The accelerated digital transformation of the global economy has deeply affected tax systems. Traditional taxation models, designed for physical economies, face significant limitations when taxing highly delocalized and intangible-based digital activities. In this context, CIAT (Centro Interamericano de Administraciones Tributarias – Inter-American Center of Tax Administrations) countries have been evaluating and implementing structural reforms, along with multilateral initiatives, to ensure a fairer distribution of the tax base and reduce tax erosion risks.
1. Effects of the Digital Economy on the Tax Base
Digital multinational companies operate in several jurisdictions without a substantial physical presence. It complicates the application of the principle of tax liability based on physical presence, a pillar of the current international system. Value increases through intangible assets-such as intellectual property, algorithms, databases, and brands-which can easily be located in low-tax jurisdictions.
Digitalization has increased profit shifting, affecting tax collection in countries where economic value is actually generated. This situation strains the Arm’s Length Principle and the allocation of profits among related parties.
2. Evolution of International Standards: The Inclusive Framework and Pillars 1 and 2
In response to these challenges, the OECD and the G20 have promoted the Inclusive Framework on BEPS, which currently gathers more than 140 jurisdictions. Two central proposals emerge from this framework:
- Pillar 1 redesigns the nexus and profit attribution rules to partially tax the residual profits of large digital multinational groups in markets where their users are located, even if they are physically absent.
- Pillar 2 establishes a global minimum tax of 15% on the profits of large multinational groups, intending to discourage harmful tax competition.
These changes represent a break with the physical presence paradigm and require tax administrations to adapt their regulatory frameworks, auditing systems, and technical capabilities.
3. Transfer Pricing Implications
The Transfer Pricing (TP) system is at the center of this transformation. Traditionally, transfer prices are based on related-party transactions comparable to independent-party transactions. Conversely, in the digital economy:
- Comparability is limited, as many digital models have no independent equivalents.
- Value is largely generated by unique intangibles that are difficult to value.
- Functions, assets, and risks focus on jurisdictions other than where sales are made or end-users are located.
Thus, it is necessary to strengthen functional analyses, employ profit-based methods, and consider alternative income allocation criteria, completing or even replacing traditional approaches.
4. Tax Administration’s Role
The CIAT study emphasizes the lack of enhancement of the institutional and technological capacities of tax administrations to address these challenges. Among the main actions are:
- Implement risk analysis and big data platforms to identify aggressive tax planning schemes.
- Promote automatic information exchange and international cooperation.
- Develop specialized teams in the digital economy and Transfer Pricing, with multidisciplinary profiles.
- Establish preventive mechanisms such as Advance Pricing Agreements (APAs) to provide legal certainty to taxpayers and reduce disputes.
5. Outlook for Latin America
Latin American countries face the challenge of adapting their legal and institutional frameworks to international standards, as well as their economic and administrative particularities. Gaps in technical capacity, information shortages, and human resource limitations persist.
The CIAT proposes moving forward in a coordinated manner, promoting harmonized regional frameworks, sharing best practices, and strengthening technical assistance among member administrations, which would increase the effectiveness of digital transaction monitoring and ensure adequate tax collection in the region.
Conclusions
The digital economy has highlighted the limitations of the international tax system based on physical presence, requiring a thorough regulatory and operational transformation. Transfer Pricing is crucial to this process, and its adaptation is critical to prevent tax base erosion and ensure fair distribution of taxation.
The conclusive implementation of Pillars 1 and 2, along with the strengthening of tax administration capacities, will be decisive in addressing the challenges posed by this new global scenario. Multinational companies must anticipate these changes, review their Transfer Pricing policies, and ensure compliance with the current international standards.
Source: CIAT