On April 26, the United Nations Model Taxation Convention 2021 was launched, allowing member countries to tax automated digital services (Article 12B and consequential amendments in Articles 23A, 24 and 29), indirect offshore transfers (paragraphs 6 and 7 of Article 13), collective investment vehicles (CIVs), and pension funds using the most up-to-date provisions (Articles 1, 3, 4 and 29).
The inclusion of Article 12B in the UN's latest model tax convention, according to some tax experts, could undermine the OECD's two-pillar solution and divide the international tax community, particularly African tax administrations, on how to address the digital economy's tax challenges.
Taxing digital services in a'simple' way
Article 12B was approved at the Committee of Experts on International Tax Cooperation's 22nd Session in April 2021. The provision allows a contracting state to tax income from certain digital services paid to a resident of the other contracting state at the bilaterally agreed-upon rate on a gross basis.
Article 12B was created by the United Nations to assist developing countries in taxing digital services while avoiding double taxation or non-taxation. It addresses some of the OECD's pillar one profit allocation rules' limitations and is better suited to the needs of developing countries. The UN tax proposal's main advantage is that it is designed to be easier to implement on top of the existing international tax framework.
According to Rajat Bansal, India's principal chief commissioner of income tax and a former member of the UN Tax Committee, the goal of Article 12B was to "have a simple solution for the developing countries to administer" and to have a "fair and reasonable share of revenue or taxes out of this activity." In 2021, Bansal collaborated with the UN Tax Committee on the first draft of Article 12B.
The OECD's digital tax framework, according to Carlos Correa, executive director of the South Centre, provides "minimal revenue benefits for developing countries." "Administration of this system is also expected to be exceedingly difficult, given the complexity of the rules," he said at the April 2022 event.
He also stated that the deal is "far from global" because half of all African countries are not members of the Inclusive Framework.
Article 12B provides two options for taxing automated digital services. The first is gross taxation, in which a percentage of gross revenue is taxed. The other shields businesses from being taxed on their losses. This second option, according to Bansal, provides a net basis taxation on qualified profits on an annual basis. " [These] were defined in the Article to be a portion of the profit from that stream of income or revenue arising from the market jurisdiction. A fair allocation was done to allow the source country to tax 30% of that at the domestic tax rate," according to Bansal.
For taxpayers, this means that a company will pay tax in the source country rather than the country where it is based. "So, it's a matter of allocation of taxing rights between the two countries," Bansal explained.
When is the 'right time' to make a change?
The UN's inclusion of Article 12B in the tax convention comes at the right time, according to Lutando Mvovo, executive head of international tax at the Vodacom Group in South Africa.
"It gives countries – especially developing countries – an option in their decision-making," Mvovo explained. "We [now] have a multilateral approach in the form of the OECD [with] pillar one and pillar two, [and] we have the UN approach, which is a bilateral approach and which, in my view, is easy to apply and, from a tax revenue perspective, it is easy to monitor."
"It is likely that most African countries will adopt Article 12B," Mvovo stated," it brings certainty and it will bring consistency in terms of application"
Since opting out of the OECD's global tax deal under the two-pillar framework earlier in April, ITR understands that Nigeria could be among the first countries to adopt Article 12B.
Kenya, Nigeria, Pakistan, and Sri Lanka have all chosen to leave the OECD's two-pillar solution due to a variety of reasons. Nigeria has been particularly vocal about its position, and a number of African countries have begun to implement a digital services tax (DST) or raise their tax rates.
As of April 1, 2022, Nigeria's Finance Act 2021 enacted a DST, requiring foreign digital companies providing e-services to charge, collect, and remit VAT to the Federal Inland Revenue Services (FIRS). Google and other digital companies have issued notices confirming that their services will be subject to a 7.5 percent VAT.
Tanzania has stated that it plans to implement a DST soon, while Kenya plans to increase its DST rate from 1.5 percent to 3 percent, according to the Finance Bill 2022.
The OECD's digital tax framework agreement and the UN's inclusion of Article 12B in its model tax convention may not be enough to prevent countries from implementing DSTs. However, if one of the two options is chosen, some clarity for businesses attempting to comply and navigate the changes may emerge, albeit at a higher tax cost.
By fLEXI tEAM