Challenges in taxing the digital economy

In recent years, the digital economy has experienced remarkable growth, with the rapid expansion of sectors like e-commerce and online service platforms. Online shopping and digital services have become essential elements of modern life, driven largely by the convenience and time-savings they offer. In the Philippines, many prefer online shopping over visiting malls to avoid the heavy traffic, which is a waste of time for many. This trend has also allowed many Filipinos, especially small business owners, to earn additional income as affiliates of online shopping platforms.

However, the rapid expansion of the digital economy has posed significant challenges for governments and tax authorities, particularly in ensuring that revenues from digital transactions are properly reported and taxed. As businesses increasingly operate online and digital services become an integral part of daily life, traditional tax frameworks are struggling to keep pace with this transformation. This article explores the challenges of taxing the digital economy and the initiatives of the Philippine government to address these challenges.

Here are some challenges encountered by tax authorities:

Jurisdictional issues: Determining where businesses should pay taxes is one of the most significant challenges. Traditional tax rules are based on concepts like “permanent establishment” (i.e., a physical presence) and “source of income.” However, digital businesses often lack a physical presence in many of the countries where they earn revenue. This creates confusion about which country has the right to tax the business and whether a country can tax a company that does not have offices or stores there.

Cross-border transactions: The digital economy relies on transactions occurring across different countries, with goods and services easily moving from one place to another. Because these transactions are global, it becomes difficult for countries to collect taxes, especially when tax rates and enforcement rules vary from one country to another. This highlights the need for countries to work together and create common rules for taxing digital transactions.

Intangible assets: Many digital businesses rely on things like software, user data and intellectual property, known as intangible assets. Unlike physical items, which are easier to value and tax, these intangible assets are harder to measure and tax correctly. This has led to discussions about how to fairly assign profits from these assets to the countries where they are created.

In response to these challenges, the Philippine government has taken steps to integrate digital taxation into tax reform initiatives. The Bureau of Internal Revenue (BIR) released Revenue Memorandum Circular (RMC) 60-2020 to remind individuals earning income through digital platforms to ensure their businesses are properly registered. In addition, the BIR clarified the proper tax treatment of cross-border services by issuing Revenue Memorandum Circular (RMC) 5-2024, as further clarified by 38-2024. Recently, President Marcos signed into law Republic Act (RA) 12023 or the Value-Added Tax (VAT) on Digital Services Law, which imposes a 12 percent VAT on digital service providers.

The growth of the digital economy has reshaped how businesses operate and how governments approach taxation. While taxing digital businesses, especially those without a physical location, presents considerable challenges, these hurdles can be addressed through innovative policies and international cooperation.

For businesses, staying informed and adapting to new tax regulations is crucial to maintaining compliance and competitiveness in an evolving global market. The Philippine government’s initiatives demonstrate its commitment to creating a fair and effective tax framework for the digital economy, balancing the need for revenue with the realities of the digital age.

Joseph Valenzuela is an Associate from the Tax Group of R.G. Manabat & Co., a Philippine partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The firm has been recognized as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review. For more information, you may reach out to Joseph Valenzuela or Manuel Salvador III through [email protected], social media or visit www.home.kpmg/ph.