Taxation in the Digital Era: Challenges and Solutions

Introduction: Why Digital Taxation Matters

Taxation in the digital era is an excellent topic for a dissertation because there is an ongoing debate about whether digital companies are paying their fair share of taxes. Some tax experts believe that digital companies enjoy effective tax rates close to zero compared to traditional companies, despite earning enormous profits. The underlying principle of corporate taxation is that "profit should be taxed where value is created" (Sestakova, 2018). However, digitalization challenges this principle because it is difficult to determine how and where digital companies create value. Digital companies also rely heavily on intangible assets and big data, which are hard to value (Sand-Zantman, 2018). Given these realities, there is a clear need to research the problems that tax accountants face when taxing digital profits.

This topic is relevant when examined from a technological perspective for two main reasons. First, taxation policy should promote fairness. Both traditional and digital businesses should bear the same tax burden. It is unfair for citizens and traditional businesses to shoulder a heavier burden simply because large volumes of digital profits go untaxed. Second, there is a need for sustainable revenues in the digital era. The digital economy is overtaking the traditional economy in terms of market presence, and if digital profits are not taxed effectively, revenue gaps will emerge and revenue bases will shrink.

Taxation Issues in the Digital Era

Sand-Zantman (2018) identified four features of digital businesses that make the taxation of digital profits especially difficult. First, it is not easy to track the digital activities that generate profits. Digital companies sell their products to customers worldwide from a limited number of locations. Moreover, a large percentage of digital goods are intangible. Existing taxation rules are based on physical location and tangible assets, and the concept of intangible property remains poorly defined in accounting and therefore difficult to incorporate into taxation frameworks.

Second, digital companies facilitate transactions between sellers and buyers of traditional goods and services — that is, they act as intermediaries. Given their unique position, these companies can collect information on consumer behavior and sell it to advertisers. Taxation issues arise because it is not clear what constitutes new value in this context: is it e-commerce services, or data collection?

Third, big data is a primary source of competitive advantage for digital companies. Large tech firms such as Amazon, Facebook, and Apple collect and use data, often without the explicit consent of the economic agents from whom it is extracted. Raw data does not add new value unless it is processed, analyzed, and applied — meaning digital companies create value primarily through managing and using big data.

Fourth, digital companies benefit from network effects related to synergies, integration, and user participation. In other words, the value of a digital platform increases as its user base grows. Consequently, large digital companies enjoy higher returns to scale compared to smaller tech firms. Network effects also disadvantage new digital entrants, who earn lower premiums compared to established players.

Recommended Policy Solutions

The tax system has not kept pace with technology. Corporate taxes were designed in an era when most businesses sold physical goods in brick-and-mortar shops, making it straightforward to track sales volumes and the tax generated from them. Today, sales and services have shifted online, and there is a pressing need to modernize the current tax framework, which is now outdated (Katz, 2015).

Corporate tax rates have declined over the years, partly due to the digitalization of the economy. In 2018, Amazon's profit exceeded $10 billion, yet the company paid no federal income tax. Organizations such as the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) have called for new tax laws that reflect the reality that many companies conduct most of their business online. This is the context in which the concept of a digital tax has emerged (Committee of Experts on International Cooperation in Tax Matters, 2019).

In 2015, the United Kingdom introduced the Diverted Profit Tax (DPT) to address tax avoidance by large tech companies. The DPT is charged at 25 percent on profits that are artificially diverted from the U.K. This policy is not targeted at any specific sector or type of activity, and it has proven effective: corporate tax revenues increased from £31 million in the 2015/2016 financial year to £281 million in 2016/2017. Nevertheless, most countries have not adopted a similar policy.

Withholding taxes on digital transactions are imposed on the buyer or recipient of digital services and function as a form of direct income tax. Under this approach, it is important to define clearly what constitutes a digital versus a non-digital transaction. In practice, this measure creates additional tax compliance challenges for banks, which handle both types of transactions. It also worsens the business environment in countries that impose it, because it can result in double taxation — which may prompt digital companies to relocate to other jurisdictions. Overall, administering this form of taxation is highly complex.

In 2016, the government of India introduced an equalization levy on digital transactions, covering activities such as providing space or facilities for digital advertising and online advertising. The levy applies only when a digital company receives more than Rs 100,000 from non-residents who do not have a permanent establishment in India, and it must be deducted by a resident of India. The purpose of the levy was to address the non-taxation of digital companies operating in India. Because it is paid from gross income, it is exempted from income tax. The policy has attracted international attention: Japan and Argentina have introduced similar measures. In Japan, the levy is 8 percent on cross-border digital services to consumers; in Argentina, it is 3 percent.

Conclusion

Overall, the research literature on taxation in the digital era describes the features of digital business that make taxing digital profits difficult, as well as a range of possible solutions. However, a significant knowledge gap remains: we do not yet understand the specific problems that tax accountants encounter in practice when assessing and collecting taxes on digital profits. This gap represents a valuable and timely focus for future dissertation research.

References

Committee of Experts on International Cooperation in Tax Matters. (2019). Tax issues related to the digitalization of the economy: Report (E/C.18/2019/CRP.12). https://www.un.org/esa/ffd/wp-content/uploads/2019/04/18STM_CRP12-Work-on-taxation-issues-digitalization.pdf

Katz, R. (2015). The impact of taxation on the digital economy. https://www.itu.int/en/ITU-D/Conferences/GSR/Documents/GSR2015/Discussion_papers_and_Presentations/GSR16_Discussion-Paper_Taxation_Latest_web.pdf

Pemerathna, A. (2016). Economic impact of digital taxation: A case on information communication technology industry Sri Lanka. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2910328

Sand-Zantman, W. (2018). Taxation in the digital economy. https://www.orange.com/fr/content/download/47110/1371114/version/1/file/Rapport TAXATION-VF-Mai2018.pdf

Sestakova, M. (2018, February). Tax challenges of the digital economy [Paper presentation]. Management Challenges in the 21st Century, Bratislava, Slovakia.