This piece was originally published in International Tax Review
Competition in the consumer-goods sector has always been intense and once-traditional retailers are now using an omnichannel strategy in an attempt to keep up with consumer-packaged-goods companies and online superstores, like Amazon or Zalando. What is omnichannel retailing?
Omnichannel retailing (meaning, all channels) is a fully-integrated approach to commerce that provides shoppers a unified experience across online and offline channels (e.g., touchpoints). True omnichannel shopping extends from brick-and-mortar locations to mobile browsing, ecommerce marketplaces, onsite storefronts, social media, retargeting and everything in between.
The omnichannel strategy, however, gives rise to (up until now) academic discussions on the tax aspects of that strategy. I.e. if a customer buys a product “online”, should part of the sales proceeds and margin be shared with other channels, like the physical stores? In recent past, retailers may have considered each channel as functionally separate with no or very limited sharing. However, given that retailers are now taking a much more integrated approach to their sales channels, the underlying taxation policy also may need to be adjusted.
At the same time that more retailers are using omnichannel strategies, the thinking about “taxation for the digital economy” is also clearly developing
- OECD BEPS Action 1 (Tax challenges of the digital economy) and Action 7 (Permanent Establishments), Action 8 (Value Creation)
- MLI (anti-fragmentation, PE)
- OECD 2018 Interim Report on Tax challenges arising from digitalisation
- OECD Additional guidance on the Attribution of Profits to Permanent Establishments (March 2018)
- EU (e-commerce Directive 2017/2455/EC) and proposals (fair taxation of the digital economy).
How can retailers adjust/prepare themselves for these changes and align their tax policy with the omnichannel approach?
In discussions with tax managers of retailers we understand this is a point of concern.
In this article we first provide some examples of the challenges that arise from omnichannel strategies. We will subsequently focus on two specific direct tax challenges: the increasing value of data collection in the omnichannel strategy and the permanent establishment (PE) risks connected with the omnichannel strategy. We conclude this article with our recommendations for retailers.
Omnichannel sales challenges
The integrated approach of the omnichannel strategy has many tax and transfer pricing consequences. In this paragraph we provide an example of a retail company (RetailCo) that concludes a sale with a customer using the omnichannel strategy.
RetailCo sells jeans wear and has its HQ in the US. All ecommerce activities are run from the HQ location and all marketing expressions, whether done by local stores or online, are coordinated from HQ. A customer makes an online purchase in RetailCo’s webshop. RetailCo instructs a local warehouse in the customer’s region to ship the goods to the customer. The Customer wants to return or exchange the goods for a different size/colour and goes to a local brand store of RetailCo. Where should the sales proceeds and margin from the ecommerce activities be taxable?
The example above gets more complex if the customer was persuaded to purchase the goods in RetailCo’s website, because he was directly targeted with advertisements via RetailCo’s mobile app. RetailCo used the data it acquired from the customer’s online profile and previous purchases to recommend these goods for a deviating price. Where should the sales proceeds and margin from the ecommerce activities be taxable? Is this margin influenced by the differential pricing? What value should be attributed to the direct online targeting?
In another scenario, RetailCo does not have a warehouse in this customer’s region, but does have a local brand store there. RetailCo instructs the local store to get the ordered item out of their inventory and send this via post to the customer; or, alternatively, the customer picks up the ordered item in the local store. Whilst on holidays abroad, the customer decides that he wants to exchange or return the item. He returns/exchanges the goods in a different brand store in another jurisdiction. This store happens to be a temporary pop-up brand store organised by RetailCo for their loyal online customers. If the customer decides to return the goods, he gets refunded in a different currency than he used for his initial purchase. Where should the sales proceeds and margin from the ecommerce activities be taxable? Who incurs the foreign exchange risk? Does RetailCo have a PE in the other jurisdiction?
The difficulties that retailers face when implementing or adjusting an omnichannel strategy typically relate to PE risks and customer data.
Looking at the value chain of a retail company, collecting and processing data has already been a crucial part of primary activities for some time. Data on the global inventory, for instance, is collected real time to adjust the inbound logistics and manufacturing activities. Collecting and processing data from consumers, however, is becoming increasingly important, because of the possibilities such as targeted advertising, identifying market trends, influencing customer behaviour and price differentiation (i.e. setting different prices for the same product for different (groups of) customers).
A retail company using the omnichannel strategy typically collects data from customer interactions on a real time basis. This happens both actively and passively. Active interaction refers to inter alia profile creation, shopping, saving items in the check-out basket and providing product reviews on the website or mobile app. Passive interaction refers to inter alia the customer’s clickstream, browser history, geographic location and information on linked social media accounts. This information is used by retailers to tailor their advertising to the behaviour of an individual customer to influence that customer’s decision making, even in real time when the customer is browsing online or in-store.
This demonstrates that customer data can be an “intangible” within the meaning of the OCED transfer pricing guidelines, as “the word “intangible” is intended to address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances”.1
Since customer data is a key value driver for the retailer, the entitlement to this intangible should be determined for transfer pricing purposes, because multiple parties within the retailer’s group will contribute to this intangible in one way or another. In accordance with the OECD transfer pricing guidelines, the entitlement should be determined on the basis of each party’s functions performed, risks assumed and assets used in the development, enhancement, maintenance, protection and exploitation (DEMPE) of the intangible.
The data can be collected using the retailer’s website and mobile app, but also via feedback systems that are located in brand stores. Subsequently, the data is aggregated and analysed by hand, or algorithms designed to analyse the data. Then the usage of the data is determined: targeted advertising and price differentiation are possible uses of the analysed customer data. During this entire process, the customer data must be stored and protected in accordance with applicable international data protection regulations.
If the retailer is organised as a classic principal-limited risk distributor (LRD) model, the major DEMPE functions, risks and assets are allocable to the principal, whilst the LRD’s functions, risks and assets are limited. Consequently, the LRDs should typically earn a limited remuneration based on the Transactional Net Margin Method (TNMM), with the principal realising all residual profits.
However, there are jurisdictions (such as France and Germany) that are of the opinion that more value should be attributable to the LRD, because the customer in the LRD´s jurisdiction provides the value to the intangible.
In the omnichannel strategy, marketing and sales functions are typically performed centrally at the HQ, with local support from the individual markets. In addition, there are local warehouses out of which the online orders are completed. Until recently, both the local marketing and sales support and the warehouse would typically not constitute a PE, because both the activities of the local office and the warehouse would be considered preparatory or auxiliary in nature. Following the OECD Anti-Base Erosion and Profit Shifting (BEPS) Project, an anti-fragmentation rule is implemented that targets this fragmentation of activities. If the local office and warehouse in the same jurisdiction perform complementary functions that are part of a cohesive business operation, each of the local office and the warehouse should constitute a PE, because the combination of activities is not of a preparatory or auxiliary nature.2
In addition to the anti-fragmentation rule, commissionaire arrangements whereby the local marketing and sales offices provide support to the HQ’s marketing and sales are targeted by the BEPS Project. Until recently, the marketing and sales support functions would typically not constitute a PE, because the support activities would be considered preparatory or auxiliary in nature. However, if this marketing and sales support office acts on behalf of HQ and habitually concludes contracts or plays a principal role leading to the conclusion of contracts, this marketing and sales support office should constitute a PE.
Retailers may also use other concepts, like pop-up stores for multiple purposes, such as testing new ideas and new markets, or as a marketing strategy to create exposure and brand awareness. Whether or not such pop-up stores constitute a PE, depends on the facts and circumstances. If a pop-up store lacks a certain degree of permanence, because it is situated in a different city/country every week, it may not constitute a permanent establishment. However, referring back to the anti-fragmentation rule, a pop-up store can constitute a permanent establishment if it is part of a cohesive business operation in combination with other activities that are performed in that jurisdiction.
In addition to the above, several versions of the so-called “virtual PE” were proposed during the OECD BEPS Project. The virtual PE is a PE based on significant digital presence in a jurisdiction, without physical presence. A website, online marketing and online sales could constitute a virtual PE. Although the virtual PE was not included in the final BEPS Project, several jurisdictions, amongst which India and Italy, are implementing virtual PE legislation locally and other jurisdictions may follow.
The example of RetailCo demonstrates that retailers may face multiple tax challenges when implementing an omnichannel strategy. Even when an omnichannel strategy is already implemented, a retailer should be aware of and closely monitor any changes in its omnichannel strategy and the tax and transfer pricing rules and regulations, because the generally accepted profit allocation principles are shifting.
Although it is not always obvious, data collected from customers can be an intangible for transfer pricing purposes. The DEMPE functions, risks and assets should be mapped precisely to determine each party’s entitlement to the intangible. Depending on the retailer’s transfer pricing model and the jurisdictions where the retailer is active, the group’s tax policy should be kept aligned with upcoming and future changes in legislation.
The omnichannel strategy provides retailers with the opportunity to realise more turnover in increasingly more jurisdictions without necessarily having any physical presence there. The anti-fragmentation and anti-commissionaire arrangement rules increase the PE risk for omnichannel retailers. All activities performed in another jurisdiction should be assessed in totality, to determine whether or not these activities combined form part of a cohesive business operation. Current other developments (including the EC’s fair taxation of the digital economy package) aim at shifting profit allocation to (ultimately) the consumer jurisdiction.
We are aware of, and are regularly discussing with, clients and tax managers on how to adjust the group policy in anticipation of the future changes in this respect and the upcoming changes in taxation of the digital economy.
OECD (2017), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, OECD Publishing, Paris, Chapter VI, paragraph 6.6.
OECD (2018), Additional Guidance on the Attribution of Profits to Permanent Establishments, BEPS Action 7, www.oecd.org/tax/beps/additional-guidance-attribution-of-profits-to-a-permanent-establishment-under-beps-action7.htm
Global: What’s on the horizon for insurance companies in 2020?
The following guide brings together summaries of the top legal concerns for the remainder of 2020 for insurers from a number of different regions.