The Digital Economy is So Taxing

– By Stephen Díaz Gavin and Claudio Palmieri

Economic activity is not only transnational, but increasingly digital.   A business is physically located in one country, sells goods or services in another country and then declares its profits in yet a third country?  Who is the taxing authority? Where is the transaction taxed and to which government do taxes get paid? This has never been a simple question internationally, but in today’s digital world, where borderless transactions are more frequent and more common, the leaders of the G-20 countries, in the Summit declaration of 18-19 June 2012 in Mexico, decried the consequences of these developments — tax base erosion and profit shifting to lower-tax jurisdictions.  Even the proposed U.S. tax reform currently before the U.S. Congress addresses concerns about tax base erosion.

In 2013 the Organization of Economic Cooperation and Development (“OECD”) began a project to combat tax base erosion and profit shifting and the first action item of their Final Report of 2015 concludes the digital economy cannot be considered separate from the rest of the economy for tax purposes – it is increasingly becoming the economy itself.   Significantly, the OECD believes solutions lie not so much in creating new rules, but adapting existing regulations to address the new, digital environment.  Meanwhile, the European Union and some countries in Europe are making their own provisions for dealing with changes caused by the digital economy. With its Communication of September 2017, A Fair and Efficient Tax System in the European Union for the Digital Single Market, the European Commission (“EC”) announced a legislative proposal for the Digital Single Market in Europe, that is intended to be available for implementation if an adequate, ready and preferably international solution inside the G-20/OECD project framework is not implemented.  The two main policy challenges addressed by the EC are: (1) where to tax digital services provided by companies with little or no physical presence and (2) what is taxable (e.g., the value created by intangible assets, data and knowledge).  While a long term approach is favored, the EC is focused on short term measures to address some of these problems quickly such as a tax on untaxed or insufficiently taxed income generated from internet-based business activities (whether creditable against the corporate income tax or as a separate tax); a standalone gross-basis withholding tax on certain payments made to non-resident providers of goods and services ordered online; a levy on revenues generated from the provision of digital services or advertising activity.

In addition to European-wide solutions, some individual countries are also attempting to address the taxation of the digital economy.  For example, in September 2016, a bill was introduced before the Italian Parliament regarding tax measures applicable to competition in digital commercial activities (DDL S.2526 “Misure in materia fiscale per la concorrenza nell’economia digitale” del 10 novembre 2016).  The bill would not only reinforce the powers of Agenzia delle Entrate, the Italian governmental agency which collects taxes and revenue, but would introduce a “hidden permanent establishment” (“stabile organizzazione occulta”) concept which would consider revenues generated from certain types of international transactions, as income generated in Italy. For example, fees paid to non-Italian companies by Italian consumers for the purchase of software licenses distributed on the Italian market. Thus, if a U.S. company engages in online business regularly, with greater than 500 transactions in any six-month period and collecting more than € 1 Million in that same period, that company would be considered to have a “hidden permanent establishment” subject to tax by the Italian authorities.  In addition, the proposed Italian 2018 Budget Law (not yet adopted), includes a proposal for a 6% web tax on services provided by nonresident companies and individuals on revenues generated from the sale to Italian residents  of fully “dematerialised services” (e.g., intangible services such as video and audio downloads).

The common theme in these new proposals in the European Union and EU member countries suggests that governments will look increasingly to tax where economic value is delivered.   If your business is part of the digital economy you clearly need to monitor these developments and pay attention to the legislative and regulatory initiatives being considered at the national, regional and multinational levels, especially in Europe, an important market and one which appears to be moving more quickly than other regions of the world.  You can read the full Client Alert on this issue and if you need more information, have questions or would like assistance, the International Practice Group at Rimon, with an office in Rome, is particularly well suited to serve your needs.  Feel free to contact Stephen Díaz Gavin, Partner based in Washington, DC and Rome or Claudio Palmieri, Counsel to Rimon and principal of Studio Legale Palmieri – Rimon Italia,  based in Rome.   Of course, you can always contact me, Joe Rosenbaum, or any of the lawyers at Rimon with whom you regularly work.

 

2016 Metamorphosis *

Legal Bytes will soon morph** and undergo a transformation***

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*    Metamorphosis: A noticeable change in character, appearance, function or condition.

**    Morph: To undergo dramatic change in a seamless and barely noticeable fashion.

*** Transformation: A marked change in appearance or character, especially for the better.

Is Your Currency Current . . . Virtual, Digital, Crypto?

In recent months, “virtual currency” has been making headlines. Most of us don’t really think about what “virtual” currency means and often confuse it with other forms of money. That said, there is good reason for confusion and concern. Like many other technology-driven innovations, lines are blurring and we know blurring lines means opportunity and danger. So Legal Bytes will tackle this in two parts. The first (below) attempts to describe what all these new terms mean and how they are used. Legal Bytes part two (later this week) will summarize current events – the confusion and concern over exactly what all this means to our economy and why you should care.

Virtual currencies got their start in virtual economies that exist in virtual worlds. For example, in massively multi-player online role-playing games (MMORPGs) such as World of Warcraft, players “earn” credits and have the ability to exchange, use or “spend” this virtual “value” in the game environment, to acquire virtual tools, weapons, skills and game items that may be recreationally fun and integral to game play; but virtual currency never bought you food to eat or housing to shelter you in the real world. HOWEVER, what happens when real people start buying, selling and exchanging virtual currency, and create markets that interact with the real world?

First, let’s get our terms straight. Digital currency is not “virtual.” Digital currency represents a real alternative to government-issued currency. It originated with accounts or promises to pay that were used primarily online. One of the most familiar paper-based examples of a non-government promise to pay is the American Express® Travelers Cheque. More than 100 years old, these payment instruments are backed purely by the full faith and credit of American Express – and not the government of any nation. They aren’t backed by gold or silver or precious jewels or even bananas – just a corporate obligation to repay you, based on a contract (the purchase application form) you sign when they are purchased! As you might have noticed, there are multiple forms of these types of digital promises – one, like its paper-based cousin, is simply a digital promise to pay: numbers representing value backed by the issuer – electronic gift cards, a promotional advertisement that can initiate or enhance a digital music subscription, are examples. In other instances, digital money may be based on some real “deposit” (e.g., using a traditional debit or credit or checking account) in which the transferred funds are held in an electronic account, uniquely identified to the user and more closely resembling a “bank account,” with which most consumers are familiar.

In most jurisdictions, companies that issue digital versions of payment instruments (e.g., Travelers Cheques) or that hold digital financial accounts (e.g., PayPal®) often fall within some banking or financial regulation. For example, in the United States, PayPal is considered a payment intermediary, regulated as a money transmitter under the U.S. Federal Code of Regulation and the various state laws that apply to money transmitters. That said, PayPal is not technically regulated by the Truth-in-Lending Act (TILA) or its implementing Regulation Z, nor by the Electronic Funds Transfer Act, implemented by Regulation E; and although PayPal takes great pains to protect against fraud, in the United States, unless you use a credit card (or debit card) to fund a PayPal transaction, consumers have no technical legal or regulatory protection from fraud by a seller. In Europe, PayPal (Europe) Ltd., was licensed by the Financial Services Authority (FSA) as an Electronic Money Issuer, and in 2007 transferred all of its European accounts to Luxembourg to a new entity PayPal (Europe) Sàrl et Cie SC, which is regulated by the Commission de Surveillance du Secteur Financier.

Some of you history buffs will remember DigiCash (originated by David Chaum in 1990), which sought to anonymize financial transactions using cryptography. Well over the past few years, a company named BitCoin (and others such as Litecoin and PPCoin, which are to a greater or lesser extent based on, inspired by, or technically comparable to BitCoin), have launched and popularized a form of digital currency that is often confused with and referred to as “virtual.” This form of digital currency is referred to by financial and security experts as “cryptocurrency.” Cryptocurrency is a digital currency that uses encryption technology to create and manage the digital currency. They are peer-to-peer and decentralized in nature and, at least for now, all are pseudonymous.

As you can guess, all of these confusing terms and the fact that virtual currency in games, gaming, online social media and networking platforms, and virtual world environments began interacting with the real world, has become not merely confusing but alarming. Look at Second Life, a virtual world that allows the purchase and sale of “Linden Dollars,” the in-world official currency, in exchange for real money through third-party websites. Second Life accords both virtual “real estate” and intellectual property real value in its virtual environment; enables “residents” (avatars) to creatively enhance and customize the resources available in-world; allows some property rights to be exclusive or limited (think supply and demand); and permits the exchange and purchase and sale of virtual property rights in-world; and one’s property remains one’s property (and one retains Linden Dollars until spent or given away or used) throughout the life of one’s avatar – at least as long as Linden Laboratories continues to maintain the Second Life virtual world environment.

These are many of the same conditions that affect real financial systems. No wonder that what started as a curiosity – online digital playgrounds with no real money or value being exchanged – have become complex economic environments that financially interact with real world economic systems and are causing concern among legislators, regulators and courts around the world. In part two, Legal Bytes will review recent developments and try to describe the challenges facing legal, financial, security and business professionals.

Are You For Real?

In the 1960s, Stanley Milgrim, then a psychologist at Yale University, conducted a controversial experiment. In an obviously controlled setting for the study, Milgrim and his associates directed their subjects to give ever-increasing electrical shocks to strangers whenever they gave the wrong answer to questions in a test of memory. The strangers were really actors pretending to experience pain and did not actually receive any jolts of electricity. The study, intended to measure how compliant people would be to obey authority figures, even to the point of inflicting pain on otherwise innocent individuals, was disturbing, to say the least. The subjects, despite some discomfort at first, continued to “shock” the test-taking actors. The experiment raised ethical concerns about subject study methodologies, among other things.

However, recently, Mel Slater, a computer scientist at University College London in England (with a joint appointment to the Universitat Politecnica de Catalunya in Barcelona), reproduced this experiment without running afoul of the ethical concerns that the original study raised. Mr. Slater conducted his experiment in a virtual world where test-taking “victims” were avatars whose expressions changed from happy to pained in response to the actions of participants in the study—much the same way the real-life actors did more than 40 years ago. Not only were the results astonishingly similar, but to the surprise of many, the real-life participants experienced increased heart rates and described feelings of regret or feeling badly about delivering electrical shocks—even though they knew the strangers on the other side of the screens were avatars and not real people!

Continue reading “Are You For Real?”