1. AI and data mining as catalysts for taxing authorities
Governments worldwide have accumulated vast quantities of data since the introduction of tax information exchange frameworks (2010-2016). Tax authorities are investing in sophisticated data mining infrastructure to help them in their analyses. For instance, the Internal Revenue Service (IRS) is expected to inject $80 billion toward technological enhancements and data mining deployments aimed at refining tax audit processes. Tax authorities will be using artificial intelligence (AI) and data mining tools to analyze information, identify trends, and focus on variances, all to be easily flagged for tax authority scrutiny.
With the expectation of exponential productivity growth coming from AI, taxing authorities are expected to continue to adapt their policies and enforcement priorities resulting in a disproportionate burden on TMT companies.
State taxes in the U.S. are a model for this trend. For example, in its 2018 decision, the Supreme Court ruled in South Dakota v. Wayfair that state taxing jurisdictions could impose their indirect taxing schemes on remote companies based solely on so-called economic nexus. Over the six-year history since that decision, states have imposed additional rules on third-party software as a service (SaaS) platforms that provide a marketplace for buyers and sellers requiring those platforms to collect and remit sales tax on behalf of buyers and sellers. State tax enforcement naturally flows to the companies that have the technology and data. Furthermore, the Multistate Tax Commission has published pronouncements stating that mere interactions between remote buyers and sellers constitute a physical presence by the seller in the buyer’s jurisdiction, opening the doors for direct taxation based solely on digital interactions.
2. Global collaboration for information transparency
As borderless digital economies emerge, the call for international cooperation (through tax information exchange agreements) – in addition to state tax visibility – becomes more resonant for information sharing. The U.S. has established more than 100 agreements for sharing tax information with other nations since the enactment of the Foreign Account Tax Compliance Act (FATCA) in 2010.
These cooperative efforts signal a new level of transparency in a global tax environment. They also mean TMT companies with multinational operations have to monitor their data and reporting more rigorously to comply with sophisticated, international tax protocols.
TMT companies need to understand how their revenue footprint and corresponding tax obligations can be affected by taxing authorities that are now shaping their policies and enforcement activities in a targeted manner to find and tax companies that are deriving revenue from digital activity.
With these potential changes regarding global tax policy and enforcement, it is critical for TMT companies to be prepared for increased and targeted scrutiny from taxing jurisdictions in addition to the potential for balance sheet impact that might come from unexpected tax exposure.
3. The renewed focus on transfer pricing
In a connected economy, where transactions have become increasingly global, transfer pricing – the pricing of goods, services, and intangibles transferred within a multinational group – has become a critical element of global taxation.
Understanding the geographical dispersion of assets and making strategic decisions about operations and risk requirements could mean the difference between tax efficiency and compliance and penalties. However, existing transfer pricing models are grappling with the complexities of always-on global operations, necessitating new and innovative adaptations. Traditional transfer pricing models are becoming outdated as tax authorities look at either unspecified methods or methods based on profit splits to ensure arm’s-length remuneration for all parties to the transaction.
4. Rethinking tax models from the cloud
With the rapid evolution of financial technology (fintech) and shifting market forces brought on by AI, TMT companies must strongly consider how their global footprint will be accessed and measured by global taxing authorities. Jurisdictions that are transparent and clear with their taxing policies will become more attractive to TMT companies that are now making decisions related to where:
- Data should be housed
- Assets can be located
- Contracts should be negotiated and by which contracting entity
The taxing jurisdictions that can reduce ambiguity and provide some level of future assurance that allows TMT companies to factor direct and indirect taxes in their financial models will become more attractive.
5. How taxing schemes will adapt to AI for indirect taxes
Indirect taxes often are imposed upon transactions, and factors affecting the tax could include the amount of consideration given, the nature of the transaction, the location where the transaction takes place, and the location where the benefit is received. Sales and use taxes in the U.S., for example, typically are imposed on sales of tangible personal property and certain enumerated taxable services as defined by each jurisdiction. While each taxing jurisdiction is unique, there are common historical trends on which companies have relied. For example, in most states, professional services are not subject to tax. A very small percentage of lawyers, accountants, and engineers need to collect sales tax in the U.S.
Alternatively, a growing number of states are taxing services performed over the cloud. SaaS companies that have faced state audits or scrutiny from third parties as part of due diligence know well how aggressive states have become in taxing even the most elegant applications. As professional service providers and their customers continue to rely more heavily on AI, it is unknown what impact this will have on historic taxing models. When is a lawyer a lawyer and when is a lawyer AI? Who gets to decide?
States already have started to push the envelope, and companies that are on the cutting edge of using technology to effectively deliver their services are being asked to prove that they are a professional service provider as opposed to a seller of software applications. Sales tax has been referred to as a form-over-substance tax, for which, in many cases, even when a transaction is obviously exempt from tax in substance (sales for resale), tax will be assessed upon audit based on form (missing resale certificate). With this in mind, TMT companies need to strongly consider both the form and substance of their activities and how they will be interpreted by taxing authorities. It will be important to clearly define the nature of services being provided and document the essence of transactions to successfully prevail against taxing authorities that seem to be rapidly changing the rules.
Conclusion
Decisions made today by multinational TMT companies will determine the success stories of tomorrow. For those focused on success, the ability to manage ambiguities and anticipate how taxing jurisdictions might adapt to a rapidly changing environment will be critical. TMT companies must work closely with their legal and tax advisers to factor potential tax outcomes for their business and economic models. Anticipating potential tax risk and capturing available tax opportunities is imperative in a postmodern tax world.
