Asian government entities are considering how to update antiquated taxation methods as their economies are increasingly becoming digitalized.
According to the International Monetary Fund (IMF), Asia's growing use of the internet, currently standing at approximately 2 billion users, will have an impact on how Asian countries tax technology companies. The challenge for many countries has been that many large tech companies are not physically based in the country. Additionally, international tax laws have been slow to adjust with the expanding digitization.
IMF released a report stating that existing income tax systems have been criticized as failing to confer taxing rights on jurisdictions where highly digitalized businesses have a large base of customers that generate value, but where they have no actual physical presence. More than half of all services trade in Asia is delivered digitally, which make it difficult to collect value-added taxes when these services cross borders, according to IMF.
"For highly digitalized firms, the ability to make cross-border sales without physical presence means a significant disconnect exists between where taxes are currently paid and the
location of consumers," IMF wrote in its report.
The Organization for Economic Co-operation and Development (OECD-IF) is leading an initiative consisting of 134 international members including the United States and most major Asian economies to form an agreement that would grant taxing rights to countries where most the most consumers and users reside. Under the agreement a portion of profits would be allocated across countries in proportion to local sales and taxed under local laws.
"The agreed changes could spur more comprehensive reforms applied to all companies and to a larger share of profits," according to the IMF. "That would cause a much larger reallocation of tax revenue across countries, with the largest losses expected for investment hubs in Asia and expected gains for several developing economies."
Several Asian countries have introduced digital services taxes, which withhold taxes on payments for cross-border digital services or user-based turnover taxes on digital activities, the IMF said. These services, however, don’t raise much revenue, distort business decisions and could be vulnerable to tax avoidance. They can also complicate trade relations, because they are usually applied only to large firms headquartered abroad. Digital services taxes could become redundant if a new global system for profit taxation is implemented.
Other solutions that are being discussed among tax experts include formulary apportionment and residual profit allocation, digital services taxes (DSTs) and extending the value added taxes (VAT).
"As Asian consumers and businesses increase their online activity in the coming years, tech giants will expand further into Asian countries, making taxation in a digitalizing economy even more important," according to IMF. "Countries in Asia, in particular, can invest in ways to harness digitalization for tax administration helping to reduce tax evasion, boost revenue mobilization, and make tax collection more efficient.
Digitalization is increasing pressure on the century-old international tax framework, which more fundamental reforms could address in the medium term. The reforms being considered in the OECD-IF could be a step toward more comprehensive reforms in the future, the IMF said.