A Wave of Digital Taxation

November 7, 2018

Following the announcement by Chancellor Philip Hammond that the UK will be imposing a tax on revenues of certain digital companies in 2020, it is worth providing some context to the proposal. Even though the proposal fails every test of sound tax policy, the UK is not alone in pushing this idea.

Sound tax policy should be simple, transparent, neutral, and stable, and many proposals countries are pursuing on digital taxation clearly fail on all accounts. Instead of policy leading the conversation, the politics of digital taxation are dragging policy along behind.  

However, not all countries that are considering taxes of this nature are planning to or have imposed them in the same manner. In general, policies that tax digital transactions using existing consumption tax regimes are superior to ones that apply special taxes on revenues associated with certain digital services. This post provides a brief survey of nine proposals by individual countries and the status of those policies.

The Early Movers

Hungary, India, Israel, and South Korea all moved forward with various digital taxes in 2016 or earlier, and each has an active policy on taxing various digital activities. The four countries took three separate approaches, with Hungary applying a tax targeted at digital advertising, India and South Korea including digital products and services in their consumption taxes, and Israel adopting a definition of “significant digital presence.”

Hungary initially imposed an advertising tax in 2014 with a progressive rate schedule which the government labeled the “Google Tax.” The European Commission (EC) determined that the rate structure violated rules on state aid because the lower rates were preferential to some companies. Following adjustments in 2017 and 2018, a 7.5 percent tax now applies to advertising revenues that exceed 100 million HUF (US $348,440) per year. Revenues below that threshold are exempt from the tax.

South Korea also acted on digital taxation in 2014. The South Korean government amended its Value-Added Tax (VAT) to include sales of digital services including audio, video, games, and software provided by foreign companies or individuals. Since 2014, the VAT has been amended to include sales by foreign companies via app stores. The applicable VAT rate for these digital services is 10 percent.

In 2016, India adopted taxes on online transactions as part of its Goods and Services Tax (GST) policy.  Currently, a 6 percent withholding tax applies to transactions where Indian businesses advertise on foreign websites such as Facebook or Google. The Indian government is also considering expanding the tax to include video streaming services, likely hitting Netflix in the process.

Israel decided in 2016 to include a definition of “significant digital presence” for purposes of taxing foreign companies that derive income from online transactions with Israeli residents. Significant digital presence is loosely defined and includes the number of contracts an internet company has with Israeli residents, the number of Israeli customers, whether a service is provided in Hebrew or uses Israeli currency, high web traffic by Israeli users, and other factors. The Israeli tax authority determines significant digital presence on a case-by-case basis.

The Follow-ons

During 2017 and 2018, most proposals for taxing digital companies outline taxes on revenues of companies that provide digital services. The EC proposal has been widely criticized, but it is somewhat of a model for these recent proposals. The EC proposal would apply a 3 percent tax to revenues of companies with total annual worldwide revenues of €750 million (US $868 million) and total EU revenues of €50 million (US $58 million). Proposals from Italy, Spain, and the UK are all taxes on revenues from digital services. Australia is exploring similar options. Chile and Singapore are expected to apply consumption taxes to certain digital transactions.

Italy followed the four early movers by adopting a digital tax proposal at the end of 2017. The policy is a 3 percent tax on revenues from digital services provided to Italian companies. This tax applies to companies with more than 3,000 digital transactions in Italy and will be effective beginning in 2019. Some of the details concerning what is covered by the definition of “digital services” will be defined by an implementation decree.

In early 2018, Slovakia adopted a new definition of permanent establishment that includes foreign companies that repeatedly mediate transportation and accommodation services via a digital platform. This policy is targeted at reservation websites like Expedia or Booking.com as well as taxi services that companies like Uber provide. Companies that fall into the permanent establishment definition are subject to Slovakia’s corporate income tax. 

Spain has also proposed a digital services tax that, if adopted, would likely apply beginning in 2019. Like the Italian proposal, it would be a 3 percent rate on revenues from certain digital services, but it would also follow the EC proposal to apply the tax to companies with more than €750 million (US $868 million) in total annual worldwide revenues and Spanish revenues of €3 million (US $3.4 million).

Chile has proposed a 10 percent tax on digital services from foreign companies to Chileans. The tax would apply to digital brokering services, entertainment services (downloadable, streaming, etc.), foreign advertising services, and subscriptions to platforms that provide technological or storage services (including cloud or software). It is expected that this tax will operate like a sales tax and be implemented in 2019.

Singapore is expected to implement a tax on digital services beginning in 2020. The current plan is to include purchases from foreign tech companies and app providers in its GST. Two thresholds for the digital GST will apply. Businesses will need to register for GST if they have annual global revenues of more than SGD 1 million (US $722,000) and have sales to customers in Singapore of more than SGD 100,000 (US $72,000).

Most recently, the UK has proposed a 2 percent tax on revenues for companies with more than £500 million (US $638 million) revenues from digital services. The first £25 million (US $32 million) in revenues would be exempt from tax. Additionally, companies with net operating losses would not be required to pay the tax and companies with low profit margins would face a reduced rate. The tax is designed to apply to search engines, social media platforms, and online marketplaces.

While Australia has not yet released a proposal, the government released a consultation paper in October 2018 that explores issues of taxation related to the digital economy. The report raises many questions about what type of tax policies should be used by governments interested in taxing digital transactions and services provided. The consultation is expected to lead to a discrete proposal at some point, and the Australian government is receiving comments on its consultation through the end of November.

Chaos to ensue?

These various proposals have been used by policymakers at the EC to argue for a unified solution at the European level, and the Organisation for Co-operation and Development (OECD) has been seeking a broader international solution as part of BEPS Action 1.

Both the EC and the OECD expect that many of the individual country efforts will be abandoned if an international solution is agreed upon. In fact, the EC itself is expected to defer to the OECD once an agreement is reached. The UK has made it clear that its proposed digital services tax would be abandoned when an international solution is in place.

The OECD continues to work towards a solution on digital taxation with a potential final report by 2020.

Arguably, some level of uniformity would be helpful to avoid creating a web of new definitions surrounding “digital services” or “significant digital presence.” However, many of the proposals are poorly conceived and would have negative economic impacts. In the case of Europe, they would likely damage an already weak investment environment for tech firms. Countries should proceed with caution before adopting policies that will likely challenge their future ability to attract and foster innovative businesses.

Meanwhile, there are clear contradictions in the ongoing discussion. While the EU is currently moving to provide member countries with flexibility to have lower VAT rates for some digital goods like e-books and e-newspapers, some of the same providers of those digital goods are targets of digital services taxes. Though this effort is intended to align VAT treatment of physical newspapers and books with digital products, the contradiction remains.

Additionally, France has been moving to become Europe’s leader with policies that support cryptocurrencies and related platforms. The French government is setting itself up as helpful to this young digital industry even as they are seeking to tax successful digital companies.

It is possible to arrive at a tax policy that rests on sound principles, addresses issues of the digital economy, and is consistent with other policy goals. Many proposals, though, begin by approaching digital taxation as a specific problem rather than rethinking general approaches to corporate income taxes or consumption taxes, where the difficulties with taxing digital goods and services originate.

Individual Country Digital Taxation Efforts
Country Status of Proposal Initial Year of Implementation Summary

Source: Bloomberg Tax

Hungary

Implemented

2014

Tax on digital advertisements at a 7.5 percent rate. Applies to businesses with advertising revenues that exceed 100 million HUF (US $348,440) per year. Revenues below the threshold are exempt.

South Korea

Implemented

2014

VAT of 10 percent applies to sales of digital services including audio, video, games, and software provided by foreign companies or individuals. Also includes sales on app stores.

India

Implemented

2016

6 percent withholding tax applies to digital advertising sales as part of India’s GST. Could be expanded to include streaming services.

Israel

Implemented

2016

Taxes digital companies based on a definition of “significant digital presence” which includes facts related to Israeli web traffic, web platform customization for Israeli customer base, and contracts with Israeli residents. Assessments are made on a case-by-case basis.

Italy

Implemented

2017

A 3 percent tax on revenues from digital services. Will apply to companies with more than 3,000 digital transactions in Italy.

Slovakia

Implemented

2018

Permanent establishment definition for purposes of corporate tax now includes foreign companies that repeatedly mediate transportation and accommodation services via a digital platform.

Spain

Proposed

2019 (Expected)

A 3 percent tax on revenues from digital services. Will apply to companies with more than €750 million (US $868 million) in total annual worldwide revenues and Spanish revenues of €3 million (US $3.4 million).

Chile

Proposed

2019 (Expected)

Expected to work like a sales tax with a 10 percent rate. Will apply to digital brokering services, entertainment services (downloadable, streaming, etc.), foreign advertising services, and subscriptions to platforms that provide technological or storage services (including cloud or software).

UK

Proposed

2020 (Expected)

2 percent tax on revenues of search engines, social media platforms, and online marketplaces. Will apply to companies with more than £500 million (US $638 million) revenues from those digital services. Exemptions and lower rates will be provided for loss-making businesses or companies with low profit margins.

Singapore

Proposed

2020 (Expected)

Included in GST if digital providers have annual global revenues of more than SGD 1 million (US $722,000) and have sales to customers in Singapore of more than SGD 100,000 (US $72,000).

Australia

Consultation

Undetermined

Released a consultation paper regarding digital taxation in October 2018 and is receiving comments on the paper until the end of November.

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