Companies Income Tax and the Digital Economy

David Akindolire[1]

Introduction

Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.

The above quote by Tom Godwin is as pertinent as it is trite. Straits Times noted that digitization has led to the emergence of new business models and increased international trade, while removing the need for a company to have physical presence in a country to conduct business with its residents.[2] It becomes essential to examine what can be taxed, who should be taxed, where and how much. A global approach is needed to adopt tax rules to the digitized economy.[3] Therefore, the Organization for Economic Cooperation and Development (OECD) has committed itself to tweaking the world’s tax rules to catch up with this economy. It commenced the Base Erosion and Profit Shifting (BEPS) Project in 2012. This article discusses the needed imposition of Companies Income Tax on cross-border digital businesses. It analyzes the status quo and draws solutions from international best practices.

The Digital Economy

The digital economy is the worldwide network of economic activities, commercial transactions and professional interactions that are enabled by ICT.[4] The technologies that fuel this economy have created a disruptive revolution within the past 20 years that have put rigid companies out of business and introduced new companies like Uber, Airbnb, Netflix and Spotify. Forbes reported that the Digital Economy was worth almost three trillion dollars in 2016. This equaled six times the U.S.’ annual trade deficit and more than half the GDP of the UK.[5]

Companies Income Tax

Companies are recognized as juristic persons in Nigeria and are mandated by the Companies Income Tax Act to pay 30% of the profit earned in the year preceding assessment. There are however two kinds of companies in this regard – resident and non-resident companies.

Section 13(1) of the Companies Income Tax Act provides that a Nigerian company is taxable on its worldwide income. By section 13(2) however, the profits of a non-resident company are deemed to be derived from Nigeria if (i) it has a fixed base in Nigeria (ii) it operates through a dependent agent (iii) it is involved in a turnkey project[6] or (iv) it is involved in a related party transaction deemed artificial.[7] The first criterion of fixed base is the most comprehensive and easily forms the basis of this discourse. The Federal High Court held in JGC v FIRS that a foreign company must have a fixed base before its profits can be subject to tax. In Shell v FBIR[8] the court held that the profits sourced from Nigeria by foreign companies cannot be taxed; except they have a fixed base and the profits are attributable to that base.

The term “fixed base” is denied of a precise definition in Nigerian law. It is explained by Paragraph 4.1 of a 2014 Federal Inland Revenue Service Circular to include facilities such as a factory, an office, a branch, a mine, gas or oil, activities such as building, construction, assembly or installation and furnishing of services in connection with the previous. A fixed base is often referred to as permanent establishment (PE) under international law. Article 5 of the UN Model Convention[9] defines a permanent establishment as a fixed place of business through which the business of an enterprises is wholly or partly carried on.

The court held in Shell’s case that “fixed base” could be interpreted to mean “residence” or “ordinary residence” but in the context of the Companies Income Tax Act, it connotes a place where a company has carried on business over a long period of time.

The Problem

Before digitization, a company supplying goods and services in a state would require a local subsidiary, permanent establishment or independent local entity. Now, digitization allows businesses to reach markets in jurisdictions where they have little or no physical presence. Meanwhile, many countries still contain in their laws, the requirement for a fixed base or permanent establishment before profits can be taxed. Thus, the source state collects a reduced amount of tax while the multinational makes significant revenue.

These days, “there are more and larger multinational corporations and many are tech businesses with novel business models, making it harder to even tell where profits are generated.” Admittedly, tech giants hardly post any profits. However, when(ever) they do, how should they be taxed? In 2017, Amazon’s UK operation reported turnover of $11.3bn and pre-tax profits of 72 million pounds. It then paid 4.5 million pounds in corporation tax.[10] Amazon defended this tax bill, and a spokesman said, “We pay all taxes required in the UK and every country where we operate. Corporation tax is based on profits, not revenues, and our profits have remained low given retail is a highly competitive, low-margin business and our continued heavy investment.”[11] Summarily, it is inappropriate to fault tech companies as governments are responsible for updating their laws. Digitized businesses have no physical presence in jurisdictions because they do not need to.

Nigeria

The development of a country relies on its capacity to generate revenue and afford infrastructure. In the face of dwindling oil revenue, Nigeria has toughened tax administration in recent years. Due to investor confidence in Nigeria’s e-commerce, the FG has set a target of generating $88 billion and creating three million jobs through the nation’s digital economy through a period of 10 years. However, there is a dearth of direction as to taxation of digital companies.?The Vice-president, Professor Yemi Osinbajo at a Federal Executive Council meeting in June last year said Nigeria had lost about $178 billion to illicit financial flows in the preceding decade.[12]

Tax leakages in the Digital Economy

According to the National Bureau of Statistics (NBS), the total value of electronic payment transactions in the banking system stood at N65 trillion in 2016, eight times the value of the national budget.[13] Therefore, a significant number of transactions are concluded via online platforms. This is broadly referred to as e-commerce. In e-commerce, physical presence is not needed and where the goods or services are digitized, neither is physical delivery. Software, video, books, music, newspapers and magazines no longer have to be delivered in hard copy. It is consequently difficult to apply the traditional rules of taxation.[14] The tax authorities are even unable to tell the value of direct and indirect taxes payable on e-commerce transactions and this is a large leakage in the system.

Tax leakages are also a consequence of the acts of aggressive tax planners. According to the European Semester Thematic Factsheet Curbing Aggressive Tax Planning aggressive tax planning consists of taxpayers reducing their tax liability through arrangements that may be legal but are in contradiction with the intent of the law. ATP includes exploiting loopholes in a tax system and mismatches between tax systems which may result in double non-taxation or double deductions. Taiwo Oyedele notes that “the fluidity of intellectual property coupled with the risk portability and the delivery of digital goods and services means that tax arbitrage is not only easier but also economically attractive.”[15]

Besides and beyond these, the very structure of certain digital companies makes them difficult to tax. In convenient consideration are Netflix, Uber and Facebook.

1.??????Over-The-Top Service Providers (Netflix)

Over The Top (OTT) services refer to any type of video or streaming media that provides a viewer access to movies or TV shows by sending the media directly through the internet. The most popular OTT providers include Netflix, Amazon Prime Video, and Hulu. They bypass cable or satellite providers and media distributors to deliver content directly to their audiences. Netflix made its way to Africa in 2016 and famously acquired its first original movie from Nigeria – Genevieve Nnaji’s Lion heart – in 2018.

A 2017 ITEP (Institute on Taxation and Economic Policy) report identified Netflix as one of the 100 profitable Fortune 500 corporations that paid a 0 percent federal income tax rate (in the US) in at least one profitable year between 2008 and 2015.?

2.?????Digital Disruptors (Uber)

Digital disruptors are companies that leverage on online tools to redefine the way services are provided. Uber is an e-hailing cab business that allows users of the Uber app to connect with rides available in real time. Uber has spread to over 700 cities and is valued at $72 billion.[16][17] Uber started operations in Lagos in July 2014 and rightly allows for cash-based payment. This way, a significant portion of revenue can only be taxed through Personal Income Tax. Uber regards its drivers as independent contractors who are liable to pay their own PIT. In response, a collaboration of the FIRS, LIRS and PwC developed an Uber driver’s tax guidance in 2016 to warrant a Tax Identification Number for Uber Drivers.[18]

Uber’s business structure is hinged on three companies – Uber International C.V., Raiser Operations B.V. and Uber Technologies Inc. Uber Technologies Inc. is the parent company with a headquarters in San Francisco. B.V. processes financial transactions and collects 20% of the top of all charges for cab rides globally, while 80% is left for the drivers. Once, Uber CV paid Uber Technologies for use of Intellectual Property rights. Since Uber CV is the owner of the IP, Uber BV pays CV about 99% of its revenue as royalty. The remaining 1% is then used to cover cost of operation. Under Dutch law, royalty payments are not taxable. Uber CV has 10 subsidiaries in the Netherlands.

3.?????Social Media Platforms – Facebook

Nigeria is Facebook’s largest market in Africa with over 26 million people.[19] Its profits have been fueled by strong growth in money-making ads to its users amounting to record profits of about $6.88 billion for the final three months of 2018.[20] As at July 2017, Facebook had 16 per cent of all global digital ad revenue, while Google had 33 per cent.[21]

At the heart of Facebook’s structure are two companies in Ireland, Facebook Ireland Limited (FIL) and Facebook Holdings Limited (FHL). The former is a subsidiary of the latter. After generating profit via FIL, majority of it is paid as royalty to FHL. FHL does not pay taxes because it is based in Netherlands (which exempts royalty payments).

Attempts to tax the Digital Economy

1.??????Efforts of the Federal Inland Revenue Service (FIRS)

In June 2017, the former minister of finance confirmed that Nigeria had ratified the necessary conventions to combat profit shifting and tax evasion. Subsequently, the FIRS introduced the ITAS (Integrated Tax Administration System) to automate key processes and improve transparency. In June 2019, the Joint Tax Board launched a unique Tax Identification Number to work alongside. The Chairman, Babatunde Fowler explained that the system is designed in such a manner that each taxpayer is assigned a unique and universal TIN and it is possible for any taxpayer to view, retrieve or update his/her tax profile from anywhere 24/7.[22]

The long-term benefit of these is that the FIRS’ electronic platforms are better positioned for a “robust and seamless interface with diverse platforms which can facilitate tracking of electronic transactions liable to tax in Nigeria”. In addition, it creates the needed familiarity for tax officers to these digitized processes.[23]

In July 2019, the FIRS organized a stakeholder’s retreat with the theme: Parliamentary Support for Effective Taxation of the Digital Economy. There, FIRS?Executive Chairman, Babatunde Fowler, disclosed plans to impose VAT on online transactions. According to him, online and cross-border transactions requiring little or no physical presence have transformed world trade. The digitalization of the economy has also created a big challenge for taxation as most local laws are not robust enough to address the complexities created by the digital economy. The agency is now working with the National Assembly to get the tax laws amended to that effect. [24]

In August 2019, the FIRS disclosed the government’s intention to impose VAT on online transactions in 2020 – specifically on purchases made via bank cards.[25] Rather than an attempt to tax the digital economy, it seems like a pragmatic anti-evasion measure concerning goods, services and taxpayers already caught by current legislation. Further, there are concerns about double taxation, and the discretion of banks who have the task of deducting 5% from taxpayers’ bank accounts.[26]

2.?????The European Union

To reiterate, efforts to tax the digital economy must be international and concerted. Incoherent responses by individual countries could result in double taxation or non-taxation. The EU has begun conversations to reach an agreement. In 2017, the EU Commission and Council reached conclusions on how to make taxation of digital activities fairer. This came in the form of a long-term solution and a short-term solution.

The long-term solution entails embedding the taxation of the digital economy in the international tax framework. That is, corporate tax rules of different countries would be reformed and synchronized so that profits are registered and taxed at the appropriate jurisdictions. This extends to determining the “significant digital presence” and attributing profits to a digital business.

The short-term solutions consist equalization tax on turnover of digitized companies, a withholding tax on digital transactions or a levy on revenues generated from the provision of digital services or advertising activities. The EU commission has proposed a Digital Service Tax, a levy on gross revenue at 3% for businesses that meet specified conditions to be enforced in the state where the supply takes place.[27]

3.?????The OECD reports

The OECD is the Organization for Economic and Community Development and its BEPS (Base Erosion and Profit Shifting) project was launched in 2012 to tackle tax avoidance and harmful tax practices with a multilateral approach.[28] The Action Plan on BEPS was endorsed in November 2015 and contains 15 measures.

The OECD published a report titled Addressing the Challenges of the Digital Economy: Action 1 in October 2015 and it is aimed at addressing challenges of the digital economy with a focus on the concept of Permanent Establishment. Three alternatives to this rigid concept were suggested. First, a “nexus” test based on the concept of “significant economic presence”.[29] The second option - impose withholding tax on certain types of e-commerce transactions. The third alternative is an equalization levy.[30] None of these options were specifically recommended however, only agreed to be options for member countries.

As a follow up to the above report, on 16 March 2018 the OECD released Tax Challenges Arising from Digitalization – Interim Report 2018. The report analyzed the main features of highly digitized businesses and favors coherent review of the nexus and profit allocation rules over interim measures. It concluded that an update to the work would be provided in 2019.[31]

4.?????Best Practices

While Nigeria has done little in plugging the drain of revenue from its digital borders, many countries where digital business generate revenue have attempted legal solutions.

Diverted Profits Tax was introduced in the UK as a response to BEPS activities of digital businesses who circumvent PE status despite having significant economic presence. The tax is upfront at 25% and enforced against companies who avoid PE, create sham structures lacking economic substance and mismatch arrangements to shift profits.[32] In April 2018, the UK proposed a withholding tax applicable to IP royalties paid by a non-UK resident entity to a related party in a low-tax jurisdiction. The proposed tax requires no UK presence for a taxpayer beyond a UK customer base.[33] The withholding tax would be waived if the non-resident has a PE or is subject to diverted profits tax.

Japan’s approach to digital economy taxation involves the imposition of consumption[34] tax on overseas businesses that offer digital services to the Japanese market. This is provided for in the 2015 Tax Reform Package. The Consumption Tax Basic Circular specifies the concerned kinds of services. In tackling the challenge of a permanent residence, Japan has set up an Overseas Business Registration System.????????????????????????????????

France has implemented several solutions – in early 2018, a 2% tax was levied on the advertising revenue of platforms that broadcast videos online such as YouTube or Netflix.[35] France also introduced a GAFA Tax (named after Google, Apple, Facebook and Amazon) to ensure that these internet businesses shoulder some fiscal responsibility.?

On July 25, 2019, President Emmanuel Macron of France signed a Digital Services Tax into law. This is a 3% tax to be imposed on digital companies such as Facebook and Amazon. Bloomberg Tax reports that "the tax will target companies with at least 750 million euros ($834 million) in global revenue and digital sales of 25 million euros in France from certain digital activities, such as targeted advertising, and providing platforms to connect buyers and sellers."[36]

Israel’s tax on foreign corporations is similarly hinged on the existence of a permanent establishment (“fixed base’ in Nigeria). The Israeli Tax Authority has issued a circular that redefines PE to include a digital presence necessary to maintain client relations and a close relationship with clients.[37] Similarly, India introduced an equalization levy on online advertising revenue by non-resident e-commerce companies earned in India.[38] India also amended the concept of “business connection” to include a significant economic presence.[39]

Italy has introduced a web tax of 3% on intangible goods such as online advertising and sponsored links, but not to online retail.[40] The Italian Income Tax Code has also amended the definition of PE to include Significant Economic Presence.[41]

More best practices abound in the form of Columbia’s VAT on digital services, Saudi Arabia’s virtual service PE[42], Turkey’s withholding tax on e-business payments[43], Austria’s advertisement tax[44], Belgium’s fairness tax[45], Hungary’s Advertisement Tax[46] and Australia’s version of the UK’s DPT.

Way Forward

It is pertinent to begin the end with an update on ongoing developments. Between May and June 2019, the international community agreed on a road-map for resolving the tax challenges arising from the digitization of the economy. The OECD adopted a Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy that outlines a process for reaching a new global agreement for taxing multinational enterprises through two main pillars.

The first pillar focuses on potential solutions for determining where tax should be paid and on what basis (“nexus”), as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located (“profit allocation”). The second pillar will attempt a system that ensures that multinational enterprises in the digital economy pay a minimum level of tax, to provide countries with a tool to protect their tax base from shifting to low/no-tax jurisdictions.

The Programme of Work brought together 289 delegates from 99 member-countries and jurisdictions and 10 observer organizations. Nigeria must now follow closely until implementation slated for 2020. It is hoped that the end results of this road-map are immediately localized in due consideration of our economic peculiarities.

In scaling this hurdle of international tax evasion, Nigeria evidently has many unilateral measures at its disposal. These include DST (Digital Service Tax) as adopted by European countries, Equalization Levy to achieve tax neutrality as well as withholding tax at source on payments regarding digital transactions. In combating the challenge of a fixed base, Nigeria can also adopt a nexus-based approach. Quantitative thresholds can be employed to determine a “significant economic presence”. As established, the criteria of “fixed base” and “carrying on business” under our acts are desperately incapable.

Although the CITA contains blanket provisions that give the executive arm the powers to effect proactive policies, it is imperative that the legislature exercises diligence in amending the Act to bring it in line with today’s economic realities. Between taxing the digital economy and legislatures of the world, political will and expediency are everything. The OECD Secretary-General, Angel Gurria was cited to have said the following (about the OECD Programme of Work) that is considerably apt:

Today’s broad agreement on the technical road-map must be followed by a strong political support toward a solution that maintains, reinforces and improves the international tax system. The health of all our economies depend on it.

[1] David Olabanji Akindolire is a first-class student of law at the Obafemi Awolowo University, Ile-Ife.

[2] Taxman cometh for the digital economy https://www.straitstimes.com/opinion/taxman-cometh-for-the-digital-economy?

[3] As submitted by the ICC, Business at OECD and Business Europe International Chamber of Commerce https://iccwbo.org/media-wall//news-speeches/3-ways-digitalisation-shaping-futue-taxation/

[4] Margaret Rouse digital economy https://searchcio.techtarget.com/definition/digital-economy

[5] Kosha Gada The Digital Economy – Let’s Follow The Money https://www.forbes.com/sites/koshagada/2016/06/20/the-digital-economy-lets-follow-the-money/#1cbb0bd078cb

[6] If the trade or business involves a single contract for surveys, deliveries, installation or construction, the profit from the contract.

[7] A transaction between a Nigerian company and a foreign company that exercises controlling interest resulting in the transfer of goods and services not at arm’s length.

[8] (2004) 3 NWLR (Pt. 859) 46.

[9] United Nations Model Double Taxation Convention between Developed and Developing Countries, United Nations, New York, 1980

[10] Gavin O’Toole Taxing the Digital economy: The Struggle for Real Cash in a Virtual World

[11] https://www.independent.co.uk/news/uk/home-news/amazon-corporation-tax-bill-uk-halves-profits-rise-jeff-bezos-a8475716.html

[12] https://allafrica.com/stories/201706150048.html

[13] Isaac Anyaogu Can Nigeria Plug Tax Leakages in the Digital Economy https://sundiatapost.com/2017/06/30/can-nigeria-plug-tax-leakages-in-the-digital-economy/

[14] Subhajit Basu, Taxation of Electronic Commerce Journal of Information, Law and Technology https://warwick.ac.uk/fac/soc/law/elj/jilt/2001_2/basu1/

[15] https://pwcnigeria.typepad.com/files/transfer-pricing---base-erosion-and-profit-shifting-beps.pdf

[16]Uber by the Numbers: Users & Drivers Statistics, Demographics, and Fun Facts https://muchneeded.com/uber-statistics/

[17] How Uber plays the tax shell game https://fortune.com/2015/10/22/uber-tax-shell/

[18] https://www.financialnigeria.com/uber-pwc-collaborate-to-expand-tax-net-in-nigeria-s-transport-sector-sustainable-photovideo-details-507.html

[19] According to Chukwuemeka Afigbo, Manager, Developer Programme at Facebook https://techpoint.africa/2018/05/23/26-million-nigerians-use-facebook/

[20] Facebook posts record profit despite year of scandal

https://www.theguardian.com/technology/2019/jan/30/facebook-fourth-quarter-profits-revenues-earnings

[21] Rani Molla Google leads the world in digital and mobile ad revenue https://www.vox.com/2017/7/24/16020330/google-digital-mobile-ad-revenue-world-leader-facebook-growth

[22] FIRS: Soon, all tax transactions will be automated https://www.thecable.ng/firs-soon-tax-transactions-automated

[23] Emeka Aginam, Nigeria’s Digital Economy to Generate $88b by 2021 October 10, 2018 https://www.vangaurdngr.com/2018/10/nigerias-digital-economy-to-generate-88b-by-2021-adebayo-alton-chairman/

[24] https://thenationonlineng.net/taxing-digital-economy-noose-tightens-around-tech-giants/

[25] https://www.premiumtimesng.com/news/headlines/348652-firs-sets-date-for-start-of-online-transaction-vat.html

[26] David Akindolire VAT and its 99 Problems https://www.dhirubhai.net/pulse/tea-vat-its-99-problems-david-akindolire/

[27] Alan M. Rhode, Current Trends in the Taxation of International Digital Activities

[28] OECD/G20 Inclusive Framework on BEPS Progress report July 2017 – June 2018

[29] “A business that generated a certain level of revenues and customers in a given country could be deemed to have a taxable presence in that country on the basis of its digital presence, as gauged by factors such as domain name and data collected from visitors and customers.”

[30] A new type of tax on digital transactions designed to equalize the tax burden on remote and domestic suppliers of similar goods and services.

[31] OECD, Tax and Digitalization, March 2019

[32] Committee of Experts on International Cooperation in Tax Matters (2017) Tax Challenges in the Digitalized Economy

[33] Jones, Seabrook, Sciliberto and Jones Taxing the digital economy Tax Journal Issue 1389 2 March 2018

[34] KPMG Taxation in Japan 2017 https://assets.kpmg/content/dam/kpmg/jp/pdf/jp-en-taxation-in-japan-201711.pdf

[35] Osborne Clarke (2016) France: Introduction of a new tax mainly targeting US leaders of the digital economy including Youtube? https://osborneclarke.com/insights/france-introduction-of-a-new-tax-mainly-targeting-us-leaders-of-the-digital-economy-including-youtube/

[36] https://news.bloombergtax.com/daily-tax-report-international/frances-macron-signs-digital-services-tax-into-law

[37] EY Israeli Tax Authorities publish draft circular regarding internet activity of foreign companies in Israel Global Tax Alert 16 April 2015 https://www.ey.com/gl/en/services/tax/international-tax/alert-isreali-tax-authorities-publish-draft-circular-regarding-internet-activity-of-foreign-companies-in-israel

[38] EY Global Tax Alert India proposes equalization levy on digital e-commerce transactions in 2016 budget 2 March 2016 https://www.ey.com/gl/en/services/tax/international-tax/alert--india-proposes-equalization-levy-on-digital-e-commerce-transactions-in-2016-budget

[39] Jones, Seabrook, Sciliberto and Jones Taxing the digital economy Tax Journal Issue 1389 2 March 2018 https://www.eversheds-sutherland.com/documents/services/taxation/tax-digitaleconomy-020318.pdf.

[40] Financial Times, Italy pushes ahead with 3 percent web tax, 19 December 2017

[41] Bloomberg Tax Special Report (2018) Taxing Digital Companies: Challenges for Multinationals Amid Emerging Regulation, p.49.

[42] Requena and Gonzalez Adapting the Concept of Permanent Establishment to the Context of Digital Commerce: From Fixity to Significant Digital Economy Presence (2017) 45 Intertax, Issue 11, pp. 732-741

[43] Avi-Yonah Evaluating BEPS University of Michigan Public Law Research Paper No. 493 (January 15, 2016)

[44] Jones, Seabrook, Scilberto and Jones Taxing the digital economy Tax Journal Issue 1389 2 March 2018

[45] Roland Ismer and Christoph Jescheck Debate: Taxes on Digital Services and the Substantive Scope of Application of Tax Treaties: Pushing the Boundaries of Article 2 of the OECD Model? (2018) 46 Intertax, Issue 6/7, pp. 573-578

[46] European Commission Press Release (2016) State aid: Commission finds Hungarian advertisement tax rules in breach of EU rules.r.