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Department of Law
Spring Term 2019
Master Programme in International Tax Law and EU Tax Law
Master’s Thesis 15 ECTS
Title; Taxation of Significant Digital
Presence
Subtitle; an evaluative study on draft EU proposal to tax significant digital
presence in context of EU primary Law
Author: Robel Mehari
Supervisor : Martin Berglund
Contents Abbreviation ................................................................................................................ 3
Chapter 1. Introduction ............................................................................................. 4
1.1Genesis ................................................................................................................ 4
1.2 Relevance of the Study: cause it’s here to stay!.............................................. 4
1.3 Research question and objective ...................................................................... 5
1.4 Methodology and Method ................................................................................ 5
1.5 Hypothesis .......................................................................................................... 6
1.6 Directives on direct taxation ............................................................................ 8
1.7 Delimitation ....................................................................................................... 8
1.8 Material .............................................................................................................. 9
1.9 Outline of the chapters ................................................................................... 10
Chapter 2 Background ............................................................................................. 11
2.1 Corporate taxation in the era of brick and mortar ..................................... 11
2.2 The digital economy and new business models ............................................ 13
2.3 Policy challenge and BEPS risk ..................................................................... 15
2.4 Taxation of significant economic presence ................................................... 17
Chapter 3. Proposal for taxation of Significant Digital presence: Salient features
.................................................................................................................................... 19
3.1 Business Activities ........................................................................................... 19
3.2 Scope of application ........................................................................................ 19
3.3 Taxable nexus .................................................................................................. 20
3.4 Attribution of profits ...................................................................................... 21
3.5 Mitigation of double taxation ......................................................................... 22
3.6 On summary .................................................................................................... 23
Chapter 4. Analysis ................................................................................................... 25
4.1 Evaluative framework .................................................................................... 25
4.2 Tax treatment of significant digital presence and TFEU ............................ 25
4.2.1 Which free movement article .............................................................. 25
4.2.2 Limitation in scope of definition of establishment .................................... 27
4.2.3 Limitation of scope of freedom to provide service .................................... 29
4.2.4 Potential ground of restriction of free movement ..................................... 30
4.3 Significant digital presence and Legal principles of the EU ....................... 33
4.3.1 Analysis based on principle of Subsidiarity ............................................... 33
4.3.2 Analysis based on the principle of Proportionality ................................... 37
4.4 Summary and conclusion ............................................................................... 40
Bibliography ............................................................................................................... 43
Abbreviation
TEU – Treaty of European Union
TFEU- Treaty on the functioning of the European Union
CJEU - Court of justice of the European Union
OECD - Organisation for Economic Co-operation and Development
BEPS – Base erosion and profit shifting
ICT - Information communication technology
Chapter 1. Introduction
1.1 Genesis
On March 21, 2018, the EU commission presented a recommendation with the
intent to address the challenge of taxation of income arising from digital
services1. The content of the message reflects the need to introduce a taxation
framework which stresses the need to levy tax where value is created2. The
recommendation is inspired by OECD´S BEPS project3.
With the intent to address taxation challenge posed by the operation of new
business models that integrate valuable digital function to their operation, the
BEPS action 1 recommended taxation of significant economic presence.
Following the footsteps of BEPS action 1, the process initiated by the EU
commission culminated to produce a draft proposal on union level, which creates
a new taxable nexus which found its name as the “significant digital presence”4.
The instrument that has been chosen by the commission is an EU directive, and
the draft proposal is presented to the council for a vote. Bearing in mind, it is
just a proposal, and proposed issues are dynamic, the fate of the draft to tax a
new taxable nexus is still under question. However, as it will be discussed in the
following paragraph, the concept is and will be remain a relevant topic.
1.2 Relevance of the Study: cause it’s here to stay!
It is relevant to ask why a proposal should be subject of a study, considering the
fact that it is a “proposal”; meaning, there is a credible chance it may not see the
light of day.
1 Commission recommendation (EC) 1650 final, corporate taxation of significant digital
presence (2018)
2 Id , P,1 3 Ibid 4 Ibid
However, the fact remains, taxation of significant digital presence is a product
of one of the most comprehensive tax researches undertaken by the OECD.
Judging from academic literatures, it can be argued the subject will occupy the
intellectual debate as panacea that should have, would have, and could have been
applied!
1.3 Research question and objective
The question which the research attempts to address is, how does the draft
proposal to tax significant digital presence interact with primary EU law? To
that end, it is the objective of the study to explore the free movement provisions
and legal principles of the EU enshrined under primary legislations.
1.4 Methodology and Method
It is observed the selection of methodology and method shall be guided by the
research question5. Considering the purpose of the study is to examine how a
proposed secondary law integrate with a primary law, the research will be guided
by doctrinal legal research, as it will be justified in the following paragraphs.
Legal doctrinal research in itself is subject of debate, it has several varying
conception of what it constitutes6. The following paragraph highlights the
chosen methodology and its application is selected based on the subject of the
research question.
5 Robert Cryer, Research methodologies in EU and international law, (Oxford: Hart, 2011 ) P
,8
6 Mark Van Hoecke, Legal doctrine; 'which method for what kinds of discipline? ', In Mark
Van Hoecke (Ed), Methodologies of legal research, which kind of method for which kind of
discipline?,( Oxford and Portland ,Oregon 2013), P,3
Doctrinal legal research address questions pertaining to validity of rules and the
influence of legal norms in multilevel legal order7. The research design within
this particular conception of conducting doctrinal research begins with
identification of legal source and showing to what extent such rules influence
other rules within the system or what effects they produce within the legal order8.
The identification of the source material requires judgment on how the source
material should be interpreted9, however, interpretation of the source law is less
relevant in context of the current study, but rather the source law will be used to
position of the new development in relation with preexisting rules10.
On a similar note, the approach of the research which the study follows has also
been described as an evaluative scholarship. Evaluative scholarship involves
presentation of assessment from a point of view of coherence with other laws
within the system11. As a research tool, the study will use a qualitative method,
combining literature review with documentary analysis.
1.5 Hypothesis
The methodological basis for identification of the source material derive from
identification of how the rules are positioned within a given legal order, to that
end identification of hierarchy plays a vital role12.
7 Douma Sjoerd, Legal Research in International and EU Tax Law (May 16, 2014). Kluwer:
Deventer 2014. Available at SSRN: https://ssrn.com/abstract=2997210 accessed May 15,2019
, P, 17
8 Id ,P, 20 & 21
9 Id,P,22 10 Id, P, 26 & 27 11 Robert Cryer, Research methodologies in EU and international law, (Oxford: Hart, 2011 )
P, 9 12 Mark Van Hoecke, Legal doctrine; 'which method for what kinds of discipline? ', In Mark
Van Hoecke (Ed), Methodologies of legal research, which kind of method for which kind of
discipline?,( Oxford and Portland ,Oregon 2013), P,15
Within the hierarchy of the system of rules of the European Union, the EC treaty
and the TFEU have an attribute of a constitutional charter13. The validity of the
provision of directives will be maintained by way of interpretation in conformity
with the primary law14. However, if the discrepancy between primary law and
lower ranking legislation exists, and if it cannot be accommodated by way of
interpretation, the provision under the lower ranking legislation would be
declared invalid15.
In particular, the aim of fundamental freedoms is to ensure the free movement
of people, service, goods, and capital. To that end, the free movement provisions
prohibit restrictive measures unless the actions can be justified by overarching
objectives16. The prohibition of actions that constitute restriction are raised
counter to measures taken by member states, however, the TFEU have a binding
effect over all EU institutions17.
The legal principle relevant in context of law making are enshrined under TEU,
the provisions prescribe obligations on EU institutions which should be adhered
while legislating, and also impose obligatory norms on member states of the
union18.
Therefore, it can be deuced any draft proposal shall integrate and acquire its
validity through adherence to primary law as manifested through TEU and
TFEU.
13 Stefan Leible and Ronny Domröse , 'Interpretation in Conformity with primary Law', in karl
Riesenhuber (ed), European Legal Methodology , ( Intersentia 2017) P, 174
14 Ibid 15 Ibid 16 Id , P, 178 17 Id, P, 178 18 Marjaana Helminen , EU Tax Law – Direct Taxation , ( 2ND IBFD , 2018) ,P, 13- 16
1.6 Directives on direct taxation
According to article 115 of the TFEU, the EU council has the power to enact
directives concerning direct taxation. The directives on direct taxation are
enacted by the council in pursuit of approximation of domestic laws of member
states on matters that will have effect the functioning of the internal market19.
Directives will have a binding effect on member states once they are enacted20.
Member states are obligated to comply with the minimum standards set by the
directive, with an option to choose the form and method. Members of the EU are
required to transpose a directive into their domestic legislation within a time
prescribed by the directive21.
Considering the fact that it is the domestic legislation of a member state that
implements the directive, the discussion on the compatibility of a proposed or
enacted directive on direct taxation can also be framed as a matter of member
state legislation compliance with EU primary law.
1.7 Delimitation
The legal principles of the EU that are applied to examine the interaction of the
draft proposal to tax significant digital presence with primary law focus on rules
relating with law making function of EU institutions. The reason for selection is
justified because not all legal principles are relevant to discuss integration of
new legal development to a preexisting legal order. To demonstrate ; the
principle of sincere corporation imposed on member states in accordance with
article 4 of the TEU is irrelevant in context of a study of draft legislation, as it
19 Id ,P, 21 20 Id, P, 22 21 Ibid
won’t reflect any insight on the validity or question of how draft concept will
integrate.
Additional note, most business activities combine a degree of traditional or
physical engagements with digital operation, hence it may be inaccurate
representation to say “the digital economy” while in the absence of, a ring
fenced, and purely digital economic system22. However, the author has
witnessed “digital economy”, the nomenclature attributed to digital oriented
business models, has gained sufficient users in various academic literatures,
hence, the pattern will woefully be continue in the thesis. Digital economy will
be used interchangeably in reference to new business models that followed
advent of digitalization.
1.8 Material
The primary materials used for the research are the draft proposal to tax digital
service TFEU, TEU, and attached annexes and protocols. The interpretation of
the CJEU will supplement the conception of primary law provisions. In addition,
the BEPS action 1 concerning the discussion on the tax challenges posed in the
advent of digital business models, and the proposed solutions will be used to
present the background of the problem.
The secondary materials used as a source include books and articles from various
journals, they will serve to reflect the insights and argument surrounding the
research question.
22 OECD ,Addressing the Tax Challenges of the Digital Economy, ( Action 1 - 2015 Final
Report ,2015 ) P, 54
1.9 Outline of the chapters
The present chapter (first) chapter is dedicated to the introduction of the study,
research question, methodology hypothesis and relevant pillars of the research
as discussed in the previous sections.
The EU draft to tax digital proposal is an offspring of the BEPS project action
1, to that end the following second chapter explores the findings presented by
OECD on the taxation challenges arising from the operation of the digital
economy.
The third chapter presents salient features of the draft proposal to tax significant
digital presence. The fourth and final chapter is dedicated to the analysis in light
of primary law, and the summary and conclusion of the research.
Chapter 2 Background
2.1 Corporate taxation in the era of brick and mortar
Brick and mortar terminology has been used to distinguish the digital oriented
economy from the traditional means of conducting business which relies on
physical presence23. The following sections show, within the context of taxation
of business profits, rules and principles embodied under international tax law,
have been designed to allocate tax burden to brick and mortar business.
From the genesis, the framework to allocate taxing power among states stems
from the connection of the individual or a juridical person with the jurisdiction,
which is usually established upon identification of status of residence, or the
income that can be said is sourced from the taxing jurisdiction even without the
tax payer being a resident of the state24.
The framework for allocation is developed in line with the fundamentals of
income taxation, which take in to consideration the ability to pay and the benefit
derived from the state25. In particular, the benefit principle is constructed with
an argument that predicates the possibility of the income being derived by using
public goods of the state, and principle is applicable to both tax payers that are
resident and also those who operate from foreign jurisdictions26.
Based on the aforementioned framework and principles, states would subject a
tax payer to an unlimited or limited tax liability within their jurisdiction. When
a tax payer is subjected to an unlimited tax liability, the worldwide income
23 https://ec.europa.eu/taxation_customs/business/company-tax/fair-taxation-digital-
economy_en 24 Hugh J. Ault and Brain J. Arnold , Comparative Income Taxation – A structural Analysis
( 3rd ed Wolters Kluwer 2010 ) , P,429 25 Martin Berglund and Katia Cejie , Basics of International taxation , ( 2nd ed Iustus 2018) ,
P, 20 26 Id, P, 20
derived by the tax payer’s activity would be taken in to consideration27. On the
other hand, limited tax liability may be levied on the tax payer on the income
derived within the territory of the taxing state28.
The consequence of the formula adopted to subject tax payers to tax liability has
entailed the possibility of double taxation of the same income29. In an effort to
mitigate the effects of double taxation, most tax jurisdiction adopted legal
mechanisms in their domestic legislation and also entered in to a bilateral and
multilateral agreements to shield tax payers from cumbersome burden of double
taxation30.
Efforts to mitigate the effects of double taxation produced a set of distributive
rules in line with transactions and grounds of payment31. Within the framework
of international law, a trend has been set where business profits of an enterprise
may be taxed in the country of their residence, and source countries will only
tax if a business enterprise carries out business activities through a permanent
establishment, a concept developed to determine taxability within the territory
of the source state32.
The concept of permanent establishment was developed in the brick and mortar
era, it is based on tangible presence within the economy for a certain period of
27 Id, P, 21 28 Id, P, 25 29 Id, P, 28 30 Id, P, 28 & 33 31 Ksenia J Levouchkina , 'Relevance of permanent establishment for that taxation of business
profit and business property ' , in Hans – Jorgen Aigner and Mario Zuger (eds) , Permanent
establishment in International tax law , ( Linde Lverlag 2003) P,16
32 Ibid
time, apparently, the concepts of permanent establishment, developed under the
traditional international tax law, doesn’t cover digital existence33.
2.2 The digital economy and new business models
The changes brought by the advent of digital technology are being compared
with the industrial revolution34. As it will be demonstrated in the following
section, the growth of digital technology presents opportunities that are
welcomed and challenges that need carful reckoning.
Various business across different sectors use ICT to enhance productivity, locate
new markets and reduce their operational cost35. With the growing usage of
broadband connectivity, multinational enterprise as well us considerable amount
of small business are increasingly relying on ICT to conduct their activities36.
The reliance on ICT has significant influence in the design of new business
models that utilize the advantage created by the rise of use of internet37. The
development of the new mode of carrying out business started with a
combination of digital as well as traditional physical intermediaries, and later
on, it grew to type of business that use fully digital means to carry out their
economic activities38. Even business that require a modicum of physical
33 José Ángel Gómez Requena & Saturnina Moreno González, 'Adapting the concept of
permanent establishment to the context of digital commerce: from fixity to significant digital
economic presence ' , ( 2017) 45 Intertax ,Issue 2, P 734
34 Patricia Hofmann & Nadine Riedel, ' Comment on J. Becker & J. Englisch, ‘Taxing Where
Value Is Created: What’s “User Involvement” Got to Do with it?’, ( 2019) Intertax , Issue 2, P,
172
35 OECD ,Addressing the Tax Challenges of the Digital Economy, ( Action 1 - 2015 Final
Report ,2015 ) P,52
36 Id, P, 52 37 Id , P, 53 38 Ibid
engagement are able to arrange their value chain in a way that was not possible
before the growth of ICT39.
The spread of ICT and the current mode of conducting business is intertwined
to the point that it has become impossible to ring-fence segments of businesses
as digital economies40. Rather the work of OECD on BEPS has identified new
business models that heavily rely on ICT and which are relevant in context of
posing challenge to fair allocation of taxation powers and risk of BEPS41.
To identified business models include; the sale of goods and services through an
integrated computer network or e-commerce (which may or may not involve
physical presence, however relevant functions of the business are still carried
out through electronic means)42. Online payment services, which provide secure
and confidential means to transfer funds43. Free or for fee applications developed
by device manufactures or third parties44.
Online advertising that often rely on user generated content to out to reach to
targeted consumers45. Cloud computing services provided through a network of
computers to store, compute and manage data46. High frequency trading, a
platform which facilitate express trading of securities47. Participative network
platforms which heavily rely on user generated content48.
On summary, the final report of the OECD has summarized the common thread
of the business model described in the previous paragraph from tax perspective.
The report observed the decreased need for use of local personnel, flexibility to
39 Ibid 40 Id, P, 54 41 Ibid 42 Id, P 55 43 Id ,P , 57 44 Id, P , 58 45 Id , P, 59 46 Id, P, 59 47 Id, P, 62 48 Id, P, 62
choose jurisdiction for operation, and heavy reliance on data and network , in
particular user contribution as a key value driver49.User data allows the business
to operate with a level of efficiency that won’t be present without it50.
2.3 Policy challenge and BEPS risk
The final report of BEPS action 1 has demonstrated two layers of challenges in
terms of digital business structures. The first layer of the problem is the
challenge of policy making to address the new business models described in the
previous section. The second layer is the actual BEPS risk posed by the digital
economy.
On border terms, in the area of direct taxation, the policy challenges posed by
digital oriented business models are characterised as challenges of establishing
a taxable nexus, attribution of value, and characterization of payments51.
The first policy debate is related with establishing a taxable nexus. The
opportunity afforded by the growth of ICT for business to operate without
physical presence has raised a question in to the current framework of
establishing taxable nexus52. In particular, the threshold used to determine the
existence of permanent establishment and methods of attribution of profit need
a revaluation to fit the reality of the current modes of conducting business53.
The second challenge is the absence of direction on how to attribute value to
user contribution54. In addition, setting aside the absence of method, there is also
a debate whether profits generated from data gather from users should be subject
49 Id, P, 64,69 50 Julia Sinning, 'The Reflection of data-driven value creation in the 2018 OECD and EU
proposals' , ( 2018) 6 EC law Review issue 6 , P, 326 51 OECD ,Addressing the Tax Challenges of the Digital Economy, ( Action 1 - 2015 Final
Report ,2015 ) P, 99 52 Ibid 53 Id, P, 101 54 Id, P, 102
to taxation. However, it has been an established fact data from users is key driver
to value creation.
The third policy challenge is characterization of transactions to fit in to the
existing allocation rules. Questions arise whether certain payments should be
treated as royalty, technical service or business profit55.
In terms of BEPS risk, the report uncovered tax avoidance opportunities from
the vantage point of source country and country of residence. One of the major
BEPS risk identified by the study is the ability to avoid taxable presence in the
source country56.
Previous sections has noted the traditional set of thresholds based on physical
presence or fixed place of business to determine the existence of a permanent
establishment. As it has been mentioned in the preceding section, the advance
in ICT has created an opportunity for companies to have less or no reliance on
physical presence in the country of their consumers57, which means the source
country will not be able to establish a taxable nexus.
Even when enterprise has a taxable presence in the source country, the tax
burden that would be allocated to the permanent establishment may be
minimized by limiting functions performed and risks assumed by the permanent
establishment58. Similar arrangements can be made to reduce taxation in the
country of residence, significant functions and risks may be assumed by a
permanent establishment in a low tax jurisdiction59.
Initially, on the basis of the identified policy gaps and risks, the report has
pointed solutions to counter the challenges. The options suggested by the report
55 Id , P, 104 56 Id,P, 80 57 Id, P,79 58 Id,P, 80 59 Id, P, 82
are to modify the threshold used for determination of permanent establishment,
imposing withholding tax on selected types of digital transactions and
introduction of tax on bandwidth use60. However, due to the chance of an
overlap, the options where further developed in to a single concept of
establishing a nexus based on significant economic presence61.
2.4 Taxation of significant economic presence
The option introduced by the report, determines the existence of presence based
on purposeful and sustained digital engagement in the economy of a certain
state62.
The significant economic presence proposal modifies the tradition conception of
source principle which pinpoints profit to the supply side or origin, where labor
and capital are marinated for the purpose of production63. Taxation of significant
economic presence mirrors VAT because it includes destination (place of
consumption) of the product as a potential taxable nexus64.
The factors that would evidence the economic presence include the revenue
derived from such economic activities, combined with digital factors and user
base factor65.Revenue is the most significant factor to establish significant
economic presence. To address the technical issues, the report has suggested to
trace transactions made with domestic customers through digital platforms, set
a threshold in terms of amount of revenue, and introduction of mandatory
60 Id, P 106 61 Ibid 62 Id, P, 107 63 Marten de wilde, 'Tax Jurisdiction in a Digitalizing Economy; Why ‘Online Profits’ Are So
Hard to Pin Down', (2015) 43 Intertax, Issue 12, P , 780 64 Ibid 65 OECD ,Addressing the Tax Challenges of the Digital Economy, ( Action 1 - 2015 Final
Report ,2015 ) P, 107,108,110
registration which will ease administrative burden of locating remote sells and
their conformity with revenue threshold66.
66 Id, P , 108 & 107
Chapter 3. Proposal for taxation of Significant Digital
presence: Salient features
3.1 Business Activities
The proposal aims to tax business activities which it termed as digital services.
According article 3(5), digital service is defined as , “ services which are
delivered over the internet or an electronic network and the nature of which
renders their supply essentially automated and involving minimal human
intervention, and impossible to ensure in the absence of information
technology”67.
The definition didn’t not ring fence a certain sector of industry as digital
economy, it merely describes type of services, which confirms with OECD´S
suggestion with regards to avoidance of ring fencing the new business models
developed with an advance of ICT.
Furthermore, it shall be noted that the draft specifically excludes broadcasting
service and sale of physical good through electronic network for the list of digital
services even though those business operate with substantial digital apparatus68.
3.2 Scope of application
The digital service tax is intended to cover business profit tax of corporate tax
payers for a business activity carried out within the EU69.The tax payers covered
by the draft proposal are those enterprises which are incorporated in EU and
enterprises which are not incorporated in EU and their country of residence
67 Council directive (EC), on laying down rules relating to the corporate taxation of a
significant digital presence, COM (2018), 147 final 2018/0072 ,art 3(5)
68 Id , annex 3
69 Id, art 2
doesn’t have a double taxation treaty with an EU member state where the digital
presence is determined to have its existence70.
The introduction of a new taxable nexus may have a potential to cause breach of
pre-existing obligations created by the virtue of a treaty, to avoid conflict of
obligations the legislators decided to exclude enterprises incorporated within a
state that has a double taxation treaty are not covered under the scope of
application71.
However, if there is a tax treaty with similar rules as that of the draft proposal,
between the member state and the non-EU party, then provisions of the directive
will apply72.
3.3 Taxable nexus
According to article 4 of the proposal, the taxable nexus is the significant digital
presence of enterprises determined by the scope of application. The introduction
of taxation of significant digital presence expands the concept of permanent
establishment, hence it will be taken that a permanent establishment exists if
there is a significant digital presence carrying out part or whole of its business
through digital interface73.
Similar to the conventional method of assigning threshold to determine the
existence of permanent establishment, the proposal has set key criteria’s to
establish the existence of significant digital presence. The criteria’s used as a
threshold are, revenue from the supply of digital service, number of users in
market jurisdiction and contracts for provision of digital service74.
70 Id , art 2 71 Id, art 2 72 Id art 2 73 Id, art 4 (1) 74 Id ,art 4 ( 3)
It is worth to note, all the criteria’s set as a threshold are not expected to be
present at the same taxable period in order to determine substantial digital
presence, it is sufficient if one or more the criteria are present75.
According to the proposal if the business derives a revenue exceeding 7,000,000
Euro, if the users within a given jurisdiction exceed 100,000 users or the number
of service contracts from a give jurisdiction exceeds 3000, the provisions of the
directive would be applied76.
For the purpose of determining the number of users, it suffices that a user of the
digital service accesses the digital interface through which the service is
rendered77. There is no requirement that the user be a resident of the member
state from which the service is consumed. However, with respect to a digital
service contract, a user is deemed to be located within a member state if such
user is a tax resident or has a permanent establishment in that state78, and the
contract shall be concluded in the course of carrying out a business79.
Furthermore, the use of the digital service through a digital interface is central
to determination of significant digital presence, to that end the proposal has
defined platforms through which digital service is delivered, and the platforms
are, software, website, and applications80.
3.4 Attribution of profits
The draft proposal has adopted an approach similar to OECD to determine the
profits attributable to significant digital presence. The attribution of profit
75 Id, P, 8 76 Id, P, 8 77 Id , art 4 (4) 78 Id art 4 (5)b 79 Id , art 4 (5) A 80 Id , art 3(2)
follows the separate entity approach, profits are determined based on assets used,
functions performed and risks assumed81.
Owning to the apparent differences between a permanent establishment with
physical presence and a significant digital presence, the draft seeks to tailor the
evaluation of functional and risk analysis in conformity with distinct nature of
the operation of a digital business. To that end, activities undertaken through
digital interface will be taken in to account even though there is no function
undertaken by an individual within the member state where significant digital
presence is established82.
On a side note, the attribution of user contribution to allocation of profit hasn’t
been addressed in the proposal. Determining the value of user contribution for
the purpose of allocating profit is one of the most difficult tasks in terms of
imposing tax where value is created83. Nonetheless, it can also be argued user
contribution is only taken as a threshold for determining taxable nexus, it holds
no value when it comes to profit allocation.
3.5 Mitigation of double taxation
The draft proposal exempts taxation of the profits derived from the operation of
digital service in the residence country. Only the source state where the
significant digital presence is established, can tax the profit in accordance with
the countries corporate tax framework84.
81 Id, art 5 (2) 82 Id , art 5(3) 83 Johannes Becker & Joachim Englisch , 'Taxing Where Value Is Created: What’s ‘User
Involvement’ Got to Do with It? ', (2019)47 Intertax Issue 2, P 168
84 Council directive (EC), on laying down rules relating to the corporate taxation of a significant
digital presence, COM (2018), 147 final 2018/0072 , art 5(1)
On a side note, a careful reading of article 5 (1) poses a bizarre question; the
article states “…the profits that are attributable to or in respect of a significant
digital presence in a Member State shall be taxable within the corporate tax
framework of that Member State only…”, the article uses the word “shall “
,instead of “may be”, hence , it opens the question whether the proposal is
actually directing member states to levy tax.
To clarify by way of comparison, the parent-subsidiary directive uses “shall”,
to direct member states to refrain from taking action, for example, the parent-
subsidiary directive states, “profits which a subsidiary distributes to its parent
company shall be exempt from withholding tax” 85.whereas wording of the draft
proposal directs member states “shall tax”, which can be construed as an
imposition of digital tax regardless of the revenue collection policy of a member
state.
3.6 On summary
The draft proposal is within the ambit of direct taxation and it covers business
profit tax. The major introduction presented through the draft is the expansion
of the permanent establishment concept, by applying thresholds that doesn’t
include the presence of fixed place of business or any form of physical presence.
The fact that an article which mitigates the risk of double taxation is included
within the draft shows the wariness towards the operation of common market,
however the proposal shall still be deconstructed to evaluate its postion vis-à-vis
the Primary laws of the union. Therefore, the following chapter attempts to
85 Council directive (EU) 2011/96/EU , on the common system of taxation applicable in the
case of parent companies and subsidiaries of different Member States, 2011, art 5
address relevant points that evaluate how the proposition to tax significant
digital presence fare within EU legal order.
Chapter 4. Analysis
4.1 Evaluative framework
Revisiting the initial hypothesis which was raised in the introductory section, the
evaluative analysis focus on how the concept of taxation of significant digital
presence interrelates with protective frameworks of the TFEU free movement
articles (primary law), and how it is positioned as a legislative agenda in context
of the legal principles of the European Union.
4.2 Tax treatment of significant digital presence and TFEU
4.2.1 Which free movement article?
The aim of the basic freedoms enshrined under the TFEU, is to prevent obstacles
to the operation of the free market86. The provisions constituting basic freedoms
apply to abolish acts that create obstacle to cross border activities, whether the
action arises from the state of residence or another state87.
The free movement provisions are drafted in a way that they would relate to
various aspects of basic freedom of EU citizens. Considering the specificity of
the proposal to digital service, and in particular the subject of study is an
establishment, some of the basic freedoms apparently fall out of scope.
To illustrate, free movement of goods refer to prohibition of custom duties on
imports and export within the EU member states88. Free movement of EU
citizens guarantees the right to freely move or reside in any of the EU member
states89. Free movement of workers protects workers from discrimination with
regards to employment90.
86 Marjaana Helminen , EU Tax Law – Direct Taxation , ( 2ND IBFD , 2018) ,P, 68 87 Id, P, 69 88 TFEU , art 28 89 TFEU, art 21 90 TFEU , art 45
Bearing in mind taxation on significant digital presence is not a custom duty,
neither is it not a matter of an individual citizen seeking residence or
employment, therefore the aforementioned freedoms cannot serve as a bases for
discussion about tax treatment of significant digital presence.
Furthermore, the protection for free movement of capital and payment enshrined
under Article 63 of the TFEU, is not related with the context because it is
concerned with cross border investment91, and significant digital presence is not
an investment vehicle, it is an abstract entity instituted for tax purpose.
On the other hand, it can be argued freedom of establishment is one of the most
significant framework to expand the discussion on significant digital presence.
This is due to the fact that among the basic freedoms, freedom of establishment
is the most relevant provision with regards to tax treatment of permanent
establishment, and significant digital presence has been identified as a
permanent establishment92. Freedom of establishment guarantees the right to
establish activities as a self-employed or through a primary or secondary
establishments, such us agencies, branches, or subsidiaries93.
The scope of the protection under freedom of establishment is explicitly
extended to companies and firms established in accordance with the domestic
law of member state94. Therefore, it can be argued significant digital presence,
as a permanent establishment, shall be protected by the provisions of freedom of
establishment.
On a side note, the general aim of the provisions of freedom of establishment is
to prohibit discrimination of non-resident in comparison with a resident95, unless
91 Marjaana Helminen , EU Tax Law – Direct Taxation , ( 2ND IBFD , 2018) ,P,127 92 Isabella Kamptner , 'Non-discrimination of a permanent establishment under EC law ' , in
Hans – Jorgen Aigner and Mario Zuger (eds) , permanent establishment in International tax
law , ( Linde Lverlag 2003), P,301 93 TFEU , art 49 94 TFEU, art 54 95 Marjaana Helminen , EU Tax Law – Direct Taxation , ( 2ND IBFD , 2018) ,P,98
the conditions that justify the difference in treatment96. To that end, a permanent
establishment shall be accorded the same equal beneficial treatment to that of a
domestic establishments97.
In addition, freedom for the provision of service can also serve as a basis for
protection from restriction considering the proposal to tax significant digital
presence is mainly concerned with service providers. The freedom to provide
service in another member state is extended to EU nationals and companies, and
it protects service providers from difference in treatment in comparison to
resident service providers98.
Overall, it is evident that each free movement articles may not be relevant to the
context of tax treatment of significant digital presence. Freedom of
establishment and freedom to provide service can serve as a vanguard articles
for the protection of significant digital presence (a virtual permanent
establishment) from discriminatory treatment. However, observing the fact that
the basic freedoms were adopted before the wake of the digital economy, it still
needs to be examined if there is a gap that may cause difficulty in interpretation
of free movement articles to the benefit of the new taxable nexus.
4.2.2 Limitation in scope of definition of establishment
The introduction of the concept of taxation of significant digital presence or a
virtual permanent establishment is marked with the advent of the BEPS project.
Therefore, it can be observed the TFEU provisions on freedom of establishment
will have limitation on protection of digital presence.
96 Isabella Kamptner , 'Non-discrimination of a Permanent establishment under EC law ' , in
Hans – Jorgen Aigner and Mario Zuger (eds) , Permanent establishment in International tax
law , ( Linde Lverlag 2003), P,315
97 Marjaana Helminen , EU Tax Law – Direct Taxation , ( 2ND IBFD , 2018) ,P , 98
98 Id 132,See also TFEU art 56
Examining the wording of TFEU, it is evident that there is no exhaustive
description of attributes of an “establishment”. Referring to case law, the
understanding of establishment within the treaty is attached to a fixed form of
economic existence with a certain degree of a physical presence99. To illustrate,
the following judgment on Case C- 205/84 (Germany) identifies minimum
requirements that shall be embodied by an establishment in order to fall under
the scope of protection of freedom of establishment;
“An insurance undertaking of another Member State which maintains a
permanent presence in the Member State in which it provides services
comes within the scope of the provisions of the Treaty on the right of
establishment even if that presence has not taken the form of a branch or
agency, but consists merely of an office managed by the
undertaking's own staff or by a person who is independent but
authorized to act on a permanent basis for the undertaking…..100”
Therefore, the understanding of permanent establishment as a physical entity
creates a gap in protection of a fully digital presence. The free movement articles
have been vital to ensure the proper functioning of the internal market; by
interpreting the free movement articles, the CJEU has fend off restrictions posed
by member states101. Hence, the absence of a definition that doesn’t cover a new
breed of establishment poses a serious question to be reckoned with.
It shall be remarked there is a potential to fill the lacuna created by limited scope
of definition of establishment, however, it depends on the active role of CJEU.
It has be recorded the CJEU applies teleological interpretation without being
99 Ibid 100 Case C- 205/84 Commission vs Germany , Para 2 101 Maria Hilling, Free Movement & Tax Treaties in the Internal Market (Iustus 2005) ,P, 19
restrained with the linguistics of the provision102. Hence, the court may adhere
to pre-exiting pattern, and accord protection enshrined under the TFEU to digital
establishments, in light of the purpose of the union. The understanding of the
term named “establishment” can be expanded to cover virtual permanent
establishment, otherwise, there will be an establishment that doesn’t get
protection under the free movement article.
4.2.3 Limitation of scope of freedom to provide service
The wording of the provisions under freedom to provide service covers only
those services rendered for consideration103. Remuneration is one of the essential
conditions that determines whether an act falls under the ambit of freedom to
provide service. The requirement of remuneration creates a difficulty to qualify
significant digital presence as a subject of protection under the provisions of
freedom to provide service.
Referring to the draft proposal, the presence of significant digital presence is
determined based on revenue, number of users and number of contracts. In
addition, the thresholds are not expected to be present in combination, within a
table period, in order to identify the existence of significant digital presence.
If a significant digital presence is established following revenue and service
contract, the taxable nexus qualifies the requirement to be protected under
freedom to provide service, since revenue and service contracts involve
consideration.
However, if the taxable nexus is established based on number of users, there will
be a permanent establishment that provides service, but does not drive an income
102 Rudolf Streinz, ' Interpretation and development of EU primary law' , in karl Riesenhuber
(ed), European Legal Methodology , ( Intersentia 2017) P, 160
103 TFEU ,art 57
or remuneration from the users. Therefore, there might be instances where a
significant digital presence may not be qualified to be protected under freedom
of service.
4.2.4 Potential ground of restriction of free movement
Member states carry the obligation of transposing a binding directive .Once the
directive is transposed to the domestic legislation, the measure is part of
domestic law, and its established domestic law must comply with TFEU. Hence,
the following paragraphs discuss the potential ground of restriction based on
cases brought against domestic measures taken by member states.
Referring the scope of application of the draft proposal, it is evident digital
companies with a certain amount of size in terms of users, revenue and contract
are classified as distinct subjects of the significant digital presence taxation. Size
has become significant in classification or creating a breed of tax payers.
The interpretation rendered by the court in case c- 385/12 (Hervies sport ),
which will be discussed in the following paragraph, poses valuable points to be
reckoned with, but first ,for an illustration which will serve as a comparable
demonstration in context of significant digital presence, consider an example
where;
State X, is a member state of the EU. Unfortunately for state X,
Companies with significant digital orientation are not registered within
state X as resident companies. Most of the digital services are acquired
from companies in other high tech European countries such as state Y.
companies that rendered digital service from state Y fulfil the threshold
of significant digital presence in accordance with the draft proposal. As a
member state of EU, state X transposes the directive in to its domestic
law and imposes taxation on virtual permanent establishment for state Y.
Case c- 385/12 (Hervies sport) relates to tax treatment of group of tax payers
classified as linked undertakings under the domestic law Hungary. The
classification termed linked undertakings refers to taxable persons within a
group of companies104. The alleged discrimination was directed towards those
linked undertakings, by levying special tax on businesses described as such, and
which carry out trading through retail stores105.
The discrimination was the fact that a tax rate applied to business classified
within the category was different from other corporate tax payers106. The court
sought to interpret freedom of establishment in context of the dispute in order to
evaluate the presence of restriction to operation of the common market107.
The findings of the court show the domestic law didn’t provide distinction based
on registration of the office, which means domestic companies and companies
from other member states are accorded the same tax treatment108. However the
court made a significant interpretation in relation with indirect discrimination.
The court has stated, provided the majority of the companies that are subject to
the special tax are registered in other member state, the special tax would
constitute a disadvantage, which qualify as a restriction imposed covertly on
companies of other states109.
It shall be noted, the case would have been more illuminating if the Hungarian
government submitted grounds for justification, and the concept would have
been elaborated had the court application of potential justifications. It is worthy
104 Case C – 385/12 Hervis Sport- és Divatkereskedelmi Kft. V Nemzeti Adó- és Vámhivatal
Közép-dunántúli Regionális Adó Főigazgatósága, ( 2012) , Para 31
105 Id ,Para 35,36 106Id,, Para 23 107 Id, Para 24 108Id , Para 38 109Id , Para 39
note to mention, the court on its own accord mentioned it would have excluded
protection of the economy of the country, and restoration of budgetary balance
by increasing fiscal receipts as a form of justifiable grounds110.
The decision highlights the target of certain types of undertakings may be ruled
as a restriction, if it is evident the action indirectly imposes discrimination on
undertakings from another member state.
The interpretation rendered in case c- 385/12 (Hervis sport) was also echoed in
a recent case C – 233/416 (Asociación Nacional de Grandes Empresas de
Distribución (ANGED)). The case was mainly about state aid, but the court
addressed a question relevant within the context of the current section.
The question referred to the court relates to validity of application of a different
tax regime on large retail establishments111. The court ruled the tax treatment is
based on objective criteria’s ,hence there is no direct discrimination, however,
there is a chance for presence of covert discrimination if the evidence shows the
treatment disadvantages companies from other states in most cases112. The court
held the evidence submitted by the referring court doesn’t show the difference
in treatment mainly targets companies for other states113.
The interpretation presented in both of the above cases shows, different tax
treatment on companies based on a certain criteria, (particularly size in the
second case), will be considered a restriction on the proper functioning of the
common market (specifically freedom of establishment) if the evidence shows
110Id ,Para 44 111 Case C – 233/416 (Asociación Nacional de Grandes Empresas de Distribución (ANGED))
v Generalitat de Catalunya , ( 2016) , Para 28
112 Id , para 31,32,33 113 Id ,Para 33
the tax treatment tend to covertly put adverse effects on undertakings from
another state.
Comparing the example introduced in the beginning of the section, with the
interpretation given by the court in the previous discussion, it can be concluded
that state X covertly discriminates on establishment of other member state( state
Y), as in most cases the taxation of significant digital presence is directed
towards companies from other member state. Which is a viable ground for
raising a case on the grounds of restriction confirming with the interpretation of
the court in the aforementioned cases.
4.3 Significant digital presence and Legal principles of the EU
4.3.1 Analysis based on principle of Subsidiarity
According to Article 5 of the TEU, the principle of subsidiarity delineates the
legislative power of EU institutions on certain areas which the EU doesn’t
exclusively assume law making function. The principle adopts EU institutions
shall exercise a legislative function only when the desired goal is better served
by actions taken at EU level rather than member states114.
Legislating matters relating to direct tax is one of the areas which the EU doesn’t
have an exclusive jurisdiction. Within the structure of relation between EU and
the member states, the core competence to legislate rules on tax matters is
centred on member states; the legislative agenda of EU institutions is limited to
enactment of laws that safeguard the functioning of the common market115.
Therefore, the EU must justify the exercise of legislative function serves an
overarching goal which can be attained more efficiently if it is coordinated at
EU level, rather than by legislation of individual member states116.
114 TEU ,art 5 115 TEU, art 5 ( 2) 116 TEU ,art 5(2)
The application of principle of subsidiarity has been detailed out by protocol 2
of the TFEU. The provisions of the protocol prescribe procedural steps which
the commission and member states should take concerning consultations and
review on the proposed actions117.
Article 5 of the protocol 2 directs the substantive content of the proposed actions;
according to the provision, the proposed actions must contain assessment of
financial impact, impact on member states, the union and other reginal
legislations, and also suggest recommendations that ease the burden caused by
the proposed action and the reason for proposing action on EU level118.
It is evident from the reading of article 5, the protocol doesn’t specify indicators
which aid to measure the reason for the necessity of introducing an action at EU
level rather than member state. Therefore, it is relevant to explore judicial
interpretation to garner additional insights.
Protocol 2 of the TFEU gives CJEU the power to review the adherence of
proposed actions to the principal of subsidiarity, however, it is argued CJEU is
not exercising its function earnestly119. There is a low record of judicial review
concerning the principle of subsidiarity120, it has been observed the CJEU does
not conduct detailed assessment of commissions reasoning other than looking
the formal preamble121.
The author of the thesis observes similar records, especially in the areas of direct
taxation, there hasn’t been any notable case in terms of assessing compliance
with the principle of subsidiarity. However, to draw out a certain pattern of
117 TFEU Protocol 2 118 TFEU ,Protocol 2, art 5 119 Gabriél A. Moens & John Trone , 'The Principle of Subsidiarity in EU Judicial and
Legislative Practice: Panacea or Placebo', (2015) 41 Journal of Legislation Issue 1
120 Paul Craig, 'Subsidiarity: A Political and Legal Analysis', ( 2012) 50 Journal of common
market studies Issue 1 , P, 80 121 Id, P, 78
judicial interpretation, the following cases can shed light on grounds that
substantiate the adherence of principle of subsidiary by the legislator.
Case C- 491/01 (British American tobacco), the court has reasoned the
“multifarious development of national laws” justifies the legislative action taken
at community level122. In addition, the court has also inferred the same reasoning
was echoed in Case C-350/92 (Spain) and C-377/98 (Netherlands)123. The
leniency of the court is glaringly evident, and it hasn’t answered on the preceding
as to how many member states has actually undertaken to adopt legislations that
create distortion to the functioning of the common market, or how many states
should take a unilateral action to justify legislative action at EU level? Or what
is the degree to establish the existence of multifarious legal development?
On another case C – 233/94 (Germany) , the court held that it is sufficient if the
legislator states the reason behind the proposed measure in the draft, moreover
the reason is not even required to be explicitly framed as a justification of
principle of subsidiarity124.
Evaluating the draft proposal, it is visible the draft proposal has fulfilled the bare
minimum of the requirements of the judiciary .The commission has stated that
the draft proposal follows the subsidiarity principle. The commission reasoned
a harmonized application is preferable because it creates legal certainty to tax
payers, it ensures tax is levied where profit is created, and if member states take
122 Case C- 491/01, The Queen |Secretary of State for Health| V British American Tobacco
(Investments) Ltd| Imperial Tobacco Ltd|Japan Tobacco Inc | JT International SA ( 2002) , Para
182,61
123 Case C-350/92 (Spain) v Council (1995) para 35,and 86, and Case C-377/98 Netherlands
v Parliament and Council
124 Case C-233/94 Germany v. European Parliament and the Council ( 1997) Para, 28
unilateral measures, there is a risk of distortion to the common market because
the policies may be fragmented and divergent125.
Investigating the statement of the legislator on its merits has shown similar
observation. The question of how to tax the digital economy is a divisive issue,
various states has their own agenda, hence there is a high risk of a proliferation
of unilateral measures126. In fact, separate frameworks have already been tabled
by Italy, France, Hungary, and UK (still in the union as of yet!)127.
It can be predicted EU member states will likely come up with divergent polices,
for instance the value of user contribution is a bone of contention among various
states128. Which in turn will give rise to double taxation for certain undertakings,
which affects the operation of common market thereof.
On final note, the lenient approach on interpretation will have ramification on
the concept of taxation of significant digital presence. An EU level action will
position taxation of significant digital presence as the sole means of addressing
the taxation of digital service among various options that are presented. For
instance, equalization levy and withholding tax on goods and services are among
the proposed measures to address taxation of digital service129, however, an EU
level measure of introducing a new taxable nexus in form of significant digital
presence will secure the acceptance of significant digital presence.
125 Council directive (EC), on laying down rules relating to the corporate taxation of a
significant digital presence, COM (2018), 147 final 2018/0072, P, 5
126 Ana Paula Dourado, 'Digital taxation opens the Pandora box: the OECD interim report and
the European Commission proposals', (2018) 46 issue 6 & 7, P , 565 127 Id, P, 568 128 Id, P, 567 129 Lisa Spinosa & Vikram Chand, 'a long-term solution for taxing digitalized business models:
should the permanent establishment definition be modified to resolve the Issue or should the
focus be on a shared taxing rights mechanism? ' ( 2018) 46 issue 6 & 7 , P, 479
4.3.2 Analysis based on the principle of Proportionality
The principle of proportionality is one of the legal principles enshrined under
EU treaty. According to Article 5 (4) of the treaty, the legislative action taken
by the EU shall not go beyond what is required to achieve the objectives of the
union130.
It is noted that there is a mechanism to scrutinize measures taken by member
states adherence to proportionality, when the member state restricts fundamental
freedom under justifiable grounds131. However, the context in which
proportionality is discussed under the following paragraph is limited to
assessment of legislative action taken by the EU.
The principle of proportionality is part and parcel of Article 5 of protocol 2,
which also governs the application of principle of subsidiarity132, therefore, the
substantive requirements discussed in the previous section also apply to
principle of proportionality. In particular, it’s relevant to highlight principle of
neutrality dictates the obligation on the legislature, to draft an action that would
not create unnecessary burden on the union, member states, economic operators
and citizen, and the actions taken shall be within the scope of the objective
pursued by the union133.
There is a growing leniency by CJEU towards reviewing substantive content of
proportionality in context of legislative actions taken on EU level134. The court
130 TEU , art 5(4)
131 Pieter van Os, Interest Limitation under the Adopted Anti-Tax Avoidance Directive and
Proportionality' (2016) 25 EC Tax Review, Issue 4, P, 195
132 TFEU ,Proposal 2, art 5 133 Ibid 134 Darren Harvey ,Towards process-Oriented proportionality review In the European Union ,
(2017)23 European Law review issue 1 , P, 94
is rather focused with a review on the requirement of stating reason that shows
the principle of proportionality is observed, it suffices if EU institutions
demonstrate they have carried an investigation in to the degree of proportionality
of a proposed action135. Relatively recent cases show the courts detailed attention
towards fulfillment to procedural aspects of principle of proportionality, such as
impact assessment and assessment of other options.
A scrutiny on CJEU interpretation demonstrates the aforementioned lenient
approach taken towards the legislature in reviewing subsidiarity is also extended
to evaluation of proportionality. In case C-380/03 (Germany), the court has
stated, EU legislatures should be accorded “broad discretion” while legislating
matters which has political, social and economic significance, (which can be
argued the discretion given to the legislator covers every aspect of human
relation)136. Furthermore, the court has interpreted, the measure will be
considered invalid if only the measure is “manifestly inappropriate”137. Yet
again, there is no detail account describing what constitutes “manifestly
inappropriate”.
In fulfillment of acceptable standard set by the interpretation of the court, the
draft proposal have stated the proportionality of the proposed measure. The
proposal reiterated the measure is necessary, suitable and appropriate138.
135 Id, P,95
136 Case C-380/03 Germany v. Parliament and Council (2006), para 145. The court referred to
following cases, which shows there is an accepted pattern in the interpretation, Case C-84/94
United Kingdom v Council, para 58;Case C 233/94 Germany v Parliament and Council, para
55 and 56;Case C-157/96 National Farmers ,para 61;and British American
Tobacco(Investments) and Imperial Tobacco, para 123, See also Daren Harvey ,P.100
137 Ibid
138 Council directive (EC), on laying down rules relating to the corporate taxation of a
significant digital presence, COM (2018), 147 final 2018/0072, P, 5
The draft proposal vies, the proposal will not harmonize tax rates, and hence it
won’t have any restriction on colleting a desired amount of corporate tax
revenue139. Furthermore, it is the most efficient way to tax digital service, in
context of operation of the internal market140. The impact assessment echoes
similar note in terms of efficiency and preferences of introducing a new taxable
nexus141.
Owing to the lax approach taken by the judiciary, it may be contended the
proposed directive may not face a stringent opposition on the grounds of
principle of proportionality. However, it is still relevant to explore the issue on
its merit.
To that end, Article 5 (1), the provision dealing with attribution of profit to
significant digital presence opens a window to question the proportionality of
the proposal form the context of fair allocation of taxation power to member
states. Article 5(1) states, “The profits that are attributable to or in respect of a
significant digital presence in a member State shall be taxable within the
corporate tax framework of that member state only”.
The allocation of taxation power presented in the provision may serve the
purpose of avoiding imposition of double taxation on digital services. However,
it totally disregards the member state where the significant digital presence
resides.
As it has been mentioned in the previous chapter, the prevalent trend on
allocation of taxation power on business profit, mainly allocates taxation power
to resident state. Source states will have the power to tax if the entity performs
activities through permanent establishment. From this sort of arrangement both
139 Ibid
140 Id, P, 6 141 Id, P, 6
source and resident state will have a claim on taxation, subject to obligations
assumed based on the tax treaty to mitigate the effects of double taxation.
The OECD model tax convention on income and capital, presents the option to
mitigate by way of exemption or tax credit142. In comparison, the draft proposal
takes away similar option which may allow resident state to collect revenue from
the profits gained by significant digital presence without causing the harsh
consequence of double taxation.
In connection with the aforementioned observation, it shall be noted member
states which are resident of the parent company of the significant digital
presence contribute in value creation, considering that the physical presence of
the virtual permanent establishment conducts its function from the resident state.
Therefore, it can be argued the impact on revenue collection capacity of member
states hasn’t received its due consideration.
4.4 Summary and conclusion
The aim of the research was to examine how a draft EU proposal which was
initiated to address the taxation challenge posed by the operation of the digital
economy interacts with a rule positioned as a primary law within the EU legal
order.
In the initial, recognizing the inspiration of the OECD´S BEPS project, the study
presented the findings reported through action 1 of the BEPS project. The
finding of BEPS action 1 identified the operation of the digital economy offers
opportunity for tax avoidance, and the preexisting international tax framework
has a gap to address the challenges posed by the new business models which
spread owning to the growth of ICT. With the pursuit of addressing the
challenge, BEPS action 1 proposed taxation of significant economic presence.
142 OECD/ Model tax convention on income and capital ( 2017) , art 23 A and 23 B
Following the study discussed the contents of the EU commission draft proposal
to tax significant digital presence. The discussion showed the proposed
legislation creates a new taxable nexus, delineates the scope of its application
and determines how profits will be attributed to the establishment. The existence
of the new taxable nexus is determined by thresholds which doesn’t require
fixity or physical presence as it is usually applied in the preexisting international
tax law framework, rather they are based on factors that indicate the locus where
value is created even without the involvement of a physical presence.
The analytical portion of the study focused on examining the interaction of the
proposed directive with TFEU and legal principle of the EU. The examination
in context of the TFEU demonstrated the existence of a gap between the free
movement provisos, in particular, the freedom of establishment and freedom to
provide service. The existence of the gaps could lead to the creation of an
establishment that is not covered by the protection of the free movement articles.
The examination based on the legal principles, specifically principle of
subsidiarity and proportionality demonstrated, (political issues not considered)
there is a viable chance to secure the acceptance of proposal to tax significant
digital presence. However, such result is due to lax approach taken by CJEU in
enforcing principle of subsidiarity and proportionality, rather than the merits of
the concept. A measure introduced on EU level may serve the purpose of
avoiding the introduction of divergent policies. However, the concept as it is
presented in the draft proposal, didn’t accord due regard to interest of resident
member states.
On conclusion, if the proposal becomes a directive or if the concept of taxation
of significant digital presence resurfaces in the legal scene of the EU through
another proposed measure, the concept can serve the purpose in harmony with
primary EU law, if the court exercises an active role in interpretation of issues
with the intent to simmer the relevant provisions of the TFEU with the new
concept that was created well after the adoption of the primary laws.
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1. Council directive (EC), on laying down rules relating to the corporate taxation
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1. Cases C- 205/84 Commission vs Germany (1986)
2. Case C – 385/12 Hervis Sport- és Divatkereskedelmi Kft. V Nemzeti Adó- és
Vámhivatal Közép-dunántúli Regionális Adó Főigazgatósága,
3. Case C – 233/416 (Asociación Nacional de Grandes Empresas de Distribución
(ANGED)) v Generalitat de Catalunya , ( 2016)
4. Case C- 491/01, The Queen |Secretary of State for Health| V British American
Tobacco (Investments) Ltd| Imperial Tobacco Ltd|Japan Tobacco Inc | JT
International SA ( 2002)
5. Case C-233/94 Germany v. European Parliament and the Council ( 1997)
6. Case C-380/03 Germany v. Parliament and Council ( 2006)
