Industry 4.0 is changing the speed investment decisions are made. That means tax regulators and business leaders must understand how to develop and implement regulations and strategic growth plans while working with governments to create global solutions.
Industry 4.0 has rapidly become a global priority for enterprises and governments alike due to multiple benefits: It can enable developed nations to reindustrialize, and it can lower the barriers to entry for developing nations.
Realizing these benefits, however, necessitates a profound transformation in business models: from economies of scale to on-demand manufacturing; from standardization to mass customization; from a linear, reactive supply chain to an agile, connected organization that can anticipate and respond to changes in the market.
While we are beginning to understand the economic, business, and social impacts of these changes, the impact of Industry 4.0 on tax policies is still largely ignored. The foundations of the current international tax system were built a century ago to address the changes of the Second Industrial Revolution and have been updated only slightly to address the changes brought forth by the Third.
Historically, tax systems have been developed to reflect the cost optimization strategies defining industries during the 20th century. Examples vary, from tax incentives for investment, to transfer pricing regulations targeting complex supply chains.
The Fourth Industrial Revolution, however, brings with it profound change. New industrial strategies are based on revenue, not cost. And that revenue comes from multiple sources, with supply chains growing leaner, more customized, and flexible in the face of an on-demand economy. Our international tax system is simply no longer fit for an age where predictive maintenance, artificial intelligence (AI), and smart factories rule the day.
How can an international tax system built around the traditional model of manufacturing cost-saving strategies deal with a data-driven, connected, and self-adaptive network? It can be challenging for regulators to adapt the tax system to adjust to—and foster the growth of—Industry 4.0. This gap between what the new industrial model needs and the ability of tax policymakers to keep pace with change triggers substantial risks of multiple taxation that will be detrimental to industrial companies.
For instance, consider three different Industry 4.0 scenarios that reflect the magnitude of the challenges ahead:
• The shift from just-in-time to on-demand manufacturing;
• The rise of aftermarket support; and
• The shift from products to data-driven services.
While each of these industry 4.0 scenarios brings with it a set of unique tax challenges for both business executives and policymakers, certain policy questions remain consistent across all, as described below:
• Direct tax. Historically, current transfer pricing regulations and approaches have been developed to address traditional linear supply chains, with clearly defined roles for entities and the sale of goods between them. As supply networks become less centralized and more interconnected, it will be vital to consider where value is generated in a supply chain, how or where the value should be taxed, and which entity should be liable for the tax.
• Indirect tax. Organizations must consider whether new establishments (i.e., fixed places of business) will be created globally, the nature of what is being supplied (i.e., goods or services), and what this means for their global value-added tax (VAT) compliance. For VAT purposes, most services are treated as supplied where the recipient is located, which can be a challenge where data generation and data analysis are performed in separate locations. Similarly, the rules regarding the supply of both goods and services create different compliance and reporting obligations.
• Employment tax. As workers find new roles and new ways of working in an Industry 4.0 ecosystem, tax considerations will vary by use case.
Tax regulation will adapt, eventually. The shift will likely be slow and inconsistent from one region to another. But by understanding the specific ways in which Industry 4.0 technologies shift the way businesses operate, policymakers and executives alike can begin to consider ways tax policy will need to adapt to the Fourth Industrial Revolution.
Industry 4.0 ushers in benefits, both for society and the economy—and new exposures to double taxation. However, for its benefits to be fully realized, global tax systems and regulators must keep pace with the changes, a challenge given the level of international coordination that will be needed. Progress is beginning to be made in this regard; more than 100 countries have recently embarked on a globally coordinated effort to create minimum standards within their local tax laws.
The more coordinated the changes are, the greater the consistency for tax policy globally. States that can bring certainty to companies via smart regulations will be preferred locations in this Fourth Industrial Revolution. Designing tax governance capable of reconciling new, global business models with fragmented, often protectionist national tax rules will be critical to making Industry 4.0 successes sustainable—for both businesses and tax regulators.
However, companies cannot afford to wait for certainty around tax; Industry 4.0 is here, and investment decisions need to happen quickly to keep pace with the change. As such, tax regulators and business leaders need to understand and discuss the magnitude of the changes afoot as they develop and implement their regulations and strategic growth plans, and governments can work together where possible to create a unified global solution. Unlike with predictive maintenance, algorithms cannot yet predict and bring solutions to the tax challenge, but planning and quick action can help regulators and business leaders anticipate and adapt to the changes taking place.
Learn more about Industry 4.0.