Planned Change in Corporate Taxation in EU Countries: Ensuring Online Businesses Are Taxed Where They Generate Income

10.2017

A few weeks ago, media outlets reported on a meeting where representatives of EU member states discussed a proposal from the European Commission that, if enacted, would require a radical redesign of national corporate tax systems. The legislation has not yet been approved, as consensus among member states has not been reached. But what exactly is this measure, which has only recently begun to receive media attention? And why do so many governments complain that the profits of online businesses are taxed at very low rates in countries where the income is not actually generated, yet those same governments appear unable to implement effective solutions?

A practical example can be seen in one of Google’s activities: Google AdWords. Each time a user searches for a service on Google—for example, “lawyer in Barcelona”—the top search results display a list of law firms offering services. If the user clicks on one of these ads, Google charges the advertising fee to the firm—in this case, a Barcelona law firm. The invoice is issued by a Google entity based in Ireland.

The profit from this transaction is recorded in the Irish company’s accounts and taxed in Ireland at one of the lowest corporate tax rates in the EU. Meanwhile, the marketing expense is recorded in the Barcelona firm’s accounts. Consequently, the Spanish tax authority sees only a business expense, while the profit generated entirely in Spain remains untaxed domestically.

Under the current system, Google is required to pay taxes in Spain on profits earned locally only if it has a permanent establishment (PE) in Spain. This is a purely tax law concept: a company must have a fixed place of business—such as offices, machinery, employees, or management—to be taxable. These rules, contained in both national legislation and Double Taxation Conventions (typically Article 5), were designed for an economy of the past, more than fifty years ago, when cross-border business required substantial local infrastructure.

The economic landscape has changed: today, services and online platforms are central to business, often without any physical presence in the country where sales occur. As a result, many online businesses are not taxed in the jurisdictions where their revenue is actually generated.

In 2011, and now again with a slightly revised version, the EU proposed that large companies should be taxed where profits are generated. This framework, known as the Common Consolidated Corporate Tax Base (CCCTB), would represent a fundamental shift in corporate taxation across the EU. Among other innovations, it would require a single corporate tax return for activities conducted across all EU countries, with revenues allocated internally according to pre-determined formulas. In our previous example, the Google transaction with the Barcelona law firm would be taxed in Spain at the standard Spanish corporate tax rate, rather than at Ireland’s lower rate.

It should be noted that final approval of this measure is challenging because EU law requires unanimity for decisions on direct taxation, and corporate tax is classified as such. Unanimity means that if a single member state stands to lose from the new rules, the legislation cannot pass. Ireland and the Netherlands—countries known for aggressive tax planning—have already expressed opposition to altering the status quo. Given that not all participants would benefit, it is unlikely that a dissenting country would accept the reform.

Additionally, the implementation of the CCCTB would require significant changes to the current global tax framework, both nationally and internationally. Coordination with other jurisdictions, such as the United States, would be necessary. The OECD is currently reviewing the proposal, and the matter is scheduled for discussion at the upcoming G20 meeting in 2018 within the context of EU taxation policy.

This proposal represents one of the most significant potential reforms of corporate taxation in the EU in decades, aiming to ensure that profits from online activities are taxed where value is actually created.

++ Article originally published in German in the magazine “Economía” (October 2017), issued by the German Chamber of Commerce in Spain ++