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Key points
- More countries are seeking to tax digital services.
- The difficulty of identifying specific digital services.
- Introduction of the Hungarian advertising tax.
- The decision in Google Ireland Limited.
- The Google decision may have wider implications.
From long before any readers of Taxation were born, tax authorities have been looking for ways to ensure they can tax profits connected to activities within their jurisdiction. For companies with activities in jurisdictions they are not resident in, the taxation of foreign profits has for the past century depended on whether a permanent establishment (typically abbreviated to ‘PE’) exists in that foreign jurisdiction.
While the current concept of a PE is remarkably similar to that put forward by the League of Nations in 1928, international commerce has been changed forever by the internet. With the consumption of media now taking place almost entirely online and businesses traditionally found on the high street steadily migrating to the digital domain, the traditional concept of permanent establishment no longer seems adequate.
Taxing digital services
To tackle the shortcomings of the prevailing definition of PE, many countries have sought to introduce digital services taxes on remotely delivered digital services, in particular advertising and social media. These taxes typically work by charging a low, flat amount on revenue derived from a particular country or from services provided to a country’s citizens.
Although the question of levying digital service taxes based on non-geographic criteria (citizenship, for example) has been fairly academic for most companies, from April 2020 India – one of the world’s largest economies – has had a digital service tax with non-geographic criteria. With India being a significant growth market for many digital companies, this concept of non-geographical criteria within tax has become very relevant.
When levying taxes on the basis of criteria other than physical location there is, however, an issue of how to determine whether the users who have accessed digital services meet the taxation criteria.
For digital services that produce revenue from user interaction (be that social media, online purchases or ‘click through’ advertising) the geographical location of the digital services’ users is relatively simple to establish from the IP (internet protocol) address of a computer or device. The question of how to determine qualities such as citizenship from anonymised user data is more nebulous.
Spotting citizens
If it is not possible to directly identify the citizenship of a digital user, is it possible to identify a quality in the digital service that would only appeal to the citizenry of a particular country? Yes, if the digital service has measurable qualities that are only very likely to appeal to citizens of a specific nation.
Qualities that might limit the appeal of a digital services to such citizens might include when they relate to an indigenous religion (such as Shinto, which has almost no practitioners outside Japan) or languages that are rarely spoken outside of their country of origin (such as Finnish).
Hungary’s digital service tax
Hungary was a pioneer of digital service taxes in 2014, with other countries such as India, France, Italy, the UK, Austria and Turkey introducing their own similar taxes in subsequent years. It is not unreasonable to expect the majority of EU member states to have digital service taxes within the next few years.
While, currently, most digital service taxes are targeting the digital giants’ revenue arising from online services enjoyed in the relevant country, some countries have introduced digital service taxes with much lower thresholds and/or non-geographic criteria. India’s 2020 equalisation levy, for example, applies to all business-to-consumer digital services that are enjoyed by individuals located in India, residents and ‘specified’ non-residents.
As mentioned, the first European country to introduce a digital services tax with a non-geographic basis was Hungary. Its 2014 advertising tax sought to impose a liability on internet advertising, predominantly in Hungarian or on a mainly Hungarian language website. This meant that its domestic legislation sought to tax revenues arising from adverts delivered in Hungarian on a global scale, even when both the online host of the advertisement and its audience appeared to be located outside Hungary.
The concept that a country could assert taxing rights over businesses and individuals potentially unconnected to it would appear to be a significant departure from traditional taxation concepts of tax nexus, whether residence, situs or activity.
The importance of language
The idea that a state can claim taxing rights over not only individuals and businesses connected to it, but to the use of its language seems alien, but it is worth understanding how Hungarian’s user base is different from that of English or other global languages, such as Spanish.
Hungarian is spoken only by about 13 million people worldwide, with around ten million of them in Hungary. So most people who speak Hungarian as their primary or only language can be assumed (with some accuracy) to be Hungarian citizens or resident in Hungary. It is worth noting, however, that there are significant Hungarian speaking minority populations in other European countries, notably Romania.
The question of whether, under EU law, Hungary is entitled to levy a tax on the basis of language with which it is strongly associated without proving an explicit territorial link was one of several points considered by the EU advocate general in Google Ireland Limited v Nemzeti Adó- és Vámhivatal Kiemelt Adó- és Vámigazgatósága Case C-482/18.
The advocate general said: ‘The Hungarian tax on advertisements... [is] directed primarily at Hungarian-speaking users who are for the large part located in Hungarian territory... If the internet had not been invented, the major share of that revenue could probably have been generated only by becoming established in Hungary, in which case Hungary could have simply levied income tax as appropriate.
‘Should that competence cease to exist solely because technical progress creates new ways of generating revenue without being present in the member state in question? I do not think so.’
The judgment went on to say that use of a country’s official language can (in principle) prove a link to a territory because language is (in many countries) an important part of national identity. It was noted that the use of a foreign language (for example, the use of Hungarian adverts in a country with few Hungarian speakers) betrays an intention to target the nationals of a state that uses that language, albeit ‘expats’.
Although this method of linking advertisers’ activity to Hungary was not perfect, the judgment noted that it was sufficient to create the territorial link required under EU law (even when more accurate techniques may exist, such as the monitoring of IP addresses). The potential existence of double taxation would no more preclude the use of language as a measure of applicability as it would preclude domestic measures of corporate residence, and should be resolved through appropriate provisions within the relevant double taxation treaty.
It should be noted that the judgment specifically referenced the fact that English, being the most widely spoken language in the world, was a possible exception to this logic due to its position as the world’s de facto ‘universal language’.
Wide implications of judgment
Although Google won in Google Ireland Limited, the legal analysis in the judgment (as it relates to Hungary’s taxing rights) is interesting obiter dictum.
Until the OECD releases the final ‘pillar one’ framework – which focuses on the allocation of taxing rights under the organisation’s base erosion and profit shifting (BEPS) action plan – it is expected that countries will implement digital service taxes according to their own taxation traditions. If countries such as the USA and Eritrea (both known for taxing individuals according to citizenship rather than residence) introduced digital service taxes, it is conceivable that these could focus on citizenship as much as residence.
It is not only countries with a history of taxing according to citizens that might be affected by the law explored in Google Ireland Limited. As countries such as India seek to expand the scope of their digital service taxes to cover transactions in data relating to their citizens between two non-residents, the introduction of the concept of non-traditional territorial links into the tax ‘mainstream’ is significant.
The fact that using a criterion such as language as a territorial link is not incompatible with EU law will have potentially wide-ranging ramifications for future digital service taxes. The effect of the decision may not be limited to the EU because the court’s decision may inform future ‘mutual agreement’ procedures between states in respect of tax treaties.
Ultimately, only time will tell when the implications of this decision might extend beyond digital service taxes. Could the language that a business conducts its business in become relevant in determining permanent establishment? This remains to be seen, although in the rapidly evolving tax landscape of the 21st century nothing seems impossible anymore.
In any case, tax practitioners (especially those working in the international tax sphere) will need to keep an eye on the continuing development of novel indicators of territorial link, and how these might apply to the taxpayers they advise.
