Taxation of the digital and global economy
After years of negotiations, the international community has agreed to reform the international tax system. As of 2023, part of the profits of the largest multinational groups should be redistributed to the countries where their goods and services are sold. Multinational groups will be subject to a global minimum tax of 15%.
Shortcomings of the permanent establishment concept
The current method of taxation of cross-border activities in terms of income tax is based on the concept of the so-called permanent establishment. A foreign company is obliged to pay tax on its profits in the Czech Republic only if it establishes a permanent establishment in the Czech Republic to carry out its business. Simply put, a permanent establishment includes a fixed base for carrying on business (e.g. an office), a construction project, a dependent agent, or the provision of services for a certain period of time in the Czech Republic.
The concept of a permanent establishment originated about 100 years ago and has not changed significantly since then. The concept is based on the principle of taxation of physical presence, which is an inappropriate model for the taxation of the digital economy where services can be provided and goods sold without a physical presence in the jurisdiction. This leads to distortions of competition and lower tax levies in countries where the company does not have a taxable entity.
In recent years, therefore, various proposals have been discussed at OECD, EU and national levels to address this unsatisfactory situation. One possible long-term solution has been to extend the definition of a permanent establishment to include a significant digital presence. However, this solution has not been agreed upon by individual countries and would require renegotiation of double taxation treaties, which would be difficult and time-consuming in practice.
As a short-term solution, some countries have proposed and, in some cases, also introduced digital taxes in various forms. In 2019, the government proposed a digital services tax in the Czech Republic of 7% on revenues from selected internet services provided in the Czech Republic. It was to apply to companies with an annual global turnover of more than EUR 750 million and a turnover of more than CZK 100 million made in the Czech Republic. The tax was not approved by the Chamber of Deputies at the end of last year. The current government, according to its representatives, has no plans to pursue the taxation of digital services solely at the level of the Czech Republic.
New rules for international taxation - from 2023
In October 2021, the OECD issued a statement publishing a draft timetable for the implementation of a two-pillar system to address the tax challenges arising from the digitalisation and globalisation of the economy. The agreement has been endorsed by 136 jurisdictions (all key OECD and G20 countries, including the Czech Republic). It is therefore a global solution.
The measures will redistribute profits of more than USD 125 billion from around 100 of the largest and most profitable multinational groups to countries around the world. In addition, a tax of at least 15% will be introduced globally. The new rules will also apply to multinational groups outside the digital economy. A public consultation on the proposals is currently underway.
- Pillar 1 - redistribution of profits
Under Pillar 1, part of the profits will be redistributed from the home country of the multinational group to the countries where the business activities are carried out, regardless of physical presence in those countries.
The rule should affect about 100 of the largest multinationals, i.e. companies with a global turnover exceeding EUR 20 billion and a profitability exceeding 10%.
The new rules will be implemented by a multilateral agreement that will amend existing double taxation treaties, with an expected effective date as early as 2023. At the same time, the parties to the agreement have committed not to apply any local digital taxes.
- Pillar 2 - global minimum tax of 15%
The second pillar introduces a global minimum effective tax rate of 15%. The measure will apply to multinational groups with a turnover of more than EUR 750 million. Within the EU, the rules will be implemented by a Directive, with expected effect from 2023.
The Czech Republic is likely to benefit from Pillar 1 by becoming eligible to tax profits from sales of goods and services in the Czech Republic by large multinational groups. Czech companies that are part of multinational groups with a turnover of over EUR 750 million would likely have to ascertain their effective tax rate if this reform were to be adopted and could be subject to additional taxation if it is lower than 15% (e.g. due to tax deductions, exempt income, tax rebates on investment incentives, etc.).