International tax agreements, as well as national law, define the creation of a tax obligation in a given country, in principle, based on the physical presence of a business. The occurrence of a Permanent Establishment is a necessary condition for imposing the obligation to pay tax on income earned within a particular jurisdiction. This aims to prevent double taxation of income generated by companies operating in more than one country. However, does this correspond to today’s market realities, where substantial profits are increasingly generated within the so-called digital economy, where companies derive revenue based on the number of virtual users? The existing framework for international treaties, primarily based on a physical presence, may not adequately address the new business models generating income from interactions with virtual users.
The Permanent Establishment is a concept that needs to be defined through the lens of the provisions of the Corporate Income Tax Act, unless a double taxation avoidance agreement involving Poland contains different provisions. According to Polish law, a foreign establishment is generally a fixed place through which the entity conducts its activities within the country. The activity may be complete or partial but should fall within the scope of the company’s business purpose. The entity must have its seat or management in another country. A Permanent Establishment can take the form of a branch, office, representation, factory, or workshop. This type of establishment is the most common. The law also envisions other types such as a construction site, assembly, or installation. This concept was and is suitable for an economy based on goods.
However, today’s digital business, which is rapidly evolving without the need for a physical presence in a particular country, exploits the imperfections in tax laws. What is the result? Companies engaged in digital activities benefit from the same infrastructure, legal systems, and internet connections as other taxpayers, but at no cost, automatically leaving them with more funds for their development. These funds do not flow into the country where these companies generate income. The risk of market fragmentation and competition distortion should be assessed as high. The phenomenon of global migration, prevalent today, undoubtedly exacerbates and will continue to deepen these disruptions.
Can digital businesses legally avoid paying taxes today? Yes. It is sufficient to place the server in a country with low taxation. Additionally, there is the possibility of allocating the value generated through intangible and legal assets, such as patents, which by definition exhibit very high mobility, to a country with zero or very low tax burdens. In practice, this means that the revenue from advertisements of a digital industry giant based in Ireland fills the account of a company registered in Ireland. Simultaneously, the company pays for a license to use technology to a subsidiary based in Europe, which, in turn, is merely a branch, transferring most of that amount to the parent company that reports income tax in a tax haven. It is no secret that the issue of taxing digital activities is a response to the actions of major players in the industry, the so-called GAFA, including digital corporations such as Google, Amazon, Facebook, Apple, but also Uber, Airbnb, or Netflix.
Italy, Spain, France, and the United Kingdom (all in 2020, except France, which did so in 2019) have already introduced into their legal systems a tax on digital services, generally covering digital advertising services. Others have opted for introducing a withholding tax on the provision of digital services at the source (Malaysia and Mexico). Unfortunately, the independent actions of individual countries will not change the international situation in this regard.
In response, the OECD (Organisation for Economic Cooperation and Development) and the G20 step in. These organizations propose the so-called Pillar One as part of the BEPS (Base Erosion and Profit Shifting) package presented in 2013 as an attempt to reform the international tax system. The aim of Pillar One is to standardize and adapt regulations to the realities of digitization and the globalization of the economy, unequivocally linking to the withdrawal of individual countries from independently introducing copyright solutions regarding the obligation to pay tax on income derived from the provision of broadly defined digital services without physical presence in a given jurisdiction.
On October 11, 2023, the OECD, in cooperation with the G20, published the text of a new multilateral convention designed to update international tax frameworks to influence the reallocation of the right to taxation between jurisdictions, improve tax certainty in this area, and eliminate the aforementioned tax on digital services imposed independently by individual countries. This is another step towards implementing Pillar One, one of the two pillars of changes in international taxation that the OECD and G20 are working on. It is also a breakthrough step, considering that many initiative member countries present different concepts regarding the functioning of the tax system in the discussed area. Current steps mainly concern the implementation of the so-called Amount A. If the total revenue of a capital group exceeds EUR 20 million for a given period (i.e., the year for which the dominant entity in the group prepares consolidated financial statements), and the pre-tax margin obtained by the capital group is higher than 10% of revenue, then a tax obligation will arise.
The convention was presented to the finance ministers and central bank governors of the G20 in a new report from the OECD General Secretariat. OECD Secretary-General Mathias Cormann stated, “The published text of the Multilateral Convention (…) represents a significant step towards opening the Convention for signature. Countries now have the means to quickly move to the steps necessary for signature and ratification, and we are increasing our support for developing countries to ensure that we can achieve our goal of making the international tax system fairer and better functioning in the digitalized world.”
It should be remembered that regulations in this area are constantly evolving, and there are many concepts. The United States is also willing to impose sanctions on countries that have implemented a tax on digital services. However, with the success of successive steps, general frameworks are emerging, clarifying the concept of adapting the international tax system to the realities of digital business.
Taxing digital services provided by companies like GAFA generally aims to introduce global rules, according to which the number of users or virtual customers and the transaction volume associated with them will determine the creation of a tax obligation in a given country. In this context, the population size of a particular country becomes relevant. This seems to be a fair model, considering that all users, through whom such a tax obligation would arise, somehow benefit from the tax that supports the budget of the country in which they reside. In this context, it is also a form of regulation that reflects global migration changes. The OECD maintains that the proposed changes should ultimately lead to an annual global increase in tax revenues in the range of USD 17-32 million.
