A digitizing economy and an aging population are creating financial problems for governments and forcing them to look at the financing of public expenditure over the longer term. In other words, the sources of taxation. What is the solution? Robert van der Jagt, partner at KPMG Meijburg & Co, explains.
In a nutshell, the problem for many governments is that their tax base, the amount that they can tax, is declining. The first reason for this is an aging population. For example, in ten years’ time, a quarter of the population of Spain will be over 65 years old. They stop working, thus generating less taxable income, they are living longer, which means their state pension must be paid over a longer period, and they use expensive healthcare. An aging population that is not productive from a tax point of view, but does need to be provided for, has implications for tax revenue.
In addition, traditional ways of taxation yield less. After the Second World War it was decided to tax at the location where a business has a physical presence. But in a digitizing economy, a local office is no longer needed to develop a market and make a profit. The profit is, simply put, only taxed in the country where service providers or manufacturers have their headquarters. This is increasingly not where consumers or customers are located.
At the same time, it is easy to establish a business in digital services or intellectual property at a location with attractive tax conditions, in order to pay less tax. Time to overhaul the tax system. What does that entail?
This is how you change a tax system
When tinkering with tax systems, there are always two important questions:
- What are the conditions to qualify for taxation? For example, making a profit in an area where you have an office.
- How much does a government tax if a business meets these conditions?
Broadly speaking, everyone knows that the basis for levying tax is profit. The total size of that pie is a worldwide fact. In tinkering with the share of that pie, countries always ask themselves: will I benefit, will I lose out, or will there be no difference for me? Any change to a system will be strongly supported by those countries that benefit, while countries that lose out will logically do their best to thwart progress. This puts a spanner in the works of any attempt at change.
A bigger pie would get everyone pulling together
Only a larger pie will ensure that countries with a smaller share of it can still retain their tax base or even increase it. That’s important, because this largely determines the willingness to cooperate. And this is there the problem lies.
How do you increase the size of the pie? BEPS
The only way to enlarge the pie is by making tax avoidance and evasion difficult. Making it more difficult to shift profits to countries with low profit tax (profit shifting) and subsequently making it more difficult to artificially reduce those profits (base erosion). This ensures that profits, which are currently not or hardly taxed, can be added to the pie. And that is precisely the idea behind the BEPS (Base Erosion and Profit Shifting) action plan, an OECD project in which more than a hundred countries are now working together. The OECD is the International Organisation for Economic Development and Cooperation.
But it is a slow process. And not surprisingly unanimity is sadly lacking. Meanwhile, many countries are dissatisfied with their share of the existing pie. They want to be able to tax the activities of US tech giants like Facebook and Google, because their citizens contribute to the profits of these digital platforms, without getting anything in return.
A number of countries are increasing the pressure with a Digital Services Tax
Although the BEPS project is making progress, a number of countries, such as France, the United Kingdom, Spain, Italy and Austria, feel that changes are not happening fast enough. They believe they receive too little of the pie and are introducing their own Digital Services Tax. This is a tax on the turnover that businesses generate in their own country and they are introducing it to increase the pressure at the OECD level.
A Digital Services Tax is disruptive, however. And that is inconsistent with what good taxation should be. It must be fair, not susceptible to fraud, must not disrupt markets and must not be accompanied by high compliance costs. What does a Digital Services Tax do? It taxes the turnover of a business, not its profit. But digital businesses often have wafer-thin margins; much smaller than the tax that a Digital Services Tax levies on turnover. Moreover, many start-up businesses incur losses in the start-up phase. Yet a Digital Services Tax would still require them to pay tax on their turnover. And finally, businesses must first pay a local Digital Services Tax on their turnover (followed by profit tax) in their country of establishment. Thus double taxation. No wonder that a country like the US, where many digital businesses are established, is nervous about this.
And the Netherlands?
What if the Netherlands were to opt for a system where it taxes at the location of the transaction? What would that mean for the Dutch share of today’s pie? Will it be larger? Smaller?
We won’t know until it happens, but it is possible to make some projections. Copenhagen Economics analyzed this for the Scandinavian countries (Denmark, Finland, Iceland, Norway and Sweden), which have economies similar to ours: small, open and innovative. Their conclusion: Denmark, Sweden and Finland would see a potential 21%-23% reduction of their tax base. For Germany this would be about 17%-18%.
So it doesn’t look good for the Netherlands. And thus the path for the Netherlands is clear: we must do all we can to increase the size of the existing pie as much as possible. Things are going to get exciting.
Would you like to know more about the consequences of the above developments for your business? Please feel free to contact Robert van der Jagt or your designated contact at KPMG Meijburg & Co.