where their consumer base lies, due to a lack of physical presence through a ‘permanent establishment’ in such market jurisdictions. Simultaneously, without this nexus, the current Transfer Pricing regime fails attribute a part of this income, arising from interacting with that economy through exchange of data, to the said jurisdiction for the purpose of profit allocation. Primarily because digitalisation has transformed the way value is created in its entirety, and the lack of its recognition has led to unilateral measures in the form of ‘digital services tax’ (DST) by a number of countries across the world. Equalization levy in India is one such attempt. It is imperative to understand here that such unilateral measures are a result of two things: (i) an inherently inequitable distribution of taxing rights between traditionally residence, and source countries; thus resulting in the ‘unified approach’ being an effort to transform the status quo of tax sovereignty; and (ii) corporations using this legal regime to escape any tax liability in jurisdictions which are their main revenue sources; thus resulting in them not receiving a piece of the global revenue pie that comes from such digital businesses. Giants such as Amazon, Google, and Facebook have thus been subject to strenuous litigation in a number of source-based jurisdictions where majority of their consumer bases exists. France, and number of European states had temporarily put a hold on implementing their DST on these companies till the end of 2020, awaiting a conclusion from the international negotiation process; however this withdrawal will automatically trigger a chain reaction of responses where in countries will move back towards exercising their sovereign authority to tax within their states, and in turn undermining the rather delicately crafted existing tax structure. We are witnessing a strong possibility of falling back into the self-consuming trap of tax competition.

While questioning the tenets of tax sovereignty of countries might seem too utopian an appeal, equity in distribution of taxing rights between countries where business are incorporated, and where they interact with the actual economy, is precisely what this international effort of the global community is aimed to achieve. This would mean for states to at some level, let go of their individualistic desires for higher revenue collection and their intrinsic inclinations towards tax competition; and move towards a more sustainable model of profit allocation to these differing jurisdictions based on the actual value created therein; on the basis of which tax can be collected. However, any proposal of change this drastic, is more likely to face the forces of inertia keeping the status quo at what it is. What we are thus witnessing is a standoff in the global legal-economic arena between countries like the USA which are heavily disinclined to give up on any of their share of taxable revenue, and countries which under the present model are not getting a piece of the cake at all. Needless to say that America backing out of negotiations attempted at reconciling these differences to reach a unified solution to distributing revenue, not only undermines the entirety of discourse that had already garnered support and reasonable consensus by many member nations, but will also have staggering effects on global trade and tax certainty; possibly putting the USA and countries imposing unilateral measures at the brink of long standing trade wars, subsequently moving the world as a whole further away from reaching any concurrence at all. This level of uncertainty in the current context of a global economic slowdown owing to Covid-19 will further prevent capital and investments to move across borders with ease, which will be rather necessary in the coming times for the revival of the world economy; essentially putting such digitalized businesses in the middle of a greedy strife for revenue between governments.

The current international taxation system hinges on a delicate network of bilateral tax treaties which divide taxing rights between states. Any tax imposed on multi-jurisdictional transactions, are thus on the basis of rights assigned to countries under these treaties. The problem begins occurring when the current system fails to account for a certain kind of transaction or business operation in its entirety because it wasn’t in the paradigm of existence when the current legal framework was created. This is where the delicate system starts failing in todays digitalized context, because as a whole it fails to include new exchanges which in turn create a value that was previously never accounted for. For many of the highly digitized business models, a large part of their value creation function happens through the participation of its user and consumer base. Heavy reliance on data in such models requires the data to be procured from its users in order to be processed and analyzed in creating further value for a different side of its market. The creation of a wide consumer base for this purpose in itself then becomes a requisite value creating function in order to gain power within the market. However the law itself is not developed enough yet to recognize the exchange of data in return for free services, as being a valid transaction for the purpose of taxation. This results in profits from such value created through the data, as not being taxable. The concept of ALP (arms length principle), which forms the cornerstone of transfer pricing regulations falls short of being applicable to such transactions, primarily because the consumers cannot be deemed as a separate hypothetical entity in order to determine the remuneration they should receive for the value their data creates. The proposed shift away from the current Transfer Pricing guidelines has also been so far as the requirement of DEMPE functions, ownership of intangibles, or attribution of risks being within the taxing jurisdiction, is concerned. This is primarily because so far as the collection, analysis and exploitation of consumer data is concerned, digitalization has made it extremely simple to locate DEMPE and associated risk functions outside of the marketing jurisdiction.

Thus, this conversation takes us outside the purview of the current international tax regime, which is built on the foundation of tax treaties. Unilateral measures come from a position of frustration caused by fatigue from the BEPS project which has now been going on forever. The lack of a solution to holistically change the system, makes it very easy to fall back into this inherent tendency to compete and fight over taxing rights as opposed to sharing it equitably. Unilateral measures take us beyond the pre-divided taxing rights allocated to countries. From a jurisprudential standpoint of fairness, these unilateral measures are not wrong per-se because it’s an attempt to transform the legal system, utilising their domestic capabilities in order to keep up with the changes that digitization is causing, and will continue to cause over the next several years. However, the current political scenario between the USA and European Countries will make any attempt at reconciliation an impossibility. The USA has initiated investigations into countries imposing unilateral measures and has openly threatened to impose tariffs on French products if the DST comes back into play. With the French government’s response stating that they will go ahead with taxing these corporate giants through the DST for the year of 2020 (which they had previously agreed not to, during negotiations), if USA fails to restart negotiations, and talks of the EU coming up with their own digital tax regime, we are staring at the possible reality of actual an actual trade war whose affects will ripple across the global economy. France and the European bloc’s agitation from the withdrawal is rightly justified, considering the talks had been going on for the last 2 years, with multiple public consultation processes to reach an agreeable outcome, that was at the brink of actualising. The unilateral measures were meant to be temporary fixtures, that would be repealed post consensus. The possibility of this entire effort collapsing, will mean that such unilateral measures will become the norm; and since they inherently traverse beyond the area of treaty assigned rights, it’ll increase the chances of double taxation, thereby prejudicing other aspects of the BEPS project. USA’s withdrawal just goes ahead to be prove the domino effect this will have on the world economy, if a solution isn’t reached. This economic situation is drifting us away from a cohesive structure of sharing taxing rights towards a war over who gets to tax, which is an inevitable race to the absolute bottom. And perhaps the worst affected will be the corporations, who will be left to navigate through a cluster of differing obligations under various DST’s.


1. TFDE, Interim Report, 2018

2. OECD (2019), Addressing the Tax Challenges of the Digitalisation of the Economy – Policy Note, as approved by the Inclusive Framework on BEPS on 23 January 2019, OECD, Paris

3. Addressing the Tax Challenges of the Digitalization of the Economy, Public Consultation Document, OECD, 2019b

4. OECD (2019), Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy, OECD/G20 Inclusive Framework on BEPS, OECD, Paris

5. Addressing the Tax Challenges of the Digitalization of the Economy, Public Consultation Document, OECD, 2019b

6. OECD (2020), Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy – January 2020, OECD/G20 Inclusive Framework on BEPS, OECD

7. New York Times, US Withdrawal from Digital Tax Talks, Alan Rappeport, 17.06.2020

(Article is authored by Arijit Ghosh- BALLB, Jindal- LLM, International Taxation, King’s College London – ADIT (Advanced Diploma in International Tax), Chartered Institute of Taxation London- Currently pursuing)

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March 2021