South Africa's response to the digital economy's direct tax challenges - Part 1

Abstract

International tax rules were developed more than a century ago. At their core is the principle that profits should be taxed where economic activities physically take place and where value is created. Advances in technology and the progression of the fourth industrial revolution have changed how businesses around the world operate and have given rise to the “digital economy”. Businesses no longer need to be “physically” present in a jurisdiction but can operate digitally or virtually anywhere in the world. New business models such as e-commerce, payment services, app stores, online advertising, cloud computing and participative network platforms have emerged. The digital economy and these new business models pose various challenges to the effectiveness of rules on the current jurisdiction to tax; businesses are able to derive significant economic benefits from a country without a “taxable nexus” to such country – for example, without the creation of a fixed place of business, permanent establishment or establishing a place of effective management. The digital economy is global in nature and, therefore, policy actions dealing with the global economy need a global approach. The Organisation for Economic Co-operation and Development (OECD) has taken a leading role in developing new direct-tax rules that will address the tax challenges posed by the digital economy and has agreed to develop a two-pillar solution that can be consented to internationally and implemented by countries. Pillar one proposes new rules on tax nexus and profit allocation for large multinational enterprises (MNEs) that meet certain revenue and profitability thresholds. The rules do not require MNEs to be physically present in a jurisdiction. Pillar two proposes mechanisms to ensure large MNEs pay a minimum level of tax (currently set at 15 per cent) regardless of where their headquarters are or the jurisdictions in which they operate. Some countries (such as the United Kingdom (UK), United States of America (USA), India, and Nigeria) have opted to take unilateral measures as they wait for a global solution. These unilateral measures are often uncoordinated and give rise to some undesirable consequences, such as double taxation. South Africa has decided to wait for global consensus and is currently not taxing the digital economy through its direct-tax rules. Although the OECD solutions are helpful proposals on taxing the digital economy and are a step in the right direction, it is submitted that they are not completely suited for South Africa as a developing African country; they do not consider some of South Africa’s unique circumstances, such as the prevalence of corruption, semi-skilled tax administration and limited resources. South Africa should not merely adopt the rules blindly but should adapt them to suit its needs as a developing country. South Africa needs to protect its tax base while embracing the digital economy; perhaps, while it waits for a global solution, it could strengthen its source rules as recommended by the Davis Tax Committee. This article is divided into two parts. Part 1 evaluates the suitability of South Africa adopting the OECD global solutions to the direct-tax challenges posed by the digital economy in a developing African country; Part 2 evaluates whether South Africa’s response to these challenges is the best option by considering the approach and consequences of select developed and developing jurisdictions (that is, USA, UK, Nigeria and India) adopting unilateral measures while waiting for an OECD global solution.