A critical analysis of the pillar one direct tax solutions for businesses in the digital economy

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University of the Witwatersrand, Johannesburg
Business profit under the existing international tax system is taxed in the state of residence unless the entity has generated the said profit through a permanent establishment in another state. Traditionally, a business had to have a physical presence in the source state to be considered a permanent establishment. (European Parliament, 2019a, p. 17; World Bank, 2021, p. 26). The digitalisation of the economy allows multinational entities to do business with customers worldwide without having a physical presence in those customers' locations. (World Bank, 2021, p. 26), while the current international tax law is depended on the physical presence of the entity in a location, i.e., a permanent establishment (European Parliament, 2019a, p. 16; World Bank, 2021, p. 26). In the digital economy, the concept of a permanent establishment becomes irrelevant (Medus, 2017, p. 15). The OECD acknowledged that businesses with high levels of digitalisation could generate significant profits and engage in national economic life without having a sizable physical presence (OECD, 2015a, pp. 100-102). The European Parliament (2019a, p. 16) reported that due to these gaps in the current international tax system, digital businesses pay an average tax rate of 9%, while traditional businesses pay an average tax rate of 21%. In October 2020, the OECD published the blueprint with the recommendation to address the direct taxation of the digital economy, entitled ‘Tax challenges arising from Digitalisation – Report on Pillar One Blueprint’ (Pillar One). These recommendations will be effective in 2024 once the inclusive framework members have signed the Multilateral Convention (OECD, 2022a, p. 5). In addition to the Pillar One report, the OECD issued a progress report entitled ‘Progress Report on Amount A of Pillar One, Two-Pillar Solution to the Tax Challenges of the Digitalisation of the Economy’ (Progress Report) in July 2021. Lastly, to address the administrative challenges, the OECD, in October 2022, issued the draft administrationprinciples to be followed by the in-scope multinational entities on the report entitled ‘ProgressReport on the Administration and Tax Certainty Aspects of Pillar One’ (the Administration Report). Researchers and tax policymakers have researched the taxation of the digital economy or e-commerce. However, the focus of those studies was to analyse the tax challenges brought about by the digitalisation of the economy and propose solutions that can be adopted to 2 | P a g e address the direct tax challenges brought about by the digitalisation of the economy (European Parliament, 2019). This research report aims to analyse how digital businesses will be taxed using the recommended direct tax solutions from Pillar One. The OECD issued Pillar One to address the current international tax law gaps.
A research report submitted to the faculty of commerce, law and management in partial fulfilment of the requirements for the degree of master of commerce (specialising in taxation), School of Accountancy, University of the Witwatersrand, Johannesburg, 2023
Digital economy, Permanent establishment, Physical presence, Direct tax, Value creation, Arm’s length principle, Current international tax law and Pillar One, UCTD
Mthembu, Sibonelo. (2023). A critical analysis of the pillar one direct tax solutions for businesses in the digital economy [Master’s dissertation, University of the Witwatersrand, Johannesburg]. WireDSpace. https://hdl.handle.net/10539/38694