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Unilateral measure considered to tax digital economy

The Parliamentary Budget Office released a report (the Report) on 26 June on the potential introduction of a digital tax in respect of the supplies of goods and services by non-residents to South African customers, which are delivered by digital means.[1]

By Wally Horak, Head of Tax | Bowmans: Cape Town

The Report acknowledges the current efforts of the OECD in conjunction with the G-20 countries (the Inclusive Framework) to design changes to the existing international tax system to allow countries to impose such digital taxes[2]. A main objective of the new approach is to grant a right to jurisdictions to tax part of the profits of multinational enterprises (MNEs) with reference to the income generated in that jurisdiction, irrespective of whether the MNE has physical presence in that country.

The Report observes that many countries have opted for unilateral rules to tax the digital economy in view of the relatively slow progress made by the Inclusive Framework to agree on a new approach, which has become critical in view of the budgetary constraints following the COVID-19 crisis.

The Report points out that South Africa was one of the first countries which introduced a consumption tax (VAT) on the supply of electronic services, which has since been adopted by many countries. However, there is a further need to also collect income taxes from the digital economy.

The Report notes that there is no scope to impose customs duties on such supplies since the members of the WTO agreed on a moratorium on the imposition of customs duties on the cross-border supply of goods and services via digital means in 1998. South African and India have submitted a proposal to end this moratorium in March 2020, but it is unlikely that the ban would be lifted in the near future.

Therefore, the Report concludes that South Africa can learn from those countries, notably France, the United Kingdom, Spain and Italy, which have introduced unilateral measures to tax digital supplies by imposing a flat tax on the supplies by MNEs to customers in their jurisdictions.

The main obstacle to such a unilateral digital tax is the basic, existing rule of double taxation agreements (DTAs) which only allows the source jurisdiction to impose tax on a resident of the other contracting state if that resident carried on business via a permanent establishment in the source state. Several of the countries which have threatened to impose the new digital tax have decided to suspend the effective date of the new tax in view of the uncertainty whether the tax may be declared invalid by the relevant courts. This is most likely the result of the approach of the USA, which has indicated that it would encourage its residents to oppose the imposition of the tax in court.

The Inclusive Framework aims to issue a final report and recommend guidelines for the new approach towards the end of 2020. Therefore, it is advisable for the Government to await this international action to ensure cooperation of other states, notably the USA, since most of the targeted MNEs are USA based.

A more immediate avenue to collect more revenue from such digital supplies is to increase the scope and the rate of VAT which is imposed on such supplies to residents.

[1] Tax Brief: Digital Economy and Taxation Policy Considerations - June 2020, Parliamentary Budget Office

[2] See the report released by the OECD in January 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

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