Taxing Digital Economy

In the modern era, digitalisation and automation are generating significant amounts of income, profit and value in the business. Unlike traditional physical transactions, this digital ecosystem crosses national borders seamlessly and creates values collectively. This shift is largely driven by the automated flow of information, data, ideas and digital services across borders, collectively contributing to creating immense business values at an unprecedented level. 

Consider the modern business landscape: a software engineer residing in Kathmandu works for a company situated in New York. A digital nomad travels across borders, while being employed by a company registered in Geneva. A digital tech-giants like Meta (Facebook) and Google, registered or headquartered in Silicon Valley, provide an uninterrupted automated digital service (ADS) to the billions of users, scattered across the globe.  Even a content creator in Pokhara can receive Views, Likes, and Subscribes from around the world.

Many similar digital activities have contributed significant amounts of income and wealth to the global economy, and this trend is continuing to increase rapidly driven by the technological advancements in modern era.  This is good news for the global economy where values are created without physical presence or personal travel, helping to generate shared prosperity. However, difficulty arises when it comes to allocating taxing rights among nations where such income is created, users are located and profit is generated. For example, what is the fair share of tax for Nepal on the income created in Nepal or the values added by its users residing in Nepal?

While businesses are interlinked digitally and values are created collectively, allocating taxing rights among various jurisdictions has been a constant headache for all nations. As the complexity of such digital transactions deepens, the challenge becomes more unsolvable to deal with. 

Sharing the taxing rights has been more difficult in the context where a few digital tech-companies dominate the digital market, most of them registered in a single location such as Silicon Valley. The global tax framework becomes more complex when countries unilaterally assert their taxing rights based on the traditional principles like sources- and residence-based taxation and if companies structure their arrangement to shift profits from higher to lower tax jurisdictions. 

Various countries and multilateral institutions including OECD and United Nations are working globally to design fair, inclusive and transparent tax rules applied to such digital transactions. Their work largely focuses on achieving consensus among jurisdictions rather than going towards tax competition. However, such efforts suggest that consensus seems elusive.  OECD and developed nations, where major digital tech-companies are registered or have their head-offices, propose to share only a tiny portion of residual taxing rights to the market jurisdiction keeping major tax rights under their domain. This proposal is included in the BEPS Pillar-One solution. 

The United Nations on the other hand proposes alternative solutions to favour the developing countries. This proposal grants the primary taxing rights to the countries where digital services are used, the users are located and value is created. However, this solution also suffers from conceptual clarity such as quantification of such automated digital services, defining tax bases whether net profit or gross turnover and confusion surrounding on how to implement indirect tax such as VAT or sale tax in a digital space. Building consensus on such diverse issues is normally difficult under the United Nations umbrella among competing national revenue concerns and the underlying geo-economics in international tax cooperation. 

Recogniuing the competing interests and gloomy prospect for unanimity, a good number of developing countries including Nepal and even some EU nations are no longer waiting for the global solution. They are instead implementing unilateral Digital Service Tax (DST) or similar withholding tax regime to assert their tax sovereignty on the economic value created within their jurisdictions in the digital space. While uniform consensus-based tax framework is fading, these individual approaches and tax competition remain the most probable path forward, leaving the digital tax architecture fragmented and uncertain.