The past week has been nearly nonstop with news on various fronts of a dispute over taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ation of digital businesses. The main characters have been the U.S., France, and the UK, although the EU and the OECD have also played roles. Though the dust is still settling, it is worth trying to tie the various events and arguments together. To that, though, it is important to know a bit of the recent history.
In March of 2018, the European Commission advanced a proposal to tax the revenues of large digital companies at a rate of 3 percent. The tax targeted businesses with both
- Total annual worldwide revenues of €750 million (US $827 million)
- Total EU revenues of €50 million ($55 million)
The tax would apply to revenues from digital advertising, online marketplaces, and sales of user data and was expected to generate €5 billion ($5.5 billion) in revenues for EU member countries.
The tax is inherently distortive and violates standard principles of tax policy. Effectively, the digital services tax is an excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on digital services. Additionally, the thresholds make it function effectively like a tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. since most of the businesses subject to the tax are based outside of the EU.
After a long debate, the European Commission was unable to find the necessary unanimous support for the proposal to be adopted. The proposal was laid aside in early 2019, but it could be picked up again depending on the outcome of negotiations that are ongoing at the OECD.
However, many countries have explored digital services taxes on their own.
The French government was a strong proponent of the EU digital tax, and when the policy was not adopted, the French decided to design their own policy. The tax was adopted in the summer of 2019 but is retroactive to January 1, 2019. Similar to the EU proposal, the tax has a rate of 3 percent and applies to online marketplaces and online advertising services.
When the tax was adopted, the French government said that the tax would be a temporary measure until there was agreement on international digital taxation at the OECD.
The United States is home to many of the large digital firms that would be impacted by the digital services taxes, and the government has a keen interest in ensuring that those companies do not face discriminatory taxes.
Following France’s adoption of the digital services tax, the United States Trade Representative opened an investigation into whether the French policy was a discriminatory tax on U.S. businesses. In December of 2019, the Trump administration proposed retaliatory tariffs based on the findings of that investigation. The administration has also threatened tariffs against other countries that have been working to adopt digital services taxes.
The United Kingdom proposed a digital services tax at 2 percent as part of its budget in the fall of 2018. The tax has already been legislated and will go into force in April of 2020. The tax has a slightly different design than the EU and French proposals especially with respect to a separate calculation for low-margin businesses. The tax will fall on revenues of search engines, social media platforms, and online marketplaces.
The tax will apply to companies with global revenues of at least £500 million ($655 million), although the first £25 million ($32.8 million) of UK revenues would be exempt.
The OECD has been working for most of the last decade to negotiate changes that will limit tax planning opportunities that businesses use to minimize their tax burdens. This process resulted in a multitude of tax policy changes that have a variety of economic impacts. Countries around the world, including the U.S., have been changing their tax rules in various ways to align to the new OECD standards.
However, one piece of unfinished business with the OECD project is the taxation of the digital economy. For the last year, the OECD has been hosting public consultations and negotiations with more than 100 countries to change the way multinational companies are taxed. The negotiations are no longer just about digital companies because the reforms could impact nearly every sector.
The reforms have two general objectives (Pillars 1 and 2): 1) to require businesses to pay more taxes where they have sales, and 2) to further limit the incentives for businesses to locate profits in low-tax jurisdictions.
The OECD has proposed to meet the first objective by changing where companies pay taxes. Income tax liability for multinational companies is usually assessed where production occurs rather than where sales are located. However, the OECD’s current proposal would mix the two. For highly profitable companies, some share of their profits would be taxed where sales occur, with the rest being taxed where production occurs.
Countries have identified a global minimum tax to meet the second objective. The policy is inspired by new U.S. international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden. s that apply to foreign earnings of U.S. companies if those earnings are not subject to a minimum level of taxation abroad. A global minimum tax would directly influence the incentives companies face when deciding where to invest.
Recent Negotiating Positions
In December, the U.S. set out two positions that created a decent amount of concern. First, as mentioned previously, the U.S. proposed significant tariffs against France for their digital services tax and threatened to use that same tool against other countries with similar policies. Second, Treasury Secretary Steven Mnuchin suggested that the U.S. would not be able to implement the international tax reforms that the OECD is pursuing under Pillar 1 unless it was designed as a safe harbor that companies could opt into instead of paying taxes under current rules.
The French responded on both accounts by saying they would not back down on their digital services tax and that the OECD proposal could not be optional. The two governments agreed to take up the conversation again in Davos.
The Scene in Davos
This week in Davos, the U.S. and France came to an agreement that the French digital services tax would not be collected until next year (although tax liability would accrue in 2020). Also, they agreed to continue work on both Pillar 1 and Pillar 2, and the U.S. is willing to make it clear that a Pillar 1 safe harbor would not mean that paying taxes would be optional.
Secretary Mnuchin also used the occasion to make it clear to the UK Chancellor of the Exchequer that the U.S. would be willing to use tariffs to retaliate against the UK digital services tax. However, it seems clear that the UK will still implement the tax as of April 2020. The tax is designed so that the first payments will most likely be due in 2021, essentially putting the UK policy on a similar footing as the French tax.
Where to Go from Here
The temporary truce between the U.S. and France could allow the OECD to press on with negotiations over the design of Pillars 1 and 2. The OECD has until the end of 2020 to come up with an agreeable solution, otherwise the French digital tax could snap back into force, and the EU would likely take up the European Commission’s proposal once again.
The OECD is working to measure the impact of the policies and has already signaled that the two pillars will shift where companies pay taxes while increasing tax rates and revenues. In aggregate, governments of the world would raise taxes and increase frictions for cross-border investment.
The logic of the U.S. safe harbor approach suggests that if the current tax chaos facing multinational businesses (driven by digital services taxes, aggressive tax audits, and double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. ) is so challenging then a new system should be superior enough for businesses to want to opt into it.
The Trump administration is interested in building on the success of its recent tax reform and the benefits of the lower corporate tax rate. However, allowing U.S. businesses to be subject to new tax rules could countermand that agenda, unless the new international rules are a clear improvement.
The burden of proof is on the OECD to show that the price the U.S. and other countries may have to pay in lost revenue or higher taxes on their companies (paid to other countries) will be worth the challenge of adopting and implementing the new rules.
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