the digital economy: how to develop effective tax planning for your digital strategy

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The Digital Economy: How to

develop effective tax planning for

your digital strategy First in a series of three articles on the tax issues and tax opportunities associated with the digital

economy, internet of things, and data analytics.

The digital revolution affects nearly every aspect of our lives.

It impacts the way the world does business, both today and in

the future, and poses a number of challenges for decision

makers. This article explains how digital is impacting the

economy, its effect on the business enterprise, and, how your

tax strategy needs to align to your digital strategy to avoid

double taxation. In addition it outlines what action is required

to minimize tax risk and maximize tax opportunities in the

digital economy.

I. The Digital Economy

Technology – including the explosion of digital, data,

analytics, artificial intelligence, mobile, and cyber security –

impacts every business and every industry. Some people are

calling this time in history the fourth industrial revolution:

everywhere leaders are highlighting the impact of technology.

For example, John Chambers, Cisco Chief Executive stated,

“Every business is a digital business. The fact is, the heads of most big companies these days will tell you that they are really running big technology companies that happen to sell groceries or shoes or gas grills or professional services. Every company is a technology company.”1

The start of the 21st century began with transformational

change in the global culture and economy. Initially limited to

a few, the internet has become globally available to billions of

people every day through the use of smart phones, tablets and

other devices. Internet search engines have opened the door

to vast amounts of information. Business models have

changed; brick and mortar stores have been replaced by

business-to-consumer ecommerce companies like Netflix

selling streaming video and Amazon providing access to

products online which are shipped to your door. Digital is

1 Wall Street Journal – February 2015 2 Digital Economic Value Index, Accenture, January 2016

enabling and disrupting all industries, and companies everywhere are looking at digital strategies to succeed.

Experts expect the transformational change, caused by the

Digital Economy, to significantly increase over the next 10

years. Advancements in data collection, storage, and

computing technologies are leading more companies to

question, “How can I make my products smarter?” And

“How can I derive maximum value from the data my company has access to?”

A leading change agent is the Internet of Things (IoT), which

includes connected devices such as machines, household

appliances, and wearables that generate huge amounts of data.

If captured and mined, this “big” data will create the divide

between profitable, high-value businesses and those which go

down the path of the dinosaurs. Another critical change

agent is advancement in the use of advanced data analytics

(i.e. includes predictive, prescriptive, machine learning and

natural language processing) which permit decision makers to

mine the hay stack of big data for the small needle of good

data to make impactful decisions which can significantly drive

up revenue or drive down costs, leading to higher profits and, in turn, higher share value.

The impact of potential digital disruption to the global economy is illustrated by these key data points;

According to a recent Accenture study 25% of the

world’s economy will be digital by 20202;

Global flows of goods, services, and finance in 2012

equal 36% of global GDP. Digitization is

transforming all flows and is expanding

opportunities for smaller players to participate.3

A Gartner 2015 survey indicates that more than

75% of companies are investing or are planning to invest in big data in the next two years.4

3 McKinsey Global Institute, April 2014 4 Gartner survey September 16, 2015

As a result of digital disruption, companies need to ask and

understand “What business is my company in?” For example

are you a manufacturer of a product or a manufacturer of a product combined with the sale of advanced analytic services?

With so many new and emerging technologies, business

models, and customer preferences, every company needs to

stress test its business strategy to ensure it is targeting the

right customers, products, and services to maximize

opportunities aligned to their competitive advantage. In doing

so, a company’s C-suite should consider the following

questions as it assesses the impact of digital across the business enterprise and the resulting tax implications:

What is your company’s share of the 25% of GDP

of the global digital economy?

How is technology, such as connected devices and

data analytics, going to disrupt my company’s

products, services and value chains?

How will my company integrate effective tax

planning into its evolving business strategy?

II. Impact across the Business

Enterprise

Today we live in a world where social networking, mobile

devices, the cloud, big data, analytics, sensors and evolving

digital technologies are ubiquitous. The reality is digital

impacts the way businesses operate with customers, suppliers

and employees. Digital impacts the marketing, selling,

production and distribution of both products and services.

Digital impacts the way customers behave and interact with businesses.

A mere 20 years ago successful businesses focused on

seamless integration of their manufacturing, supply chain,

distribution and sales functions to create efficiency that drove

down costs and increased revenue. Overlapping this

traditional model business change was limited, to a large

degree, to a company’s ERP system. In many cases the functions of the company were not portable.

With today’s technology, research and development can be

successfully conducted from multiple locations using labour

savings in countries such as India and the Philippines.

Companies engaged in B2C ecommerce can rely on shipping

companies to supplement their distribution systems.

Marketing is no longer limited to a sales force on the ground

but is complemented by the internet which has national and global reach to new global markets.

In the next 10 years the digital economy will continue to

create new revenue streams. For example, data analytics

permits companies to drive external new revenue streams or increase sales. For example

a manufacturing company which sells machines in

the future will have those machines connected to

the internet and will, for a service fee, collect data

which will be converted using advanced analytics

into information the customer can use to determine

when and how to optimally maintain the machine

A well-known retailer has an app for smart phones

which remembers when customers come in their

store and what they have purchased. The customer

may plan to spend $100 but during the visit receives

coupons and reminders on things to buy. At the cash register $200 are spent.

In these business models the point of sale becomes blurred. Is the location for tax purposes where:

The consumer is?

The server with the software is located?

Where the data scientists providing the service is

located?

The impact of the digital economy is not limited to the B2C

or B2B space. The digital economy will also transform how

businesses operate. The overarching theme is that big data, if

captured and used effectively, will enable companies to work smarter, faster, and more efficiently.

For example, data analytics is impacting internal enterprise

functions, including the way businesses operate with

suppliers and employees, production and sales, and

distribution. Using the procurement function as an example,

based on working with customers to create procurement efficiencies we have seen the following results:

decrease procurement costs by 7%

decrease production costs by 10%

The next decade will see a significant increase in how digital

impacts the business enterprise in ways not currently imagined today

One lesson companies have learned is that their digital

business model will continue to change at a rapid pace (e.g.

think of how often you have updated your mobile phone and

the software that runs it and the related technological changes

over time). Successful companies will be those which embrace

and anticipate digital change and have the framework to

execute on a real time basis changes in their strategy. An

effective tax strategy will need to keep up with changes in the

business while at the same time deal with tax authorities

including a myriad of historical and ever changing tax laws and regulations.

III. Tax Strategy Alignment with Your

Digital Strategy

Developing effective tax planning requires alignment with

your digital strategy and flexibility to change the tax strategy

over time as your digital strategy changes. Your digital

strategy may include aspects related to mobile, social media,

cloud, data privacy and cyber security. You will need to

consider how your tax strategy needs to be modified to

consider each of these key business elements. To effectively

manage tax costs we recommend a holistic approach to

address global direct, indirect, withholding, and personnel taxes.

Tax Laws and Tax Authorities Struggle to Keep Pace with “Digital Disruption”: Taxpayer’s Risk

Countries and tax jurisdictions are hungry for revenue and are

seeking ways to increase revenue through direct and indirect

taxes. At the same time tax authorities and politicians are very

concerned about the digital world and getting their fair share

of taxes related to the digital economy profits enabled by

portable technology and information.

The Organization for Economic Co-operation and

Developments (OECD) best describes the environment as

"the digital economy is increasingly becoming the economy itself, it would

be dif f icult, if not impossible, to ring-fence the digital economy f rom the

rest of the economy for tax purposes." The OECD has

acknowledged that “the digital economy continues to develop, it is

important to continue working on these issues and to monitor

developments over time.” In recognition of the complex fluid

environment the OECD has recommended “A report reflecting

the outcome of the continued work in relation to the digital economy should be produced by 2020.”5

The pace of technology changes and the global political and

economic environment create ongoing tension between

certain and uncertain tax results, changing tax laws, and

regulations. Existing federal, state, and foreign tax laws were

typically not enacted to anticipate future technological

changes. However today, many tax authorities are changing,

or contemplating changing, tax laws in response to current

technological advances and entrepreneurial and corporate applications of technology.

All businesses, regardless of size, will continue to innovate in

developing new products and services and bring them into

the marketplace. Technology development is likely to

continue to outpace the ability of tax authorities to create tax legislation to address technology changes.

The tax risks and opportunities presented by the digital age

are illustrated by the fact that key tax issues may vary by type of tax and by tax jurisdiction.

5 OECD report issued October 5, 2015

IV. Tax Considerations to Avoid

Double Taxation

The direct and indirect tax issues a company engaged in the

digital world needs to analyse will depend on the country or

state it is located in, the countries or states it interacts with,

and whether its focus is intercompany or third party digital

transactions. The key tax factors to consider are:

Nexus to pay tax in the digital economy

Characterization of transaction: What did I sell?

Sourcing of revenue

Transfer Pricing and Base Erosion and Profit

Shifting (“BEPS”)

Merger and Acquisition tax implications

Value Added Tax (VAT)

Nexus to pay tax in the digital economy

Determining nexus to pay tax (i.e. also referred to as a

permanent establishment) in the digital economy continues to

evolve and requires ongoing analysis for companies to

develop effective tax planning. We recommend companies

review their tax digital footprint on a regular basis, at least

annually, and whenever there is a significant event such as a

merger or acquisition or a significant change in tax legislation

to update their tax planning. The starting point for effective

tax planning is having a good baseline of your tax digital

footprint and a process in place to update your tax footprint

for changes in your digital/business strategy, such as

expanding markets or development of new types of technology, etc.

Since digital is portable, there will be opportunities to

consider moving profitable digital activities to lower tax

jurisdictions as long as the move is driven by business

purpose and has substance. Even if the business is not ready

for international expansion, significant state and local tax

benefits can be achieved by effectively locating profitable

digital activities in optimum locations. Tax savings can be

achieved through minimizing tax rates, use of income

apportionment rules and or taking advantage of available credits.

Characterization: What Did I Sell?

The income stream of what you sell and its character for

direct and indirect taxes may vary, and it may be certain or

uncertain as to when the income is recognized. As new and

existing digital products and services are sold companies will

need to determine their character for tax purposes. Are you

selling goods, services, or rights to an intangible? This

distinction may be difficult for technology companies that are

providing software as a service (SaaS), platform as a service

(PaaS) and other “as a service” offerings since state and local,

federal and foreign tax authorities may seek to characterize

the digital transaction differently and often times seek a

characterization that results in tax being paid. A fundamental

tax planning question is whether you get the best tax result by

bundling (e.g. services vs product vs license) or unbundling

your digital offerings.

Sourcing of Revenue:

Sourcing, like characterization, has similar tax considerations

that determine the tax consequences. At times the sourcing

may not be certain given the evolution of digital revenue

streams, and there will be differences in how local, national,

and foreign tax authorities determine the appropriate sourcing.

Query – How is this transaction taxed for direct and indirect tax purposes?

The answer is this: it depends on the functions performed by

each of the companies and the laws of the countries or states in which the companies do business.

Transfer Pricing and BEPS

The OECD’s BEPS project addresses tax avoidance strategies

and mismatches in various tax rules to artificially shift profits

to low or no-tax locations. The import of substance in setting

up your global operations supported by appropriate transfer

pricing methodologies are key to integrating and executing an

effective tax strategy aligned to your digital strategy. State tax

jurisdictions have also increased their focus on transfer

pricing through the Multistate Tax Commission’s Arm’s-

Length Adjustment Service, a program to increase states

ability to audit intercompany transactions across state lines.

Further, an appropriate transfer pricing analysis can ensure

your company’s allocation of profits are in line with where value is created.

Merger and Acquisitions Tax Implications

The digital economy presents new opportunities and pitfalls

as companies seek to grow via mergers and acquisitions to

supplement their organic growth. In due diligence, buyers will

need to consider the nexus, characterization and sourcing of a

target’s digital business models to evaluate both the direct and

indirect tax risk associated with the acquisition. In addition, it

will be imperative that companies consider the planning

opportunities associated the acquisition structure, and post-acquisition integration.

Value Added Tax (VAT)

Virtually every major economy outside the United States has a

VAT or GST in place. Digital services are generally taxable

and indeed there is a growing trend to tax supplies of digital

services by non-resident businesses. While a business

customer is generally able to self-account for VAT/GST due,

under the reverse charge mechanism, many countries will

require a non-resident to register and charge VAT/GST on

digital services supplied to private consumers. There is often

a grey area in ascertaining the business status of the customer,

and there is generally a requirement for the supplier to

evidence this by obtaining and validating a VAT registration

number from the customer. Where a number is not held on file there is a risk of assessment from the tax authority.

Other complexities relating to VAT on digital services

include:

Evidence of customer location (e.g. the EU requires

two pieces of non-contradictory evidence such as IP

address and credit card address, to achieve safe-

harbour protection).

Selling through intermediaries such as marketplaces

/ app stores

validating VAT registration numbers in real-time

What action is required to avoid tax risk

and maximize tax opportunities in the

digital economy?

The digital future is rapidly evolving creating new ways for

companies to create revenue, decrease costs, and interact with

their customers, suppliers, and employees. We recommend

you proactively engage your tax advisor to:

Understand the value drivers of your digital strategy

and what legal entities own the value drivers and the

functions the entities perform

Review your digital footprint to identify exposures

for taxable nexus

Determine the character and sourcing of your digital

transactions.

Implement a tax strategy which supports your digital

strategy and identifies and mitigates tax risks and

recommends appropriate tax planning strategies to

optimize your digital strategy

Update your current tax strategy for changes in your

digital strategy and or for changes in tax laws in the

countries in which you operate.

Next Article in the Series

The second article in the series will explore the explosive

growth of the connected world “the internet of things” and the tax considerations of connected devices.

Who should I contact?

If you would like advice on any of the points covered in this

article, please contact:

Erich Pugh Randy Free

Minneapolis, US Irvine, US

T +612 677 5570 T +949 608 5311

E [email protected] E [email protected]

Doug Watson Martin Lambert

Minneapolis, US London, UK

T +612 677 5220 T +44 (0)20 7383 5100


Joseph Coniker Elizabeth Hughes

Raleigh, US London, UK

T +919 881 5893 T +44 (0)207 728 3214


Connect with us

gran ttho rn ton . co m

@grantthorntonus

linkd.in/grantthorntonus

mailto:[email protected]


Grant Thornton Global Digital Economy, IoT

& Data Analytics Tax Team

GT Data Analytics

Joseph Coniker Shannon Kreps

Raleigh, US Raleigh, US

T +919 881 5893 T + 919 633 4385


Richard Cline

Charlotte, US

T +980 282 1980

E [email protected]

GT Strategy and Performance Improv ement

Chris Smith Luke Ekhoff

Bellevue, US Bellevue, US

T +425 214 9820 T +425 214 9861


Elliot Savoie Tim Michaels

Minneapolis, US Minneapolis, US

T +612 677 5104 T +612 677 5479

E ell [email protected] E [email protected]

GT Technology Solutions

Chris Unruh John Stilwell

Overland Park, US Overland Park, US

T +913 2762 2723 T +913 272 2721


GT Transfer Pricing

Nick Scott Liz Hughes


T +612 677 5220 T +44 (0)207 728 3214

E [email protected] E: [email protected]

Matt Piper

Minneapolis, US

T +612 677 5377

E [email protected]

GT International Tax

Erich Pugh Randy Free

Minneapolis, US Irvine, US

T +612 677 5570 T +949 608 5311


Doug Watson Stephan Baumann

Minneapolis, US Zurich, SW

T +612 677 5220 T +41 43 960 71 04


Doug Wood Peter Vale

Raleigh, US Dublin, IR

T +704 632 6837 T +353 (0)1 6805 952

[email protected] E [email protected]

Martin Lambert Onno Backx

London, UK Rotterdam, NL

T +44 (0)20 7383 5100 T +31 (0)1 886 769 376


Jennifer Zins Kyle Brandon

Minneapolis, US Minneapolis, US

T +612 677 5226 T +612 677 5269


GT Industry Teams

Steve Perkins

Alexandria, US

T +703 637 2830

E [email protected]

GT Indirect Tax

Bill Lunka Alex Baulf


T +612 677 5220 T +44 (0)20 7728 2863

















the digital economy: how to develop effective tax planning for your digital strategy

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