Are Mobile Apps Subject To Tax?

The digital economy in numbers

Because there is no settled definition of the digital economy, measuring its size is genuinely difficult. Depending on the definition adopted, the digital economy represents somewhere between 5% and 15% of total global economic output. As of 2019, goods sold digitally accounted for 11% of all goods sold worldwide. Seven of the eight largest companies globally by market capitalisation operate digital platforms — a fact that becomes all the more striking when you recall that none of these companies featured in the top 100 in 2009. Between 2015 and 2017, a span of just two years, the revenues of digital-platform companies grew by 67%. Internet advertising made up 15% of total advertising spend in 2010, rose to 38% by 2017, and is projected to reach 60% by 2023. The mirror image is equally telling: advertising revenues of US printed newspapers stood at USD 66 billion in 2000 and are expected to fall to USD 4 billion by 2023. Comparing the top 100 companies by market capitalisation between 2009 and 2018 leaves little doubt about the pace of digital expansion.

THE DIGITAL ECONOMY IN NUMBERS

The digital economy entered tax authorities’ radar in direct proportion to its growth. The reason is straightforward: the overwhelming majority of companies driving — and earning revenue from — the digital economy are resident in the United States and China. These companies generate income from activities that span the globe, yet pay tax almost exclusively in their home jurisdictions. To put it in figures: digital-economy giants earn more than 60% of their revenue outside their country of residence, but pay over 90% of their total tax in that home jurisdiction.

Today, 70% of the value added in the digital economy is created by companies headquartered in the United States, 25% in China, and only 5% elsewhere (4% in European countries and 1% in the rest of the world). The monopolistic dynamics inherent to the digital economy — the user-base advantage of being first, superior data-processing capabilities, and users’ reluctance to change habits — combined with the practice of acquiring emerging competitors (or developing copycat products to neutralise those that refuse to sell) leave little prospect of this picture changing in the near term.

Where is the problem?

With internet usage rising steadily — and the age of first contact reportedly falling below seven — digital-economy companies operate and generate revenue across borders without restriction. Tax authorities in countries where these companies are not resident see that they are unable to collect their share of the tax pie, and recognise that the status quo is unlikely to change of its own accord. The result is a proactive stance aimed at securing a slice of digital-economy revenues.

This is what produces the broader problem we now group under the heading of “taxation of the digital economy.”

The root of the problem lies in the existing international tax rules, which trace their origins to the 1920s. Under those rules, economic activity that spans more than one country can be subject to income tax in a given country only if it is carried on through, or by means of, a place of business located in that country. The principal source of international tax rules — the network of double tax treaties — generally defines this place of business as a fixed place and provides illustrative examples.

Under those existing rules, websites cannot really be regarded as a fixed place of business. As a consequence, where a company operates a website from outside a given country and earns revenue from users located in that country, the source state is effectively prevented from taxing that revenue.

International work toward a solution

As the problem has grown, and as countries other than the United States and China have started to make their voices heard, work has begun internationally to develop a new approach to taxing the digital economy. The Organisation for Economic Co-operation and Development (OECD) is leading this effort, given its central role in shaping international tax rules.

To identify and prevent revenue losses caused by mismatches between domestic tax regimes, the OECD launched the Base Erosion and Profit Shifting (BEPS) Action Plan, which envisages work across 15 areas. The very first of those areas is the taxation of the digital economy. Work under the Action Plan started in 2015 and is intended to be concluded by the end of 2020. As part of this work, the OECD recently prepared a “Unified Approach” document for consensus among member countries and opened it to public consultation at the end of 2019. The objective is for the final version of the Unified Approach to be approved at the G20 Leaders’ Summit at the end of 2020 and for implementation work to begin from there.

What does the Unified Approach bring?

The most important innovation is that the requirement of a fixed place of business for taxation is being abandoned. Under the new approach, a non-resident company without a fixed place of business in a country, but earning revenue above a defined threshold from activities conducted via a website, will be required to pay income tax in the source jurisdiction.

Taxable income will be determined in three steps. The aggregate of these three amounts will be subject to income tax in the source country.

Approval of the Unified Approach at the G20 Leaders’ Summit will not, by itself, be sufficient to start taxation. Rules consistent with the system will need to be put in place both domestically and at international level. From a Turkish perspective, this would mean amending the Income Tax Law and the Corporate Tax Law, as well as renegotiating Turkey’s double tax treaties — individually or in a bundle.

The Turkish picture

The Turkish tax administration took its first steps on digital-economy taxation through tax audits, which it carried out in two distinct waves.

In the first wave, the administration argued that local subsidiaries or branches — even those rendering relatively limited support services — of non-resident companies earning Turkish-source revenue through websites should be treated as dependent agents of those non-resident companies; and that, accordingly, a portion of the Turkish-source revenue had to be taxed in the hands of those dependent agents. The resulting tax assessments were annulled by the courts on the basis that the findings supporting the existence of a dependent-agency relationship were insufficient.

In the second wave, the administration argued that the websites themselves constituted a place of business. It anchored this argument on a provision enacted in 1961 — a time when the internet was not even in use. As expected, the courts did not accept this approach either.

Unable to obtain the desired result through audits, the administration moved to tax-policy measures. The first of these was the introduction of “VAT registration No. 3”. Under this regime, non-resident digital-economy companies without a Turkish tax registration are required to charge and remit Turkish VAT on services rendered to individual customers in Turkey (B2C sales). The second step was the introduction of digital advertising withholding tax, allowing advertising payments made to such companies to be taxed at source by the paying person or entity, at a rate of 15%. The final step was the Digital Services Tax, which entered into force in March 2020 with the first return filed on 30 April 2020. Under the Digital Services Tax, in-scope companies are required to compute and report DST at a rate of 7.5% on internet advertising revenues, sales of digital content and revenues from the operation of digital platforms.