UN tax committee to consider adding new automated digital services article to model convention

October 20, 2020 Africa, Americas, Europe, Featured News, Multinational, United Nations
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By Jian-Cheng Ku & Xander Stubenrouch, DLA Piper Nederland N.V., Amsterdam

The UN Committee of Experts on International Cooperation in Tax Matters plans to consider at its 21st session a proposed new model tax convention article that addresses automated digital services income.

New Article 12B “Income from Automated Digital Services,” will be discussed by the UN Tax Committee on October 23.

This is another effort by the UN Tax Committee to tackle the digitalization of the economy by shifting taxing rights from developed countries to developing

The proposed new article is similar to the UN’s earlier proposed inclusion of software payments in the definition of royalties, also under consideration during the Committee’s 21st session. The 21st session will be held as a series of virtual meetings from October 20—23 and October 26—29.

Impact of the new Article 12

The placement of automated digital services under a new Article 12B would ensure that these specific services are no longer covered by Article 7 of the UN model tax convention (the business profits article). The business profits article excludes the levying of any withholding tax by the state in which the income arises, i.e., the market jurisdiction.

Currently, income from automated digital services can only be taxed by market jurisdictions if the companies providing these services would do so through, inter alia, a fixed place of business situated in these market jurisdictions.

However, in the present highly digitalized economy, companies can carry out significant business activities in market jurisdictions without any physical presence. Therefore, the current principles of taxation are no longer considered appropriate.

Newly proposed Article 12B provides that income from automated digital services is, in principle, only taxable in the state in which the recipient of the payment resides, i.e., the state of residence.

However, income from automated digital services may also be taxed in the market jurisdiction at a bilaterally negotiated fixed rate of the gross amount of that income. The Commentary on Article 12B suggests that the contracting states negotiate a modest tax rate of 3 or 4%.

In addition, the beneficial owner of the income from automated digital services may also opt for annual taxation on a net profit basis.

In both cases, potential double taxation as a result of the imposed withholding tax should be relieved by the state of residence.

Automated digital services

Proposed Article 12B of the UN model tax convention defines ‘income from automated digital services’ as follows:

“any payment in consideration for any service provided on the internet or an electronic network requiring minimal human involvement from the service provider.”

The definition of automated digital services is very broad and covers, inter alia, online advertising services, online search engines, social media platforms, online gaming, and cloud computing services.

Under the proposed Article 12B, taxing rights on income from automated digital services partly shifts from states of residence, predominantly developed countries, to market jurisdictions, mostly developing countries.

If this article is added to bilateral tax treaties, the relevant developing countries may effectuate their domestic taxing rights by imposing a withholding tax on income from automated digital services.

Unlike the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) provisions, which became effective without countries needing to agree with each tax treaty partner to change the entire tax treaty, the implementation of Article 12B will require contracting states to re-negotiate and agree upon amending the tax treaty.

Comparison with OECD’s approach

There is no doubt that the concept of automated digital services under proposed Article 12B of the UN model tax convention is, to a significant extent, based on OECD’s previous reports on Pillar 1 ‘Addressing the Tax Challenges Arising from Digitalization.’

On October 12, the blueprints for Pillar 1 were presented by the OECD for public consultation.

Pillar 1 also provides a unified approach for applying to businesses without a physical presence the existing international tax rules on taxable presence and on the allocation of taxing rights over business profits.

A significant difference between the UN and OECD approach to tackling of the digitalized economy is that, in addition to covering businesses that provide automated digital services, the OECD’s Pillar 1 also covers consumer facing businesses.

The UN’s Article 12B does not seem to include consumer facing businesses, which are businesses that sell goods and services that are primarily intended for consumers.

In addition, the scope of Pillar 1 is limited to MNEs with consolidated revenue of at least 750 million euros.

This threshold was set to avoid the compliance burden of a lower threshold. These burdens could outweigh the potential benefits of relocating taxing rights to market jurisdictions.

The UN model tax convention does not provide for such a threshold. It has been acknowledged by some states, however, that the lack of a threshold could lead to unreasonable administrative burdens for some companies.

Key takeaways

If the UN’s proposed new Article 12B is adopted in the UN model tax convention and is ultimately included in bilateral tax treaties, this could lead to a shift of taxing rights towards the relevant developing countries acting as market jurisdictions.

As the currently proposed Article 12B of the UN model tax convention does not consist of a threshold, any company providing automated digital services to customers in market jurisdictions could become subject to withholding tax in those market jurisdictions.

As the currently proposed Article 12B of the UN model tax convention does not consist of a threshold, any company providing automated digital services to customers in market jurisdictions could become subject to withholding tax in those market jurisdictions.

It should, however, be noted that developing countries have generally not concluded many bilateral tax treaties in which they could include the article on income from automated digital services.

Moreover, it is questionable whether developed countries will take a positive stance when negotiating the implementation of such an article in their bilateral tax treaties with developing countries, given the interests at stake for the developed countries in which the major digital companies are resident.

Finally, the concept of subjecting income from automated digital services to withholding tax in market jurisdictions is increasingly recognized globally.

Therefore, the introduction of Article 12B into the UN model tax convention, together with Pillar 1 of the OECD, should be closely followed, as these initiatives could have a significant impact on international companies providing digital services.

Jian-Cheng Ku

Jian-Cheng Ku

Partner at DLA Piper Nederland N.V.

Jian-Cheng Ku advises on international tax law and transfer pricing with a particular focus on international tax planning, M&A and private equity transactions, corporate reorganisations, and planning and design of transfer pricing policies.

Jian-Cheng Ku

Jian-Cheng Ku
Partner


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Xander Stubenrouch

Xander Stubenrouch

Tax Advisor | Junior Associate at DLA Piper Nederland N.V.
Xander Stubenrouch advises on international and Dutch tax law, with a particular focus on M&A and private equity transactions and international tax structuring.

Xander Stubenrouch

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