Taxation

The term Grid computing is one of the most widely used nowadays in the ICT business sector, and many international big players, like Sun, Amazon, etc (not to mention all the other research labs, supercomputing centres and undertakings all around the world) are involved in that. Grid computing may appear to be mysterious for the absolute majority of non-experts, but it is expected to become familiar to many tax consultants that deal with IT companies. Some of the most interesting and urgent issues that European businesses operating in a Grid environment have to face regard Value Added Tax (VAT) and income taxes.

The first question to answer is why taxation issues are likely to be relevant in a Grid environment, provided that such issues are likely to arise in a Grid scenario and they regard the nature of the service provided and the consequences deriving from the use of servers that all together contribute to the creation of taxable income but are located in different locations. The problems that tax consultants and managers have to face are thus in many cases cumbersome and innovative. It is therefore necessary to provide a solution to the following questions:

1. Which VAT rules are applicable to a European ICT company that is willing to provide e-services to businesses or individuals located in the same country, in another European country or outside the EU? In particular, what services can be considered as e-services (electronically supplied services)?
2. As regards international income taxation, how should a single server, node, etc of a Grid infrastructure be considered? Is it a permanent establishment (thereinafter, PE) of the company?

These questions and the corresponding solutions are likely to have a great impact on the concrete business of ICT undertakings, and taxation is one of the most important drivers when drafting business plans. As regards the former question, the solutions are based on the applicable EC law sources, namely Directive 112/2006/EC, including the amendments introduced by Directive 2008/8/EC, while for what concern the international profiles of the server (and, in more general terms, Grid components) as PE we will refer to the Model Tax Convention and its Commentaries drafted by the Organisation for Economic Cooperation and Development (OECD).

VAT

We find useful to briefly mention a few major problems that are linked to the implementation of the VAT Directive as regards the provision of e.s.s., starting from the enforceability of the solutions adopted by the European lawmaker, especially in connection with the individuation of the place of establishment of the consumer. It has been pointed out, in fact, that enforceability is the Achilles heel of the VAT system. Enforcement causes problems owing to the difficulties in identifying customers in general within the digital world and such issues are likely to affect the business of companies operating in a Grid environment. 

Unless technology will solve this problem and new tools aimed to identify with absolute certainty the location of the customer will be invented, the European lawmaker should probably reconsider the solutions adopted in the VAT Directive and in Directive 2008/8/EC and investigate whether or not taxation at the supplier’s place would be more feasible, taking into account the place of corporate establishment of the supplier (and not the place from where the supply materially takes place). From a legal perspective, in fact, the identification of the place of consumption can tell very little about the place of establishment of the consumer: just to make an extreme but realistic scenario, what about a customer who downloads software on his laptop or mobile phone while flying on an airplane?  One could argue that the relevant information can be inferred from the credit card data of this client, but they are not always very reliable, as one can be established in a country and have a bank account in another one. In other words, technology is not likely to definitely solve the problem of the identification of the consumer’s location.

Apart from that, another very sensitive issue concerns the rate of taxation of e.s.s. Without entering into a detailed comparative analysis of the VAT rates applicable in all EU Member States, in many cases it appears that on-line taxes for downloaded items would be higher than the taxes, which were being applied to the same products when these are delivered through traditional ways. The typical example regards the printed and the digital versions of a book: in many countries the former will be taxed at a reduced rate, if not at a zero rate, while the latter will be taxed at the normal rate. This implies a violation of the equal treatment principle, pursuant to which similar goods and services should bear the same tax burden. From a non-tax (and innovative) perspective, such ‘discrimination’ of e.s.s. is not really understandable if we consider the need to save natural resources. In other words, if a book delivered online is supposed to have less impact on the environment (in terms of resources necessary to create it), why should it be taxed more heavily and thus should be (at least potentially) more expensive for the final user?

The issue of rates introduces a different, and more general, topic, i.e. the need to reconstruct the notion of goods and services provided that such traditional division has been dramatically altered by technological changes. In other words, it is not possible to deny that electronic deliveries warranted a revision of the interpretation of the distinction between goods and services which is fundamental in the workings of VAT. This point is undoubtedly crucial and needs to be carefully assessed by the European lawmaker in order to provide solutions which are both implementable and technologically viable. With this regard, it is possible to disagree with the position of the European Commission that refuted the argument that the differentiation between VAT on traditional articles and their electronic counterparts is inconsistent. The Commission believes that it is impossible to argue that there is direct equivalence between these items, as they are by their nature two fundamentally different products that need not necessarily be taxed identically. It would be necessary to better assess to what extent material and digitalized products are really different and, above all, if it is still advisable to have a plurality of different regimes applicable to items that, at the end, have the same content and the same function.  Without entering into further discussions, we point out that such a reconstruction does not necessarily mean that the supply of e.s.s. should be treated as a supply of goods.

Another important issue to mention regards the reform introduced by Directive 2008/8/EC, that will enter into force in 2015, for what concerns the ‘special scheme’ for EU-based companies and taxation at the rates applicable in the consumer’s Member State. The actual regime, as we said above, created the conditions for competition between EU countries, and apparently Luxembourg is the winner in this race, provided that it is convenient for many suppliers of e.s.s. to be established in this country for the very fact that B2C transactions are taxed in the supplier’s Member State, and Luxembourg offers attractively low VAT rates (the standard rate is 15%). As soon as the planned reform will be implemented in 2015, thus, the conditions for competition between European jurisdictions will not exist any more (or at least will be dramatically reduced), and, in more general terms, this could lead to a potential increase in the costs sustained by e-suppliers and final users. The way to create a European VAT system for e.s.s. which is enforceable and fully fair, both for companies and consumers, seems to be still long, and the reforms introduced by Directive 2008/8/EC, in particular, can be a very useful starting point for further discussion and analysis rather than the final harbour.

Finally, the last concern regards the notion of e.s.s. developed by the European lawmaker. In better terms, we can say that it is necessary to infer such a notion from the list of e.s.s. provided by (mainly) the VAT Directive, but it is evident that this list needs to be updated and must be, in the meantime, interpreted in an extensive way. If we take into account, for instance, the concept of “supply of online services automatically generated by a computer following specific data input by the user”, we see that the EC lawmaker refers in particular to ‘search engines’ and ‘Internet directories’ but the business and technological evolutions created many new scenarios that can be encompassed by the notion of “supply of online services etc” not only limited to search engines and directories. This is the case, for instance, of a distance service through a web-portal where the user has to input data in order to receive the service. The BEs furnish very good examples of this kind of supply of services and, in general, of e.s.s. not included in the list provided by the EC lawmaker and such cases clearly show that the distinction between e.s.s and services (and between services and goods) should be rethought at European level.

Income taxation: permanent establishment

The implementation of Grid technology is a challenge for lawyers and the fact that assessing the relation between tax law and Grid is absolutely pioneering makes it even more interesting and fascinating. We can summarise the analysis carried on in the Project by saying that the actual OECD position, expressed in the Commentary on Article 5, as regards the link between servers and PE is a barrier for ICT companies that are willing to set up international Grids. In particular, if such approach is followed by national tax authorities (as it is in many cases) it implies practical problems like, for instance, the calculation of the portion of profit generated by every component. In other words, undertakings have to face an increase of costs and the risk of litigation with tax departments.

This danger is not really mitigated if we assume that the activities performed by every element of the international Grid are preparatory or auxiliary in connection with the overall performance of the Grid. Apart from technical considerations, it would be probably very cumbersome for the taxpayer to give the evidence of it, and in any case the proceedings will be costly and risky for the Grid company. The overall conclusion is that the most consistent and correct solution is the exclusion of servers from the notion of PE, or, more radically, that the PE concept “in general is no longer useful in the era of information.”

ICT firms do nevertheless have to face the actual reality and the fact that the OECD findings are widely followed by national tax authorities. They have the possibility in any case to choose the locations of the components of their international Grid and to take advantage of the tax competition between jurisdictions. The UK and Estonia, for instance, are in a good position to attract foreign companies, the former because it does not consider servers to be permanent establishments, the latter for the very fact that the profits reinvested in the country are not taxed.

From a broader perspective, then, policymakers should re-think the concept of PE and adapt it to the actual technological development, in order to find ICT-oriented solutions that nevertheless respect the principle of non-discrimination between traditional and electronic business. At the same time, new solutions have to be found in order to avoid that companies, as explained above, exploit the ‘volatility’ and potential of technology to elude any sort of income taxation.

It seems that the BEs are only to a certain extent affected by the above issues, for the very fact that the majority of the technology providers located their Grids in only one country. Nevertheless, many other partners of the project, especially some major ICT companies, should be definitely concerned with the tax treatment of their international Grids and Grid components. From a general point of view, then, if we believe that Grid technology will prove to be successful, a growing number of technology providers will increase the size of the resources and will set up international Grids. This is already the case in point in the banking and financial sector, but it is expectable that also other business areas will be affected by this trend.