Over the last few weeks, different news stories appeared on the airwaves, warning that wine and cheese prices may see an uptick in the United States. Once you dig a little deeper, you find out that the increased prices come from potential 100% tariffs on $2.4 billion worth of French products ranging from handbags to champagne to Roquefort cheese to Le Creuset baking dishes. And once you read even more into these tariffs, you discover why the threat exists in the first place: France’s decision to impose a digital services tax.
France is but one country among several who have announced, proposed or implemented a new tax on digital services. While the specifications of each tax varies from country to country, the implications on American businesses remains significant, especially for major tech companies and digital service providers like Facebook, Netflix, Apple and Google.
As the Organization for Economic Cooperation and Development (“OECD”) and the European Commission struggle to develop a multilateral plan for taxing the digital economy, many countries have elected to take a unilateral approach. Digital service taxes may have only burst onto the scene in recent years, but they show no signs of going away. Find out what they are, who they affect, and what the future may look like for your business.
What’s in this article?
- What is a digital services tax?
- What approach has the OECD taken on the increasing digital economy?
- What unilateral digital services tax measures currently exist?
- What are some examples of different digital service taxes imposed around the world?
- What are the driving principles behind a digital services tax?
- What are the concerns and criticisms of a digital services tax?
- What is BEPS and how does it relate to digital service taxes?
- Where are the latest developments from the OECD on the digital tax issue?
- How can Squar Milner help?
What approach has the OECD taken on the increasing digital economy?
Towards the end of 2019, negotiations on overhauling the international tax framework for business income taxation accelerated. The OECD launched a public consultation in October centering on a “Unified Approach” for dealing with tax challenges arising from the digitalization of the economy. In late November, more than 400 participants from many different nations convened to discuss the best approach to handle these challenges.
Per the Unified Approach, at least some multinationals will begin to be subject to income taxes in countries in which they have neither subsidiaries nor a physical presence.
At least some portion of many other companies’ profits will be allocated to countries in which their customers reside, in a manner that deviates from the traditional “arm’s length principle” of transfer pricing. Instead, profit will be split according to formulae that reflect customer (or user) bases or marketing expenditures.
Note that the Unified Approach does not specify which companies will be affected, how much of their profit will be reallocated, and how these reallocations will be implemented.
Many observers are skeptical about whether the OECD can deliver a “consensus solution,” yet many assert that decisive action is necessary. Without a multilateral agreement brokered by the OECD, there is a fear of absolute chaos in the international tax arena with an unstoppable arms race of unilateral tax measures. Perhaps, as you may find below, that chaos has already emerged.
What about the European Commission?
The European Union first proposed a DST Directive in March 2018 to all of its member countries. The proposed Directive gained strong support from a number of countries, including France, Austria, Italy, Spain and others. However, the UK, with the anticipation of leaving the EU, proposed its own DST in 2018.
Therefore, the EU failed to secure a unanimous agreement among its member countries in adopting the DST. The new European Commission announced that if the OECD does not reach an international agreement on the taxation of the digital economy in 2020, it will restart its work on the digital services tax.
What unilateral digital services tax measures currently exist?
Without an agreed-upon strategy from the OECD or EU, several countries have begun to move forward with their own unilateral measures to tax the digital economy.
As of 2020, Austria, France, Hungary, Italy and Turkey have implemented a DST. Not far behind, Belgium, the Czech Republic, Slovakia, Spain and the United Kingdom have published proposals to enact a DST, and Latvia, Norway and Slovenia have either officially announced or shown intentions to implement such a tax.
Outside of Europe, Canada, Israel and Malaysia have also instituted a digital services tax.
Each proposed and implemented digital services tax differs in structure. For example, while Austria and Hungary only tax revenues from online advertising, France’s tax base is much broader, including revenues from the provision of a digital interface, targeted advertising and the transmission of user data for advertising purposes. Additionally, tax rates range from 2% in the United Kingdom to 7.5% in both Hungary and Turkey.
Many of the listed countries consider the DSTS to be interim measures until the OECD reaches an agreement.
What are some examples of different digital service taxes imposed around the world?
With the Trump administration threatening significant tariffs against French products, the DST established in France is among the most notable. Under the new law, France levies a 3% tax on revenue – not profits – that large tech firms make when selling or operating online marketplaces. The size threshold ranges from global revenues of at least €750 million ($830 million) and French “qualifying revenues” of at least €25 million.
In December 2019 Italy passed a new tax which took effect on January 1, 2020. Similar to the French DST, Italy imposes a 3% levy on some digital revenue for companies with more than €750 million in global revenue, including at least €5.5 million in Italy alone.
The Italian digital services tax affects business-to-business transactions such as advertising, as well as services such as cloud computing. As such, the law spares digital streaming services like Netflix and Spotify.
What are the driving principles behind a digital services tax?
The debate around how to tax digital services stems from the belief of the European Commission and some countries that there is a mismatch between where profits are currently taxed and where and how certain digital activities create value.
While the idea originates from the OECD’s BEPS initiative, it is not about tax avoidance or the existence of stateless income. Rather, it centralizes on the division of tax rights among countries who consider that their citizens contribute to the profits made by some digitally focused companies, even if they do so in unconventional ways.
According to proponents for a digital services tax, there are a number of factors contributing to the mismatch. For instance, there is the ability to supply digital services in places where a company does not have a physical presence.
Another consideration is that digital business models rely heavily on intellectual property assets and are naturally more mobile.
What are the concerns and criticisms of a digital services tax?
Some experts express concern with the structure of a DST as a turnover tax. Effectively, this means that the law taxes gross revenues rather than net income. Therefore, by design, this can lead to high marginal tax rates on less profitable business. Furthermore, experts often reject turnover taxes as poor tax policy due to its inefficiency, unfairness, and barriers to economic growth.
Further concern arises over targeting of a single sector or activity. This approach has been called unfair and could generate complex circumstances. In addition, the definition of what constitutes a digital service stirs uneasiness. Taxpayers in more traditional sectors who offer online services are unsure of the implications on their business under the new laws.
What is BEPS and how does it relate to digital service taxes?
In 2013, the OECD published their Action Plan on Base Erosion and Profit Sharing and officially launched their initial Base Erosion and Profit Sharing (BEPS) project. The plan outlined a multilateral process for the OECD to review and address policies that allowed multinational businesses to use tax planning practices to pay very low or no income tax.
The BEPS action plan spurred the adoption of numerous anti-tax avoidance measures including controlled foreign corporation (CFC) rules, patent box nexus rules, thin-capitalization rules, transfer pricing regulations and cross-country reporting requirements.
Despite the significant policy and regulation changes, one piece of unfinished business continues to be the taxation of the digital economy. To get started, in May 2019 the OECD released a new work program on addressing the tax challenges of digitalization. Since then, the scope of the project – now referred to as “BEPS 2.0” – expanded greatly. This new action plan consists of i) addressing the challenges of digitalization of the economy (Pillar 1), and ii) addressing tax avoidance through a global minimum tax (Pillar 2).
This pillar consists of the “Unified Approach” (mentioned above) which aims to require businesses to pay more taxes where their consumers – and naturally, their sales – are located. Under current international tax rules, multinationals’ corporate income tax liability is usually assessed where production is located rather than where the sales occur. The OECD’s current proposal mixes the two. It taxes some profits of highly profitable companies where the sales occur and taxes the rest at the site of production.
The second pillar, known as the Global Anti-Base Erosion Proposal (“GloBE”), outlines a global minimum tax to further limit incentives for businesses to locate profits in low-tax jurisdictions. The policy is inspired by the new U.S. international tax rules that apply to the foreign earnings of U.S. companies if those earnings are not subject to a minimum level of taxation abroad.
Where are the latest developments from the OECD on the digital tax issue?
On January 31, 2020 the OECD released a Statement by the OECD G20 Inclusive Framework on BEPS to reaffirm the international community’s commitment to reach a consensus-based long-term solution to the tax challenges developing from the digitalization of the economy. Within the statement, the OECD noted a continued dedication to having an agreement in place by the end of 2020.
The Inclusive Framework on BEPS, which groups 137 countries and jurisdictions on an equal footing for multilateral negotiation of international tax rules, decided during its January 29-30 meeting to move ahead with the two-pillar proposal to address the tax challenges of increasing digitalization. This means that the group agreed to move forward with the Unified Approach of a consensus solution.
The Statement also takes note of US Treasury Secretary Steven Mnuchin’s proposal to implement the Unified Approach on a “safe harbor” basis. However, the OECD deferred the final decision on the safe harbor proposal until the architecture of the Unified Approach is set.
How can Squar Milner help?
Squar Milner’s International Tax Services team is committed to staying up-to-date on the latest happenings in the global tax environment. Our team is here to help you navigate a turbulent digital tax landscape as many countries propose or implement a digital services tax and wait for the OECD to take action.
With uncertainty lingering and some countries choosing a unilateral approach, our tax professionals are prepared to help you and your business tailor effective tax strategies to maximize your profits and minimize your tax liabilities.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.