The current tax rules underpinning practically every tax code around the globe are derived from a “bricks and mortar” or manufacturing based economy. What this means is the underlying concepts were developed when all world economies were based on building physical products that were bought and sold (think industrial revolution). For example, the tax treaty phrase “permanent establishment” was actually developed by League of Nation’s negotiators during their preliminary discussions to develop a working tax treaty framework. Compare this to today’s digital economy where “products” are actually multiple lines of computer code that exist in cyber-space (or a trademark or patented item) or where a “store front” (the old “permanent establishment”) is in fact a web site located halfway around the globe on a server in a tax haven. This mismatch between the underlying concepts of the old tax code and the new economy have allowed tax planners to devise tax plans that exploit the inherent conceptual incongruity between the underlying tax code and actual business being taxed.

The original OECD model tax treaty attempted to deal with some of the problems created by this situation in their electronic commerce section of the OECD model tax treaty commentary (paragraphs 42.1-42.10). Paragraph 42.8 of that section concluded:

Where, however, such functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the computer equipment, these would go beyond the activities covered by paragraph 4 and if the equipment constituted a fixed place of business of the enterprise (as discussed in paragraphs 42.2 to 42.6 above), there would be a permanent establishment.

However, this solution is rather narrow; serious exploitation of the old rules when applied to a more modern business is still part and parcel of modern international tax planning. As such, this is an area which the OECD recommendations target for change, including a targeting of the following areas:

1. the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules,

2. the attribution of value created from the generation of marketable location-relevant data through the use of digital products and services,

3. the characterisation of income derived from new business models, the application of related source rules, and

4. how to ensure the effective collection of VAT/GST with respect to the cross-border supply of digital goods and services. Such work will require a thorough analysis of the various business models in this sector.

Each of these areas is a topic onto itself, but suffice it to say that breadth of the potential changes is incredibly broad.

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