Challenges of the U.S. and Mexico tax systems with regards to the cross-border digital economy

Dra. Lillian Sumi Imaoka

Mex Co.Mexican Suppliers

Mexican Customers

Mex Co. is a Mexican Project Management Company with industry-specific sales.

Dividend

Assets

Services

Related Party Country B

Related Party Country C

Related Party Country D

Related Party Country ADutch.com

Services and equipment

Antilles Holding

Netherlands

Other countries

Netherlands Antilles

Services

Mexico

For Tax Administrations Digital Economyis not a single-industry challenge

Mex Co.

Dividend

Dutch.com

Antilles Holding

Netherlands

Other countries

Netherlands Antilles

Mexico

Dividend payment

Royalty/Services payment

The compensation agreed in the intercompany transaction is an initial subscription payment per user, and a fixed fee per click or download of online information:- Intellectual property $$$- Services / Technical Assistance $S- Training $

However, the content is available online is not entirely developed by Dutch.com

Dutch.com

Know-how

Local Adapt.

IP, Technical info.

Know-how

Technical Assistance

Online platform

develop. & maintenance

Information and

experience gathering /

storage

Data analysis and

classif.

Training

Dutch.com offers users (related parties exclusively) access to an online platform with technicalinformation useful globally to any operative company within the Multinational Group, including:• Intellectual property.• Know-how based on previous experiences from any operative company.• Technical assistance.This information is constantly updated with users’ experiences (operative companies).

Operative CompanyAvailable to

Update or Input of new data

Dutch.com Functions / Activities

Tax Administration’s ChallengesRegardless of the industry, Tax Administrations face BEPS issuescaused by Digital Economies singularities:

Permanent Establishment

• Is there significant economic presence?

• Revenues• Interaction with users

Characterization of payments

• Services (Art. 7 business profits).

• Know-how, IP (Art. 12 royalties)

• Software license• Database user

access• A combination?

Functional/DEMPEAnalysis

• Creating value in the intercompany transaction:

• Users experience• Online platform• Gathering/storage

functions• Data analysis and

classification• Know-how development

• How to attribute value?

Taxation challenges on Digital EconomyGabriela Pellón, Galicia Abogados, S.C.Edgar Klee, Haynes & BooneRaúl Navarro, Chevez, Ruiz, Zamarripa y Cía., S.C.Moderator: Raúl Villarreal Garza, Procopio

The digital World is perceived differently…

The World’s biggest 

transportation 

company

Hasn’t got any 

vehicles

The World’s 

biggest media 

company…

Doesn’t create 

content

The World’s most 

valuable retail 

company…

Doesnt’s have any 

stock

The World’s biggest 

lodging company… 

Doesn’t own real 

estate

The videoconference 

company with the 

widest reach…

Doesn’t have 

telecomm 

infrastructure

Digital businesses and its characteristics

• Multinational presence without physical presence. Digital businessmodels enable companies to have economic presence in severalcountries without the need to have any physical presence on them.

• Reliance on intangible assets (Including intellectual property rights“IP”). Digital business models invest and rely heavily on intangibleassets, such as brands, patents, software or code property rights,copyrights.

• Data, user participation and synergy created with IP rights. Digitalbusiness models might rely on the interactions that their usersmaintain between them and the information shared by such usersthrough a given platform.

Digital businesses’ characteristics

1. E-commerce

Products and content

providers

Product sale(B2B)

Product re-sale

(B2B)Customers

Product price / fees for access to content.

$

$

2. Multilateral platforms

Controlled transaction

User / Provider User / Customer

• Promote the network• Customer management• Intermediary services implementation• Platform maintenance

• Fee payments• Advertisement fees• Data collection

3. Vertical growth in digital businesses

• Digital businesses generate their own production chain.

• Example: Amazon (Warehouses and storage), Netflix(original productions).

Commercializingcompany

End customers

One Company, several business lines

• Digital economy is characterized by its dynamism and flexibility. Companiescan easily create new business lines.

• New business lines = new value creation models, new legal relationshipsand income sources = new tax consequences. Example (Amazon):

Provider

Final Customer

CommercializingCompany (reseller)

Intermediary(Source State)

Sale Resale

Sale

FeeServices consideration

Multilateral business(network)

E-commerce

Vertical Growth

Digital Economy Taxation-

Legal Framework

Applicable framework - Mexico• Income Tax Law

• OECD transfer pricing guidelines.

• Value Added Tax Law

• Digital Services Tax Law Bill

• Double Taxation Treaties’ framework• OECD Model Tax Convention• Commentaries on the OECD Model Tax Convention• Multilateral Instrument - Action 15 BEPS

International Background

Technical Advisory Group (TAG) reports

OECD (2000-2001)

Action 1 Final Report – Digital Economy Tax Challenges(Oct 2015)

OECD international guidelines on

VAT and sales taxes

(Dec 2015)

Unilateral taxation

measures on Digital Economy

emerge 2015 (India, UK, Italy)

OECD interim report published

– Taxation challenges on the economy digitalization. (Mar 2018)

European Union’s

Directives issue proposals for the to tax the

Digital Economy(Mar 2018)

Multilateral instrument to adopt preventive measures as regards to BEPS (Action 15)

Relevant aspects of the Digital Economy

1. Permanent Establishment

2. Tax Havens

3. Transfer Pricing

4. Payments characterization

5. Value Added Tax

1. Permanent EstablishmentSales Co(Ireland)

Subsidiary Co(Mexico)

• Local marketing and productpromotion

• Interaction with customers• Significant negotiating role

• Software location• Transactions proccesing• Marketing strategy

Payments (i.e. $100)

Services payment (i.e. $10)

Customers(Mexico)

1. Permanent Establishment – Dependent Agent

Income Tax Law – Article 2

Article 5 of the Tax Treaties under the OECD Multilateral Instrument

Execute contracts in name and on behalf of the foreign

resident for tax purposes

Habitually executes contracts or habitually

develops a substantial role in the execution of such contracts without being

modified by the company

2. Tax Havens – Patent Boxes

Holding Co(Spain)

Patent Box Co(Switzerland)

• Mantains owners, technical people and developers• Charges fee for development to the Patent Box Co

(costs+markup)• Pays general corporate income tax (25%)

• Hires development services from Holding Co• Legally owns the software• Charges to Clients around the World• Pays taxes at a preferential rate (7%‐8%)

Service fee payment(costs+markup)

Pays royalties

• Software users at global scale• Where the software is “standardized – off

the shelf”, there is no tax withholding onroyalties’ payments

2. Tax Havens – Mexico’s Test

¿Is Patent Box Co a tax haven?

• Tangible goods commercialized out of Switzerland

• Services rendering from within Switzerland

• Services rendering out of Switzerland

• Services rendering through a digital platform (SaaS)

Passive income test

SI

NO

SI

?

Holding Co(Mexico)

Patent Box Co(Switzerland)

Pays Service fee

Pays royalties

• 20%+ of net income comes from passive acitivies  = Tax haven

• Where income is originated from services or goods sold out of residence country = passive income

3. Transfer Pricing

Patent Box Co(Switzerland)

• Is the owner of the software• Licenses the software to a distributor in Colombia• Pays taxes at a preferential rate (7%‐8%)

Low risk distributor(Colombia)

• Pays licensing royalties (3% sobre ventas)• Sublicenses the software to Clients in Colombia• Develops local marketing activities• Promotes the platform to acquire new users• Pays general corporate income tax (33%)

End users/Clients(Colombia)

Royalties for the software licensing

Sublicensing royalties

3. Transfer Pricing1. BEPS actions’ 8, 9 and 10 main purpose is to align the transfer pricing results with the value

creation. This is achieved when the value attribution for tax purposes is consistent with theeconomic activity that generates such value.

2. The OECD Council approved changes to the Transfer Pricing Guidelines in March, 2016.

3. The income assessment regarding intangibles shall comprise the developed functions, usedassets and assumed risks in the following:

Development,

Improvement,

Maintenance,

Protection and

Exploitation of the intangible

4. Payments characterizationTransaction/operat

ionIT

Withholding Tax treaties Examples

Purchase/disposalof tangible and

intangible goods

No sourcedincome N/A

Services 25% ¿Business profits? 0%

Software 25% 10%-15% exceptwhen “standardized”

Publicidad 25% ¿Business profits? 0%

5. Value Added TaxOECD Recommendation VAT Law/ Customs’ Law / International Trade

RegulationsDestination principle

The intermediary shall be obliged to be registered as withholding agent

The importer is the legal and economic bearer of the VAT

Recommendation is aimed to simplify VAT registry (accountability) to foreign residents

1. Every taxpayer is obliged to have the same register.

2. PE presumption where an establishment is registered for VAT purposes.

Facilitate the imports VAT collection with the elimination of exemptions on low-cost products and collecting through post services and shipping companies

Exemption over low-cost goods (USD$300)(International Trade Regulation 3.7.1.-Exención sobre bienes de menor valor ($300 USD) (Reglas Generales de Comercio Exterior 3.7.1. – Merchandise shipping through postal services)

Data, data, data…

Customers (World)

Permanentestablishment

Tax Havens

Transfer Pricing

• Withholding at source

• VAT

?Digital value creation

Data, data, data…2007

Anyone who lives in Philadelphia, studies philosophy and has between 18 and 22 years

2009Anyone who lives in Philadelphia, studies

philosophy and has 21 years

2013Anyone who lives in Philadelphia, studies

philosophy, has 21 years and purchased a blue shirt within the last year.

2014Anyone who lives in Philadelphia, studies

philosophy, has 21 years, purchased a blue shirt within the last year and owns a pair of white shoes.

2016Anyone who lives in Philadelphia, studies philosophy, has 21 years, purchased

a blue shirt within the last year, owns a pair of white shoes, earns more than USD$20,000 and is passionate about cars.

Unilateral Measures to tax Digital Economy

Initial Positions (2014-2017)

Significant economicpresence

Special taxes Anti-avoidance measures for multinationals

Israel

India

India

Italia

Hungary

Diverted profits tax in UK (google tax)

BEAT in EUA

Directives Proposal – European UnionDirective Proposal.- Temporary tax on digital services:

Directive Proposal.- Digital Permanent Establishment:

3% tax rate over gross income obtained by a Company within the EU (regardless of its location), from the following activities:

• Online advertising;• The utilization of a web platform that allows

users to interact with each other, and can also facilitate the provision of goods and services between such users;

• Transmission of data collected from users and generated from the digital interaction of such users.

The tax is only applicable to entities whose gross income exceed the following thresholds:

• Global income = EUR 750 million; • EU income = More than EUR 50 million

Digital permanent establishment as a consequence of having a “significant digital presence”.

An entity has significant digital presence if at least one of the following conditions are met:

• The proportion of the total income in any given Fiscal year obtained from the provisionof digital services to users located within the member State exceeds EUR 7 million;

• The number of users that receive digital services within a member State in any given Fiscal year exceeds 100,000;

• The number of concluded contracts for the provision of digital services to users within a member State in any given fiscal year exceeds the amount of 3,000.

Measures in Mexico (Digital Services Tax Law Bill)

Proposed bill on digital taxation services in Mexico

3% tax rate over net income (deductible items are not specified) obtained by a Mexican resident or a foreign resident with a permanent establishment in Mexico (regardless of the place in which the are generated) from the following activities:

• Online advertising;• The utilization of a multilateral web platform that allows users to interact with each other, and

can also facilitate the provision of goods and services between such users;• Transmission of data collected from users and generated from the digital interaction of such

users.

The tax is only applicable to entities whose gross income exceed MXN$100’000,000 (USD$ 5’260,000)

Exempt activities:• Streaming content, communication and payment services;• Financial services; and• Data transmission by financial services providers.

Measures in America – Netflix, Uber Tax

Argentina – 21% VAT charged on users 

United States – 6% ‐ 9% State Tax

Brazil – 2% over gross income

Peru – 30% withholding on digital services