The UN Committee of Experts on International Cooperation in Tax Matters has issued the draft provision and its Commentary in accordance with the outcomes of the 20th session of the Committee, concerning the drafting of a provision that would allow the source taxation of income from the rendering of automated digital services.
Article 12B was added to the United Nations Model Convention in 20XX to allow a Contracting State to tax income from certain digital services paid to a resident of the other Contracting State on a gross basis at the rate negotiated bilaterally.
Under this Article, a Contracting State is entitled to tax payments for automated digital services if the income is paid by a resident of that State or by a non-resident with a permanent establishment or fixed base in that State and the payments are borne by the permanent establishment or fixed base.
Income from automated digital services are defined to mean payments for services provided on the internet or an electronic network requiring minimal human involvement from the service provider. Until the addition of Article 12B, income from automated digital services, derived by an enterprise of a Contracting State was taxable exclusively by the State in which the enterprise was resident unless the enterprise carried on business through a permanent establishment in the other State (the source State) or provided professional or independent personal services through a fixed base in the source State.
Before the introduction of Article 12B, countries were faced with more restrictive rules of application when digital services were provided cross border. In general, the rules under Article 7, together with Article 5, and Article 14 of the United Nations Model Convention give limited scope for taxing income from such services, in particular without a fixed base or permanent establishment in the State of source. As noted in these Commentaries, countries have different interpretations of those rules, which can make their application difficult for all parties.
Income from automated digital services arising in one Contracting State and paid to a resident of the other Contracting State may be taxed in the other Contracting State. It does not, however, provide that such income is taxable exclusively by the State of residence.
The expression “income from automated digital services” means any “payment” in consideration for any service provided on the internet or an electronic network requiring minimal human involvement from the service provider. The term “payment” has a broad meaning consistent with the meaning of the related term “paid” in Articles 10 and 11. The concept of payment means the fulfilment of the obligation to put funds at the disposal of the service provider in the manner required by contract or custom.
Article 12B deals only with income from automated digital services arising in a Contracting State and paid to a resident of the other Contracting State. It does not, therefore, apply to income from services arising in a third State. Paragraph 6 and paragraph 7 specify when income from automated digital services are deemed to arise in a Contracting State and deemed not to arise in a Contracting State, respectively. However, unlike Articles 10 and 11, which do not apply to dividends paid by a company resident in a third State or interest arising in a third State, Article 12B applies to income from automated digital services paid by a resident of a Contracting State or a third State that are borne by a permanent establishment or fixed base that the resident has in the other Contracting State.
The Contracting State in which income from automated digital services arise may tax those payments in accordance with the provisions of its domestic law. However, if the beneficial owner of the income is a resident of the other Contracting State, the amount of tax imposed by the State in which the income from automated digital services arises may not exceed a maximum of percent of the gross amount of the payments, as may be negotiated.
The term “beneficial owner” is therefore not used in a narrow technical sense (such as the meaning that it has under the trust law of many common law countries1), rather, it should be understood in its context, in particular in relation to the words “paid to a resident”, and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.
The beneficial owner of the income from automated digital services the option to be taxed on its qualified profits for a net basis annual taxation, as against the withholding mechanism provided for in paragraph 2. According to this paragraph, the beneficial owner of the income may request the Contracting State where the income arises to be subject to taxation on its qualified profits. This option would provide relief in those cases where the taxpayer may have a lower tax liability than the liability determined as per the withholding tax mechanism as also in cases where it has a global business loss or a loss in the relevant business segment during the taxable year.
A service is regarded as automated when the user is able to make use of service because of equipment and systems being in place, which allow the user to obtain the service automatically, as opposed to requiring a bespoke interaction with the supplier to provide the service. In determining whether a service requires minimal human involvement, the test only looks to the supplier of service, without regard to any human involvement on the side of the user. Furthermore, the definition focuses on provision of service and therefore does not include human interventions in creating or supporting or maintaining the system needed for provision of service. The threshold of minimal human intervention would not be crossed where the provision of service to new users involves very limited human response to individual user requests. An important indicator of the concept of automated is whether there is ability to scale up and provide the same type of service to new users with minimal human involvement. In other words, once the service offering of an automated digital business is developed (such as music catalogue or social media platform), then the business can provide that service to one user, or to many more, on an automated basis with the same basic business processes. On other hand, a non-automated digital business would see a proportionate increase in per unit costs in connection with providing the services to new customers.
On the general principles the services are considered to be automated digital services namely Online advertising services; Online intermediation platform services; Social media services; Digital content services; Cloud computing services; Sale or other alienation of user data; and Standardised online teaching services.
The provisions of Article 12B do not apply to income from automated digital services if the person who provides the services has a permanent establishment or fixed base in the State in which the income arises and the income is effectively connected with that permanent establishment or fixed base.
Thus, if a resident of one Contracting State provides automated digital services through a permanent establishment or fixed base located in the other Contracting State, the payment received for those services will be taxable by the State in which the permanent establishment or fixed base is located in accordance with Article 7 or Article 14, rather than in accordance with Article 12B.
The restrictions are imposed on the operation of the provisions concerning the taxation of income from automated digital services in cases where, by reason of a special relationship between the payer and the beneficial owner of the income or between both of them and some other person, the amount of the payments paid exceeds the amount that would have been agreed upon by the payer and the beneficial owner if they had stipulated at arm’s length. Paragraph 8 provides that in such a case the provisions of the Article apply only to the last-mentioned amount and the excess part of the payments for automated digital services would remain taxable according to the laws of the two Contracting States, due regard being had to the other provisions of the Convention.
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