Digital service tax: is an international agreement reachable?
“France demands tax payments from big techs”: you may have heard this over and over in the past few weeks. Indeed, this statement refers to the “digital service tax” (or “web tax”, “Internet tax”) France has recently imposed on companies providing digital services, such as the GAFAM (Google, Amazon, Facebook, Apple and Microsoft). In this article we will review the reasons behind such a tax, how it can be implemented and the international developments around its introduction.
Why a tax on digital services
The main problem concerns the growth of the digital economy over the last few decades, which has seen a further boost during the pandemic. Several governments claim big tech companies pay too little in taxes on the profit they make in their countries, as they are able to record it in “tax haven” jurisdictions, a phenomenon known as tax avoidance.
The issue lies in the traditional international tax principles, according to which revenues must be recorded (and, most importantly, taxed) in the country where the company has its permanent establishment, its fiscal residence, that is where they have employees and operations.
It is immediate to see that companies offering digital services no longer need a physical presence in a country to operate and make a profit there. Hence, according to the current rules, they manage to not pay taxes (except for VAT) in the countries where they actually produce revenues. For example, it has been calculated that the 15 largest providers of digital services worldwide paid in Italy only as little as €68 million in taxes in 2018, in contrast with revenues amounting to €2.4 billion.
To tackle this issue, starting from 2017, the countries in the Organization for Economic Co-operation and Development (OECD) have been working on a multilateral agreement aimed at designing a fairer international tax regime. At a time of great financial difficulties, it is even more important that those who benefited from lockdown measures contribute more, according to their means.
An agreement was expected to be reached by the end of 2020. However, the COVID-19 crisis has called for a pause in negotiations and unilateral actions from many countries are threatening the possibility to reach a compromise. There is disagreement even among countries belonging to the same block, the EU.
The European Commission, indeed, acknowledged the problem already two years ago and warned Member States against adopting unilateral solutions. Instead, it presented two proposals aimed at preventing incoordination in the tax framework at least inside the EU.
The EU proposal
The first was a long-term, forward-looking solution revising the concept of permanent establishment, whereby companies would be taxed based on their “virtual presence” in a country rather than where they have their operations and employees. The great obstacle for this proposal is that it would have to be accepted not only by EU member states but also by the other members of the OECD and that relevant international tax treaties would have to be amended to include it.
For these reasons, the Commission put forward a second proposal based on a 3% tax on revenues originating from digital services (the aforementioned “digital tax”). According to this solution, presented as temporary, the taxable services would be those where the collaboration of the final users in the value creation is particularly fundamental. These include advertising, intermediation (such as online marketplaces like Amazon) and the sale of data (such as by search engines, social media platforms and streaming services). Also, affected companies must have a global turnover of more than €750 million, of which at least €50 million must originate from digital services provided in the EU.
As we have mentioned, however, despite multilateral negotiations still ongoing both at the European and at the wider OECD level, about half of all European OECD countries have proceeded with unilateral measures and either announced, proposed or implemented a digital tax.
Each country on its own
As you can infer from the graph above, as of October 14, eight countries (Austria, France, Hungary, Italy, Poland, Spain, Turkey and the UK) have implemented some form of digital tax, three (Belgium, the Czech Republic and Slovakia) have a proposal in place and three (Latvia, Norway and Slovenia) have expressed the intention to introduce one.
Yet, these taxes differ even in their configuration. For instance, while Austria and Hungary only tax revenues from online advertising, France, Italy and Spain have followed the European Commission’s proposal in taxing all the previously mentioned services. As a matter of fact, the latter three countries’ digital tax resemble that Commission’s proposal even more, as they target companies with global revenues higher than €750 (although they have different in-state revenues thresholds) and they have a 3% rate. Tax rates are also very different among countries, from 2% in the UK to 7.5% in Hungary and Turkey.
If interested, you can find additional details regarding the digital tax designs in each country here.
It is thus clear that such a system of uneven measures might be sustainable only in the short run and an international agreement will have to be put in place at some point.
Is the digital tax really fair?
In fact, it all boils down to one discussion: whether we are interested in crafting rules that apply to a few very large digital companies or in fully redesigning the cross-border taxation principles affecting also other companies that are not necessarily entirely digital. The digital tax drives us in the first, narrower direction.
First of all, it is a regressive form of taxation because it is based on gross revenues rather than on profits. Let’s assume a digital tax of 3% of revenues, as in the Commission’s proposal. For a company with a 12% profit margin (profits as a percentage of gross revenues), the digital tax amounts to a 25% profits tax, whereas for a company with a 3% profit margin, it amounts to a 100% profits tax. Governments argue that companies providing digital services have higher than average profit margins, but this fact, while generally true, does not eliminate the regressivity which is intrinsic in the tax.
Secondly, these are very targeted policies aimed at “hitting” a specific industry and making a distinction between big and small players. Should policies be designed in such a way? Are they “tariff-like” policies pursuing a purely protectionist goal? I’ll leave the answers to these questions to the reader.
Politically speaking, indeed, since most of the revenues from the digital tax will impact U.S. companies, the U.S. government has claimed these measures to be discriminatory and understandably threatened retaliatory measures. Although we might see a more collaborative and less aggressive approach in the future Biden administration, the hostility towards unilateral actions waiting for a multilateral agreement is likely to continue and compromise will have to be reached.
Now, having established these design weaknesses, we cannot be so naïve to think that a compromise regarding general international taxation rules will be easily reachable. It will probably take time and effort. But we can and must demand that our governments work together and find a common solution, possibly not involving regressive effects.
Will the international community succeed in finding a sustainable and fair common ground and overcome differences? At the end, posterity will judge us.