It’s no secret that COVID-19 times have forced us to quickly adapt to an online reality. As a result, services of IT companies have become deeply rooted in our life and have turned into not only its integral, but often a vital attribute.

Despite a bleak picture in the world, it is difficult to deny that digital services along with pharmaceutical companies have benefited most from the pandemic.

Due to these processes, a significant part of the global income accumulated in the digital economy rather than in the traditional and familiar forms of trade.

In turn, the leading world economies were forced to realize that the legislative regulation and taxation in respect of IT companies fail to keep up with the development of the industry and lag behind its potential.

Seeing how the principle of taxation of  IT companies’ income based on their place of registration does not allow for its fair allocation and taxation in countries where such companies operate, recently, national leaders have been actively discussing the need to develop common approaches to taxation in this sector. At the same time, IT giants such as Apple, Google and Facebook have been using tax loopholes and low-tax jurisdictions for many years to reduce their tax burden to a minimum.

Back in 2015, the Organization for Economic Cooperation and Development (the “OECD”) released the Addressing the Tax Challenges of the Digital Economy, Action 1 – 2015 Final Report as part of implementing the BEPS project, noting the emerging problems and giving proposals for resolving them.

Since then, countries have repeatedly attempted to develop common approaches to taxation of digital companies, both in terms of regulation of indirect taxes and with respect to profit. At the same time, while some countries managed to introduce a regime that allows imposing VAT only on transactions that are performed in the relevant country, the issue of income taxation remains more complicated and inevitably affects interests of several countries.

Common digital tax vs minimum tax rate

On July 1, 2021, the OECD announced that 130 leading countries, including Russia, joined the plan to carry out an international tax reform providing for introduction of common approaches to taxation of the digital economy.

This global initiative has two main directions:

• The first direction (Pillar 1) provides for rights to levy taxes on excess income of major companies to be allocated among jurisdictions of their registration and jurisdictions where such companies operate and receive income without being physically present (where their users reside). In particular, it proposes to allocate the amount of profit exceeding USD 100 billion per year among jurisdictions of business operation.

• The second direction (Pillar 2) is designed to limit the competition between national tax systems through setting lower tax rates and assumes introduction of a minimum income tax rate. It provides for a tax rate of at least 15%, which, as estimated by OECD, will increase budget revenue by approximately USD 150 billion annually.

The plan for implementing the said measures is expected to be finalized by November 2021, and member states are expected to implement them by 2023.

Meanwhile, there has been long ongoing discussion on tax regulation measures in this area among EU members. They have formulated the General Rules on developing common regulation procedures, adopting approaches to define digital presence and imposing a tax on certain income.

One of the main and widely discussed issues is the introduction of a common digital tax on corporate income from selling goods, works and services via the Internet. The proposed measures provide for the countries where users of digital services reside to be entitled to impose tax on companies with global annual income exceeding EUR 750 million, and income in the EU exceeding EUR 50 million.

In light of the OECD announcing its initiatives to develop common rules and introduce a minimum tax rate, EU’s controversial proposal has now been postponed. However, despite the proposal not being adopted and being officially put on hold, some member states adopted digital tax laws without waiting for the final agreement on approaches within the OECD reform.

Slovakia was one of the first countries to regulate the taxation of income from digital services. In 2018, the country implemented a tax reform under which the concept of permanent presence was broadened to apply to digital platforms, so that it is possible to tax income from digital services at the national rate of 21%.

Similar provisions were adopted in EU states in 2020. For example, Austria since January 2020 has been taxing income from advertising services on the Internet at a rate of 5%. Spain, Italy and France have adopted digital tax laws prescribing taxation of income from digital services at a rate of 3% which was previously agreed within the EU. However, there is no unified list of taxable transactions. At the same time, most states are unanimous in their intention to tax IT companies’ income from advertising on the Internet. It seems that countries regard this direction as the main source of revenue and, accordingly, a positive outlook for replenishing national budgets.

At the same time, due to the said initiatives within the OECD, enforcement of some of the provisions is currently suspended. See information on examples of introduction of a digital tax in some countries in the table attached.

It appears that the main directions of the proposed reform are already evident, and we expect that certain arrangements on the issue of taxation of IT companies will be reached in the near future.

Meanwhile, such changes should be taken into account as we speak if you are planning to create IT structures, in order to avoid additional difficulties and unforeseen financial costs in the future.

Russia also does not want to miss out on its part of IT platforms’ income. This summer, Russia introduced some initiatives with respect to digital companies, which we will discuss below.

In an effort to reach a compromise following the best traditions of the win-win strategy, this year, many negotiations were held and initiatives put forward both at the international and national levels in order to identify common approaches and resolve urgent issues.

This article strives to examine the latest trends and to attempt to foresee which of them are expected to be implemented in the near future.

The agony of choosing or waiting for the audience to help

The initiative to introduce a digital tax that would apply to income of foreign digital services and marketplaces in the Russian Federation has long been under discussion within the Russian Ministry of Finance and Ministry of Digital Development. We believe that a digital tax similar to that of the EU with the same rate of 3% may be adopted in the Russian Federation. The tax is expected to be included in the second package of measures as part of the tax maneuver in the IT sector.

Due to the abovementioned circumstances, Russia also stands at a crossroads, facing a choice of whether to wait until the OECD tax reform is completed and establish national rules taking into account the agreed provisions and restrictions, including the income tax rate, or to introduce a tax in order to replenish the budget with new revenue starting from January 1, 2022, and, as the initiators say, to use the received funds for supporting national IT services.

While waiting for the global community to deliver a verdict, this September, the Russian Government published a road map containing a proposed package of measures to support the domestic IT industry (see our review of the main measures here) (the “Road Map”). Notably it proposes amendments to the Russian Tax Code concerning taxation of foreign IT companies’ income as the very first measure. The Ministry of Finance, the Ministry of Digital Development and the Federal Tax Service of Russia will have to submit their relevant proposals by November this year.

Accordingly, prospects will become clearer by the end of autumn, since during that period tax-related lawmaking tends to peak, and most laws are adopted in order to allow them to be enforced starting from January 1 of the following year.

Regions will help to provide IT harbors

Along with efforts to levy taxes on foreign services, the government is striving to be consistent in its initiatives and takes measures to attract and stimulate the development of IT services in Russia.

On July 2, 2021, the Russian President signed a law authorizing the regions to determine a preferential income tax rate in relation to income derived from the use of intellectual property.

The amendments prescribe that starting August 2, 2021, the regions are authorized to determine a preferential income tax rate in relation to income of companies that issue licenses to use intellectual property. However, there are no benefits in respect to alienation of rights to intellectual property.

Regional acts will determine the rate in the range from 17% to 0%, the types of intellectual property covered by benefits and other terms.

This measure can be very useful for encouraging the regions to create a comfortable tax and investment climate on their territory in order to attract IT companies and to build some kind of digitally advanced development areas in the future.

In addition, as mentioned above, the second package of the tax maneuver in the IT sector will be adopted soon.  It proposes an additional set of measures to support Russian IT companies.

At the same time, measures to stimulate the development of domestic IT companies go hand-in-hand with additional restrictions for foreign ones.

Real Russian hospitality even on the Internet

On July 1, the Russian President signed the so-called law “on landing” foreign IT companies. It prescribes that starting January 1, 2022, the owners of web resources whose daily audience exceeds 500,000 Russian users will have to comply with a number of obligations in Russia:

1. Posting a complaint form on their resources following Roskomnadzor’s requirements.
2. Creating an account on the Roskomnadzor web site and using it for communication with Russian state authorities.
3. Setting up branches, representative offices or legal entities in Russia to ensure that such a foreign company will abide by court decisions and government resolutions/requirements adopted against them.

Apparently, foreign IT companies might find the latter obligation very hard to take. The Russian branch is meant to consider complaints filed against the foreign company in Russia, represent its interests and take measures in Russia to restrict access to or delete information that violates Russian laws.

Given the policy regarding the media, such an office will in fact act as a “negotiator” for the foreign company in Russia. In this regard, it seems that the role of such a branch will be determined by the specifics of the service, e.g. Ikea or Wikipedia are unlikely to receive many complaints from Russian users, whereas Instagram and YouTube will highly likely be faced with lots of complaints about, inter alia, publication of information prohibited in Russia.

At the same time, the law provides for a set of measures to be applied to a foreign service in case of its failure to fulfill this obligation, which includes complete blocking of the service. In our opinion, the most effective measures are a possible ban on advertising on an information platform (e.g. note that the lion’s share of YouTube’s income comes from advertising), and limitation on money transfers to a foreign service (this will be especially painful for Amazon and Aliexpress).

Introduction of these obligations for foreign IT companies is another attempt of Roskomnadzor to achieve its dream of being able to control content posted by users on the Internet, ever since the unsuccessful blocking of Telegram and constant wars with Twitter over deletion of undesirable accounts. 

However, there is another side effect to the obligation to register representative offices and branches, in particular, foreign IT companies’ income from sources in Russia may be taxed under Russian laws. In this regard, it is important to note another support measure contained in the Road Map, which proposes introduction of a “digital residence” system for foreign IT companies and individuals. It is not yet clear whether such an initiative will be associated with a permanent digital presence for tax purposes or if it will entail application of a special taxation procedure. Nevertheless, it is obvious that Russia has a strong desire to take a place among the ambassadors of IT harbors, and we can expect to see the outcome in the near future.

We will continue to monitor the developments and will keep you updated. Stay tuned!

Should any questions arise, we will be glad to assist.

Examples of a digital tax introduced in foreign jurisdictions can be viewed here. 

Thus, it appears that all countries recognize the particular importance of clear and understandable rules for taxing digital services income, which will ensure fair allocation of their income among jurisdictions. It is hard to deny that the planned reform will help not only the world’s leading powers to potentially accelerate the recovery of the global economy suffered from COVID-19, but will also allow small and developing countries to protect their financial interests.