Taxation of Multinationals in the Digital Economy.

1. Introduction

The practice of corporate tax avoidance has been a serious problem for world governments since the
1990s. Instead of getting better, the issue has been getting worse over time (Ní Chasaide, 2020).
Multinational enterprises have been continuously practicing tax avoidance throughout a long period of
time without a way to prevent it. One of many examples could be the time when when Apple was able to
generate large sums of taxable income such as 15.95 billion in 2011, which happened to not be subject to
any tax. Nevertheless, tax avoidance schemes by MNCs have been continuing in recent times.
Furthermore, there may be an increase in concerns regarding corporate tax avoidance with the advent of
the digital economy. As the digital economy has been exponentially increasing in size, thus resulting in
the digital economy becoming a significant part in the entire economy ( Kadet, 2020). As a result, the
digital economy has allowed tax avoidance by digital businesses to further continue. Many jurisdictions
have been allowing large digital companies to only pay tax rates of 9.5% on average. Whereas, firms that
operate in a traditional manner are continuing to pay tax rates of 23%. This has created a rise in concerns
within several governments, regarding the low taxation that large digital companies have been able to pay
(NÍ Chasaide, 2020). Since September 2013, the G-20 leaders have decided to pursue the Base Erosion
and Profit shifting project (Kadet, 2020), Which was designed by the Organization for Economic
Cooperation and Development (OECD) to create an international tax structure which could be capable at
forming measures against tax avoidance (Kadet, 2020).
The purpose of the paper is to assess whether the two pillar solutions will benefit the tax framework at
targeting MNCs tax avoidance in view of the digital economy, or if a digital service tax may be a better
alternative. In this research paper, a review of past literature will be completed to assess the current tax
framework and its impacts regarding tax,and whether the implementation of the OECD pillar initiative or
even a digital service tax may be more beneficial. Regarding the structure of the paper, the following
section describes the theoretical background, which will cover the current tax system and why MNCs and
digital companies are able to avoid taxes under the current tax system implemented, and a description of
the given proposals. The next section will follow with an analysis to understand whether the OECD Two
Pillar Initiatives is more appropriate to implement, or if a digital service tax should be utilized instead. In
conclusion, the research paper will explore the ways in which tax avoidance has been performed by
MNCs in the digital economy and whether, the current proposal, if not other proposals may be able to
reduce and prevent tax avoidance within the digital economy.

2. Theoretical Background

This section covers a description of the different taxation topics and models that are related to
Multinational Companies and to digital products and services. These are:
- Base Erosion and Profit Shifting (BEPS) Project
- Tax Avoidance by MNC’s
- OECD Pillar Initiatives (1 and 2)
- The Digital Service Tax

The current tax systems that are implemented, were created from the results produced by the BEPS
project (Kadet, 2020). The Organization for Economic Cooperation and Development (OECD) was
responsible for the creation of the BEPS project. the OECD is composed of a restricted group of 36
nations (Kadet, 2020). However, an all-encompassing BEPS framework was established by OECD
member states and countries belonging to the G-20. This initiative's inaugural gathering took place in
mid-2016, and by December 2019, 137 countries were actively engaged in the inclusive
framework( Kadet, 2020). The inclusive framework is the leading platform for global negotiations in the
quest for a long-term, agreement-based resolution to the taxation challenges caused by the digitization of
the economy.
(Kadet, 2020). the BEPS report comprises 15 action plans that address the existing tax issues related to
Multinational Enterprises (MNEs). By the conclusion of 2015, nations had the option of selecting from a
range of measures to guarantee harmonized action, in response to the BEPS action plan's implementation
(Schön, 2021).
The reason for MNEs' ongoing involvement in tax avoidance is that the existing global network of
bilateral tax treaties still incorporates outdated international tax regulations that were agreed upon in the
1920s (OECD, 2021). Therefore, the tax treaties currently implemented may be considered out of date.
As per the previous regulations, the initial principle mandates that the profits of a foreign company can
only be taxed in a different country where the said company has a physical presence, thereby allowing
MNEs to engage in extensive business operations within the digital economy without incurring taxes, as
they might not have a physical presence in that location (OECD, 2021). Another issue is the majority of
nations solely impose taxes on the domestic revenue generated by their MNEs, presuming that foreign
income earned by these MNEs will be taxed by other tax jurisdictions. Consequently, MNE profits have
been able to evade taxation by means of transferring profits into low or zero-tax jurisdictions, utilizing
intangible assets such as patents, copyright, and brands. Furthermore, several tax jurisdictions compete in
tax competition, aiming to attract foreign direct investment (OECD, 2021). They provide low corporate
tax regimes to attract foreign companies. The majority of nations solely impose taxes on the domestic
revenue generated by their MNEs, presuming that foreign income earned by these MNEs will be taxed by
other tax jurisdictions. Consequently, MNE profits have been able to evade taxation by means of
transferring profits into low or zero-tax jurisdictions, utilizing intangible assets such as patents, copyright,
and brands. Furthermore, several tax jurisdictions compete in tax competition, aiming to attract foreign
direct investment (Kadet, 2020). After years of meticulous and strenuous efforts and negotiations aimed
at modernizing international tax regulations, members of the OECD/G20 Inclusive Framework on BEPS
reached a consensus on the Two Pillar Solution to address the tax challenges posed by the digitalization
of the economy on October 8th. The first pillar of the two-part solution entails assigning taxing rights
over 25% of the residual profits of the largest and most lucrative MNEs to the jurisdictions where these
entities' customers and users are based (OECD, 2021). Secondly, assurance through compulsory and
binding dispute resolution, with an optional system to account for some low-capacity countries. Also,
digital Services Taxes are also being eliminated, suspended, as well as other pertinent, related acts.
Lastly, is the creation of a well run and simplified approach to apply the arm’s length principle (ensuring
organizations are tax compliant) in particular circumstances, especially on the requirements of lower
capable countries (OECD, 2021). The second pillar within the two pillar solutions firstly ensures a global
minimum tax rate on all MNEs, that are yearly achieving revenue of above 750 million euros of 15%
(OECD, 2021). Furthermore, every jurisdiction is obligated to include the "Subject to Tax Rule" in their
bilateral agreements upon request, and establish an all-encompassing structure for members to curb the
misuse of their tax treaties. This rule is applicable to all nations that impose a nominal corporate income
tax rate of less than 9% on certain payments, such as interest, royalties, and a specific category of other
payments (OECD, 2021). Moreover, it is possible to deal with tax benefits for major corporate activities
by creating an exception towards them. Additionally, OECD pillar initiatives have suggested a digital
services tax. Even though negotiations are ongoing in this field, some countries have chosen to take
individual actions to tax the digital economy (Asen, 2021). Roughly half of the european countries
involved with the OECD, have either already implemented a digital services tax, or have also been
proposed to do so (Asen, 2021). Every nation that has a implemented a Digital services tax, have
implemented in their own structures. As France have implemented a more broader tax base in comparison
to other countries, through the taxation of targeted advertising, the provision of user data for advertising
purposes and revenues obtained from the … Whereas countries such as Austria focus on taxing revenue
from only advertising. The tax rates also tend to differ depending on country, as Poland placed a tax rate
of 1.5%, in comparison to the 7.5% tax rate in Hungary ( Asen, 2021).The proposal aims to advance the
adoption of a policy that promotes fairer contributions to the recuperation effort and encourages more
sustainable practices from digital companies.
(Kadet, 2020). The theoretical framework is very complex. It is clear, therefore, that there are multiple
existing and proposed taxation systems that can be applied to Multinational Enterprises that operate in
different tax jurisdictions as well as several competing proposals on how to best tax the digitalization of
the economy.

3. Analysis

The two initiatives that will be analyzed are the Digital Service Tax and the OECD Two Pillar Initiative.
Within the analysis in order to best evaluate the initiatives, a criteria was established to analyze both
schemes. The criteria selected, covers two particular aspects in order to assess which initiative may be
more beneficial:
1. The first aspect of the criteria is assessing the type of taxes that are implemented by both
proposals, and whether it provides more positive effects rather than negative impacts on the
jurisdictions.
2. The second aspect of the criteria focuses on the ease of implementing each proposal into an
international tax framework.

3.1 Digital Service Tax

The digital service tax (DST) may be considered a beneficial implementation of international taxation of
multinational companies engaging in digital commerce. First of all, a significant amount of tax revenue
could be generated through implementing a turnover tax on sales, with little complications regarding the
implementation. Therefore, it could be argued that this may improve government tax revenue, especially
for multinationals that may have previously engaged in tax avoidance within the digital economy. This
measure could potentially allow governments to gain a fair share of tax revenue. However, a drawback
towards a digital levy could be the conflict of the digital levy tax with the ability to pay principle. As,
within the digital levy tax, tax payers are obligated to pay tax on its turnover, even if the entities are
making overall losses (Nogueira et al., 2021). Therefore, it may reduce competition within an economy,
because digital companies may tend to initially incur financial losses but would still be subject to tax on
their turnovers. Therefore, this may hinder innovation within the economy, as the turnover tax may
incentivise potential digital companies to start up. Thus, technology based companies may be reluctant to
set operations within the European Union (Nogueira et al., 2021). This may further reduce tax revenues
from foreign MNEs, as companies that incur significant costs may decide not to locate to the European
Union due to higher tax costs. Another problem that may arise with DST are the consequences associated
with implementing it. As US multinationals are the most attractive subject to tax for the DST. Therefore,
the United States has been opposing the implementation of the DST.
(Vella, 2019). The United States Trade Representatives released their report on the France Digital Tax in
December 2019. This was based on an enquiry that was conducted under Section 301 of the Trade Act of
1974.(Shukla, 2020). Furthermore, the United States has warned of imposing tariffs on France, as a form
of retaliation (Watanabe, 2021). Therefore, this may be a significant drawback, resulting in political
conflicts between the EU and the US, potentially disrupting trade between economies.
It’s expected that digital transformation will total US100 trillion by 2025. This forecast was made by the
World Economic Forum (Duran, 2021). The digital economy may be growing at a significant rate. It may
be beneficial to implement a digital services tax as the European Commission referred to the digital levy
as a provisional solution for the time being (Nogueira et al., 2021). This implies that the digital services
tax may be significantly quicker to implement compared to other measures. It would allow countries to
collect their tax revenue from MNCs operating in the digital economy within the country's jurisdictions in
a faster time frame.

3.2 OECD Two Pillar Initiative

Another solution to resolve the international taxation of MNC’s especially within the digital economy is
the OECD 2 Pillar initiative. It ensures that MNEs that are annually generating beyond 750 million euros
of revenue, are subject to a tax rate of 15% (OECD, 2021). Therefore, this may ensure that governments
may be able to achieve national wealth maximization by taxing both the traditional and digital
commercial activities. The digital economy enables MNE’s to operate globally. E-commerce allows
firms to achieve revenue via the global market, with no regard to the period of time (Kehal et al., 2005).
Therefore, one may argue that a significant portion of tax revenue achieved via the global minimum tax
rate of 15% may have been generated from revenue achieved in the digital economy. However, it is
unclear whether the zero and low jurisdictions will enact taxes immediately (Kadet, 2020). The true
effectiveness of the minimum tax rate may be questioned, as some economies may be reliant on attracting
foreign direct investment from MNEs by not implementing this framework. An example could be Ireland.
As, a small number of US multinationals are responsible for a large portion of Ireland’s tax revenue (Ní
Chasaide, 2020). Therefore, this may act as a drawback, as some countries may choose not to participate
in implementing the global minimum tax rate, not allowing the global minimum tax rate to be widely
implemented. With regard to the second criteria, an issue with the OECD Two Pillar initiative is ease of
implementing it. Since, many tax treaties need to be either re-negotiated or changed.
(Kadet, 2020). Hence, an argument against this initiative could be the time lag of when the Pillar initiative
may be effectively in place. The odds of a consensus to take place are very low (Kadet, 2020). A deadline
was established by 2023 to ensure the regulations and mechanisms of the Two-pillar solution will be
operational, also reaching an agreement on the strategies to implement (OECD, 2021). Since the
framework contains 137 nations as members, the Two-pillar solution may be able to help solve tax
challenges for a considerable number of nations which would the costs associated with its implementation
(Kadet, 2020).

4. Conclusion

The goal of the research paper is to assess whether the OECD Pillar initiative may be the best solution to
help the current tax framework, or whether the Digital Service Tax may be more beneficial. The paper
focused on addressing several advantages and disadvantages regarding the two initiatives proposed to
help the current tax framework effectively tax Multinationals, especially ones engaging in digital
commerce. The issue regarding tax avoidance is a significant issue, because tax avoidance and evasion
carried out by MNC’s has resulted in the loss of billions of potential tax revenue for governments around
the world. (Kadet, 2020). It is beneficial for taxation purposes to ensure a solution is agreed to prevent
tax avoidance conducted by Multinationals. Both proposals provide various benefits and drawbacks, with
regard to the criteria.
As a whole, it may be more beneficial to implement the OECD Two pillar initiative. However, the
Digital services tax has already been implemented and put into effect in many jurisdictions, half of OECD
European countries. The implementation of the Two Pillar initiative has not yet occurred, and there may
still be some uncertainty on the success of implementation. However, with regard to the criteria, it could
be argued that the two pillar initiative may be a more beneficial long term solution as it accommodates a
much greater number of jurisdictions. Furthermore, the global 15% minimum tax rate subjected towards
certain MNCS (Kadet, 2020), may ensure a more fair allocation of tax revenues towards jurisdictions
involved. Thus, it may be more sustainable to adopt as a long term solution into the current tax system.
There are several limitations that lie within the paper. The first limitation lies with the word count of
the research, as in order to ensure that the research paper fulfilled the criteria presented, the concepts and
content provided within the paper are presented in a comprehensive manner. Another limitation of the
paper may be due to the lack of research, as based on the time the research paper has been written, the
Two Pillar initiative has not been implemented and put into effect on the current tax framework.
Therefore, there is no research on the true effects of the Two Pillar initiative. Therefore, suggestions for
future research could be a longer research paper may be more appropriate, as this may allow for a deeper
comprehension of the topics presented in the paper. Another suggestion for future research may be to
conduct research within a later period of time, as more research with regard to the Two Pillar initiative
may be present, allowing for a more detailed and more in-depth analysis.

Word Count: 2,828

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