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The Italian DST Remix

6 min readBy: Daniel Bunn

The Italian government has been working for multiple years on a proposal that would 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. the revenues of digital companies. This effort has been delayed more than once and even now, it is unclear when the policy will ultimately be implemented. According to the most recent news, the tax will be introduced in 2020, hoping that an agreement will be found by then at the EU level on the design of digital taxes.

The Italian government was an early leader among European countries pursuing digital services taxes. In 2017, the lower chamber of parliament’s Budget Committee advanced a proposal that would apply a 3 percent tax on revenues from digital services provided to Italian companies. However, that proposal was withdrawn prior to implementation, and the Italian government went on to design a new proposal. The 2019 budget law introduced a different version, but the deadline for the implementing legislation passed on April 30, 2019. Now that Italy faces potential disciplinary actions on account of its fiscal situation, it is possible that the digital tax will be presented as a way to address budget deficits.

Digital services taxes (DSTs) are being considered by many countries around the world. In the European Union (EU), many of these proposals are based on a 2018 initiative at the EU level. That initiative failed to create a DST for all EU countries, but several of the supporters of the policy (like Italy) are working to implement similar taxes into their own country’s laws.

Just like the EU proposal for a DST, though, individual country DSTs are distortionary and discriminatory.

Sound tax policy should be neutral, transparent, simple, and stable. However, digital services taxes follow none of those principles. The taxes are particularly distortionary. They create a tax burden with an incidence that will have uncertain impacts. They are designed with several layers of complexity, which will make both administration and compliance quite difficult, and some DSTs are designed as short-term measures.

Overview of the Policy

The pending proposal in Italy would work in the following way. First, only businesses with total worldwide revenues of more than €750 million (USD $846 million) and taxable revenues in Italy of more than €5.5 million ($6.2 million) would be subject to the tax. These thresholds mean that most of the companies subject to the Italian DST would be foreign firms, and this feature makes the DST work very much 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. .

Second, a 3 percent tax on revenues for digital services would be owed if the user of that service is located in Italy. The covered services include:

  • Digital advertising
  • Digital networks (including both social networks and online marketplaces)
  • Transmission of user data

The government expects to raise €150 million ($169 million) in 2019 from this tax, with the tax generating €600 million ($677 million) in both 2020 and 2021. The 2020 revenue estimate, when compared to data on Italy’s tax revenue for 2017, is 0.08 percent of total revenue and 1.6 percent of corporate tax revenue.

Italian Digital Services Tax Revenue, 2019-2021


2019 2020 2021
Millions of Euros 150 600 600

An Implied Formulaic Approach

Digital taxes rely on an assumption about the value that is created in countries where digital companies have no offices, equipment, or staff but do have large user bases. To tax that assumed value, countries are choosing to define a new tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. despite no taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. in their jurisdiction according to international tax norms.

A 3 percent tax on revenues works as a strange substitute for standard business taxation. Italy has a statutory corporate tax rate of 24 percent. If a business has €10 of taxable income in Italy, it would owe €2.40 in income tax, assuming the business is taxed at the statutory rate.

However, if that business does not owe corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. but is instead subject to the DST, it would pay tax on its revenue rather than its income. If the business has revenues from digital services connected to Italian users of €100, then the DST liability would be €3. If the business subject to corporate income tax has a profit margin of 12.5 percent, the corporate tax and DST liability would be equal (24 percent of €12.5 = €3 and 3 percent of €100 = €3).

One way to think about this analysis is that the Italian proposal uses a formulaic approach to tax digital companies. This is instead of doing the difficult work of identifying the value specifically attributable to Italian users of digital services and separating that from the value created by businesses in developing software, building and managing servers, and acquiring advertising customers. The Italian approach is to assume that digital companies have a 12.5 percent profit margin on their services in Italy, and that the entire 12.5 percent profit margin should be taxed in Italy.

A problem with such a formulaic approach is that not all businesses fit the formula. The formula does not recognize that some digital companies may effectively be losing money on their Italian user base in some years or that they may be less profitable than the formula suggests.

Additionally, the tax is structured to only apply to large businesses. If a digital business that operates an online marketplace with Italian users is just below the threshold for the DST, the formula does not apply. As soon as the business crosses that threshold, though, it is effectively attributed a 12.5 percent taxable profit margin regardless of the value that is derived from its Italian user base.

This last point should be especially concerning for digital companies in Italy that aspire to become global giants. Such a company may be running losses while building its user and customer base, but if it grows to a stage where its revenues are above the threshold, then the DST would kick in and its tax situation could change drastically.

The Broader Context

Europe is well behind the U.S. and Japan when it comes to tech companies and their capital spending. Italy should be looking for ways to support and encourage innovative companies to do business in Italy rather than adopting a tax proposal with protectionist attributes.

Those attributes have already been identified by the U.S. Trade Representative (USTR) in its 2019 report on foreign trade barriers. In addition to specifically pointing out the Italian DST as a policy that would erect a new trade barrier, the report says, “Such proposals are based on an unprincipled and unsupported distinction between digital companies and non-digital companies.”

Countries like Italy should avoid adopting distortive policies and focus on opportunities to simplify their tax systems and become more internationally competitive. Designing a tax for a specific industry will not only cause some damage to people who rely on that industry’s services, but it also creates an unlevel playing field for the businesses that have to pay the special tax.

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