While much of the focus has remained on the efforts of the Organisation for Economic Cooperation and Development (OECD) with respect to digital taxation, the United Nations (UN) has finalized revisions to the UN Model Double Taxation Convention (UN Tax Treaty) that would specifically address the taxation of “automated digital services.” On April 20, 2021, the UN approved the final version of new Article 12B of the UN Tax Treaty, Income from Automated Digital Services. Generally, the approach taken by Article 12B is to permit a withholding tax on gross payments for “automated digital services” made by a resident of one treaty country to a resident of the other treaty country. In order to eliminate the withholding, the recipient can declare a permanent establishment in the payor jurisdiction and instead be subject to tax on its net income from automated digital services. This approach represents a departure from traditional international tax principles applicable to income from the performance of services, which allocate taxing rights to the jurisdiction where the services are performed, rather than the jurisdiction where the recipient of such services is resident. Although Article 12B is not self-executing, it serves as a model for countries to consider in determining their approach to taxation of automated digital services, and may be considered in the context of future treaty negotiations.
As the question of the taxation of digital services has been debated within various countries and at the OECD, the UN Committee of Experts on International Cooperation in Tax Matters (UN Tax Committee) took up consideration of a digital services article in the UN Tax Treaty in 2018, releasing the first draft Article 12B in August 2020. The guiding principles of the UN Tax Committee’s work included avoiding both double taxation and non-taxation, with a preference for taxation of digital services income on a net basis where practicable. The UN Tax Committee also was focused on simplicity and administrability.
In preparing the final Article 12B, the UN Tax Committee consulted the work of the OECD, EU, and African Tax Administration Forum, among others.
Final Article 12B
Under Article 12B, “[i]ncome from automated digital services arising in a Contracting State, underlying payments for which are made to a resident of the other Contracting State, may be taxed in that other State;” however, the rate of tax that may be imposed on such income is generally limited to an agreed percentage of the gross amount of the payment.1 In other words, Article 12B contemplates that a Contracting State may subject income from automated digital services paid to a non-resident of such Contracting State to a withholding tax, subject to a rate limitation to be agreed between Contracting States. The UN Tax Committee recommended a “modest” rate of between 3 and 4 percent for income from such services.2
Article 12B contemplates that, in lieu of withholding, the beneficial owner of income from automated digital services can request that its “qualified profits” from automated digital services be taxed at the rate provided under the domestic laws of the Contracting State.3 In effect, this is designed to permit the beneficial owner of the automated digital services income to declare a limited permanent establishment in the jurisdiction where the payer is located in order to be subject to tax on such income at a net income basis.4 Specific rules are provided for determining the amount of “qualified profits” from automated digital services income by applying the overall (or ADS segment where available) profitability ratio of the beneficial owner (or its group where relevant) to the gross amounts.5
|Eversheds Sutherland Observation: This alternative provides relief for taxpayers that may be subject to a lower tax liability on a net basis, but does not provide any mechanisms for a more localized calculation…|