Taxation of the Global Digital Economy

On January 29, 2019 the OECD announced that the OECD/G20 Inclusive Framework on BEPS has made important steps towards addressing tax challenges associated with the digitalisation of the global economy, committing to deliver a progress report to the G20 Finance Ministers in June 2019 and to release a long-term solution in 2020.

Background

The OECD/G20 Base Erosion and Profit Shifting (BEPS) Project consists of 15 discrete action areas, which target gaps in the international tax system that enable the shifting of profits away from the jurisdiction of the underlying economic activity. Action 1 of the BEPS Project is focused on tax challenges associated with digitalisation.

The Task Force on the Digital Economy (TFDE), with participation from more than 45 countries including all OECD and G20 members, was established to carry out the work of Action 1.

The TFDE developed the 2015 BEPS Action 1 Report, Addressing the Tax Challenges of the Digital Economy (the “Action 1 Report”),[1] which was released in October 2015 as part of the full BEPS Package and was endorsed by the G20 Leaders in November 2015.

Following the release of the BEPS Package in October 2015, the OECD/G20 Inclusive Framework on BEPS (“Inclusive Framework”) was established in June 2016. The Inclusive Framework includes 125 countries and jurisdictions brought together to collaborate on the implementation of the BEPS Package. Upon the establishment of the Inclusive Framework, the mandate of the TFDE was extended to include the delivery of an interim report by 2018 and a final report in 2020.

In March 2018, the Inclusive Framework delivered its Interim Report, which provided analysis but no conclusions regarding the tax challenges of the digital economy. 

Tax Challenges of the Digitalised Economy

The tax challenges recognized in Action 1 Report and the Interim Report include the questions:

  • where tax should be paid and in what amount in a world where businesses can be heavily involved in the economy of different jurisdictions without any material physical presence;
  • how enterprises in the digital economy add value and make their profits;
  • how transfer pricing rules should account for intangible value drivers such as branding and innovation;
  • how the digital economy relates to the concepts of source and residence; and
  • how to address BEPS risks exacerbated by the digitalising economy.

The Policy Note

In January 2019, the Inclusive Framework produced a Policy Note, which sets out that renewed international discussions on the digitalisation of the economy will focus on two central pillars: (i) problems raised directly by digitalisation; and (ii) general BEPS problems exacerbated by digitalisation.

The first pillar will focus on how the existing rules dividing up the right to tax the income of multinational enterprises among jurisdictions could be modified to address the challenges of digitalisation.

Under the first pillar, the Policy Note identifies that proposed approaches require reconsidering current transfer pricing rules, going beyond the arm’s length principle, and abandoning the idea that taxing rights must be determined by reference to a physical presence.  In addition, the Policy Note indicates that new ideas about profit attribution and nexus may need to be developed, and that doing so could require changes to tax treaties and changes to the permanent establishment threshold.

The second pillar will focus on how to resolve remaining BEPS issues not directly associated with digitalisation, recognizing that features of the digitalised economy exacerbate more general BEPS issues.

Commentary

The following are concerns and questions which any solution to the digitalisation of the global economy will be required to face.

How far?

There is no doubt that digitalisation has created substantial changes to the global economy and that traditional taxation rules need to be reconsidered. However, how far this reconsideration should go remains a question.

Transfer Pricing without the arm’s length principle?

It is unclear how to develop rules that don’t rely on the arm’s length principle or how this shift away from a core element of traditional transfer pricing could be justified.

Transfer Pricing without the concept of permanent establishment?

Additionally, how could taxing rights be determined without reference to physical presence, and under what authority could such rights be exercised? Once physical presence is removed as a threshold, what would prevent a jurisdiction from taxing everyone everywhere?

Is Consensus Possible?

An important element of the OECD’s pending solution is that it is to be “consensus-based”, which is a tall order especially given the diverse interests at stake. It is difficult to imagine how the required consensus could be formed where the participating jurisdictions have such divergent interests.

Relation to Unilateral Efforts

How will a solution to the challenges of the digital economy operate with the various unilateral efforts that are emerging?

The Traditional Approach is Still Required

There will not be a purely digital economy so any new rules will have to be appropriate to both a digital and a traditional economy. 

With respect to the tax challenges of digitalisation, members of the Inclusive Framework renewed their commitment to reaching a long-term solution by 2020, and have agreed to deliver an update to the G20 Finance Ministers in June 2019.  With so many questions and such a complicated mandate, it will be impressive if the Inclusive Framework is able to report on meaningful progress before the deadline.

Up Next

In March 2019, the OECD held a public consultation and invited submissions from stakeholders on potential solutions to the tax challenges arising from the digital economy. Despite the limited timeframe, approximately 200 comments were received, some referring to the proposed solutions as “draconian” and other suggesting solutions should go further and make the tax base as “broad as possible”. Stay tuned for more details on the consultation process and results.


[1]       OECD (2015), Addressing the Tax Challenges of the Digital Economy, Action 1 – 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris. http://dx.doi.org/10.1787/9789264241046-en

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Cotisation par mouvement de trésorerie : « On n’utilise pas un canon pour tuer une mouche »

 

Dans une décision récente de la Cour du Québec (Dion c. l’Agence du revenu du Québec, 2018 QCCQ 10280), division des petites créances, l’honorable Juge Dortélus réitère à l’Agence du revenu Québec (« Revenu Québec ») l’importance d’appliquer les méthodes estimatives avec rigueur, sans excès ni exagération.

Dans cette affaire, Revenu Québec a utilisé la méthode estimative mouvement de trésorerie afin d’ajouter des revenus présumés non déclarés à Mme Dion pour les années d’imposition 2006, 2007 et 2008.

Initialement, le dossier de Mme Dion avait été sélectionné pour vérification dans le cadre du projet organisationnel de lutte contre l’évasion fiscale selon les « Indices de richesse ». Dans le cas particulier de Mme Dion, les indices de richesse qui avaient attiré l’attention de Revenu Québec étaient qu’elle était propriétaire d’un immeuble ayant une valeur de 352 400$ et propriétaire d’un véhicule ayant une valeur de 30 366$, ce qui, selon les propos du juge, est « une hypothèse très mince d’indices de richesse ».

Le Juge Dortélus réitère à Revenu Québec l’importance de prendre en considération la réalité du contribuable, mais aussi d’analyser sérieusement les motifs de contestation de celui-ci lorsqu’il y a utilisation par les autorités fiscales d’une méthode estimative :

[39] Lorsque cette méthode indirecte de cotisation est appliquée, on doit tenir compte de la situation réelle du contribuable qui connaît et possède des renseignements dont le l’ARQ ne dispose pas. On ne doit pas écarter sans motif valable ces renseignements, ce qui semble avoir été le cas dans la situation ou Mme Dion.

Dans le cadre de l’audience, Mme Dion soulève que les revenus ajoutés suivant la vérification ne sont pas des revenus, en démontrant, entre autres, qu’un montant traité comme une augmentation de placement par Revenu Québec était en fait des sommes provenant de ses comptes bancaires.

De plus, Mme Dion conteste le calcul du coût de vie effectuée par Revenu Québec selon les données de Statistiques Canada, puisque celui-ci ne reflète pas sa situation réelle. Mme Dion a démontré lors de l’audience que son coût de vie réel était jusqu’à trois fois moindre que celui calculé par Revenu Québec.

Finalement, le Juge Dortélus rappelle qu’un contribuable continue de bénéficier de la présomption de bonne foi prévue à l’article 2805 du Code civil du Québec, et ce, même s’il fait l’objet d’une vérification selon une méthode estimative. À cet effet, il précise que cette présomption légale n’est pas renversée par la seule présence d’indices de richesse qui pourraient mener les autorités fiscales à soupçonner qu’un contribuable n’aurait pas déclaré l’ensemble de ses revenus.

Dans le cadre de l’audience, Mme Dion a été en mesure de démontrer la non-fiabilité de la méthode utilisée par Revenu Québec et que le calcul du coût de vie ne tenait pas compte de sa réalité. Son appel a donc été accueilli et les avis de cotisation ont été annulés.

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Cryptocurrency Audits Have Begun

Forbes reports that the Canada Revenue Agency (“CRA”) has initiated audits in the cryptocurrency space, sending select taxpayers a lengthy and exacting questionnaire requiring information regarding the taxpayer’s investments, cryptocurrency purchases and sales, mining history, assets, wallets, and Initial Coin Offering (“ICO”) participation.

The initiative is part of the CRA’s underground economy strategy, which describes its general purpose as protecting the integrity of Canada’s tax system and limiting the reduction in tax revenues that results from, amount other things, the digital economy.

In a public statement, the CRA commented that in 2017 it developed a dedicated crypotocurrency unit. Unsurprisingly, in this statement, the CRA refused to provide any information on the specific information or criteria they use to select files for audit, though it has confirmed that it currently has over 60 active audit files in the cryptocurrency space.

The questionnaire asks about the history of the taxpayer’s involvement in the cryptocurrency space, investments, transactions with specific exchanges such as shapeshift exchange and changelly, use of cryptocurrency mixing services and tumblers, and the reasons for using such services. The questionnaire also inquires into cryptocurrency storage, requiring information about both hot and cold wallets, and requires detailed information on trading activity, the source of funds used in cryptocurrency activities, investments in ICOs, commercial transactions using cryptocurrency and mining activities.

The questionnaire describes itself as an ‘initial interview’ and alerts taxpayers that there may be follow up questions.

The CRA’s cryptocurrency audits follow the example of the Internal Revenue Service, who has been actively auditing the cryptocurrency space for several years and which won a partial victory in late 2017 when the United States District Court Northern District of California ruled that the San Francisco coin exchange Coinbase must supply the IRS with identifying information on all users who had more than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013 to 2015 period.

Despite the underground, ‘off the grid’ character of cryptocurrency, Canadians who have invested in cryptocurrency, or engaged in the space in any capacity, may have significant tax liabilities.

The CRA takes the position that cryptocurrency is not a form of money, but a type of property. Generally speaking, what this means is that cryptocurrency will be taxed like a commodity such as gold, and taxpayers are required to report all associated gains and losses.

If you have invested in cryptocurrency, if you have engaged in the space as a miner or trader,  if you have been paid in cryptocurrency or if you have participated in an ICO, regardless of whether you have gains or losses, we advise contacting a tax professional to discuss your exposure.

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British Columbia introduces an Employer Health Tax in 2019


BC’s, employers should become familiar with the new EHT rules so as to determine whether registration is required, and if so, whether early registration is required before May 15, 2019.

British Columbia has decided to implement an Employer Health Tax (“EHT”), effective January 1, 2019. The EHT is a payroll tax, calculated on gross employment income, that employers in British Columbia will need to self–assess and remit. For all employers that will be required to pay instalments during 2019, the deadline for registration for this new tax is May 15, 2019. For all other employers that will be subject to the tax, registration will not be required until the end of December 2019. Determining whether instalments will need to be paid requires an exercise in determining how much EHT would have been due in 2018 if the EHT had already been implemented. For any employer who would have owed more than $2,925 in EHT, instalment payments for 2019 will be required.


At its core, the EHT – similar to the one imposed in Ontario – can be a fairly simple tax to deal with in many circumstances, particularly for companies with employees that report for daily work at a location in British Columbia. However, for companies with employees that report for work in multiple provinces, or that get paid from offices outside of British Columbia, or for non–Canadian companies that send employees into British Columbia (among many other potential scenarios), the rules can be much more challenging to apply, and can potentially lead to circumstances of double taxation or assessments for failure to properly report and pay the EHT.


The general rules indicate that employers with total annual payroll in British Columbia of $500,000 or greater will be liable to report and pay EHT, with an increased threshold for charities and non-profits, for whom EHT is not payable until their total annual British Columbia payroll reaches $1,500,000 (with certain other special rules for potential exemptions). However, determining whether you have any payroll amounts in British Columbia, and if so, whether you have crossed these monetary thresholds, can often be a more complicated matter, particularly for entities with related parties that may carry on some business in British Columbia or those that send employees into British Columbia for parts of the year.


At this time, we would advise all businesses that have employees working in British Columbia, whether full–time, part–time or even temporarily, to become familiar with the new EHT rules so as to determine whether registration is required, and if so, whether early registration is required before May 15, 2019. We would be pleased to assist with any questions that arise in trying to determine whether compliance will be required.

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Be Careful with Sensitive Tax Information!

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The Federal Court’s recent decision in Atlas Tube Canada ULC v MNR[1] showcases an important advantage that lawyers bring to multi-disciplinary teams working on corporate transactions, namely solicitor-client privilege.  The case instructs that, wherever appropriate, arrangements should be made to protect communications and other documents as legal advice.   We recommend consulting with a tax lawyer to determine where and how this can be achieved.

The case concerned a due diligence report (the “Report”) prepared by an accounting firm for Altas Tube Canada ULC (“Altas”) in respect of a  transaction that occurred in 2012.

In the course of auditing Altas for its 2012 taxation year, the Minister of National Revenue (the “Minister”) relied on subsection 231.1(1) of the Income Tax Act (the “Act”) to request a copy of the Report. Atlas refused and the Minister applied to the Federal Court for a compliance order under subsection 231.7(1) of the Act.

At the time the Report was commissioned, Atlas’s U.S. parent corporation was in the process of acquiring two corporations. The purpose of the Report was to describe and explain the tax attributes of the target corporations.

The Federal Court observed that paragraph 231.7(1)(b) of the Act requires that before issuing a compliance order for a document, a court must be satisfied that the document is not protected from disclosure by solicitor-client privilege. Holding that, among other things, the Report was not protect by solicitor-client privilege, the Federal Court decided in favor of the Minister.

The Federal Court relied on the test for solicitor-client privilege set out in Solosky v Canada[2], which established that a communication will be subject to solicitor-client privilege if it is a communication (i) between solicitor and client; (ii) seeking or giving legal advice; and (iii) intended to be confidential by the parties.

Reviewing the evidence, the Federal Court found that while the Report was commissioned for two purposes – the business purpose of assessing whether to proceed with the acquisition and the legal purpose of determining how to structure the transaction – ultimately the business purpose was dominant. The Federal Court concluded that the legal purpose was merely ancillary.

In addition, the Federal Court noted that Redhead established that solicitor-client privilege can extend to communication with a third party where the communication is “in furtherance of a function essential to the solicitor-client relationship or the continuum of legal advice provided by the solicitor”[3], but cannot be extended to communications in which a third party such as an accountant provides an opinion.  The Federal Court found that the Report included an explanation of material tax exposures, an assessment of the probability that filing positions would be challenged, and an evaluation of whether appropriate reserves had been taken.  In other words, the Report provided accounting opinions and as result could not draw upon Redhead’s extension of solicitor-client privilege.

Finding that the legal advice provided in the Report was ancillary to the Report’s business purpose and finding that the Report provided an accounting opinion, the Federal Court concluded that the Report was not protected by solicitor-client privilege.  Accordingly, the Federal Court was able to issue a compliance order requiring Atlas to provide the Report to the Minister.

This case serves as a reminder that, wherever appropriate, arrangements should be made to protect communications and other documents as legal advice.  Taxpayers involved in corporate transactions including sensitive tax information should consult with their tax lawyer to determine what can be protected and how to do so.

[1] 2018 FC 1086.

[2] [1980] 1 SCR 821.

[3] Redhead Equipment Ltd v Canada, 2016 SKCA 115, at para 45.facebooktwittergoogle_pluslinkedinmail