Taxing the digital economy

Several corporate giants have benefited by avoiding taxes

Even as the US-China trade war appears to have paused, another dispute could be on the horizon. This time, it could be the US versus several major European Union (EU) nations, including France, Italy, Belgium, The Czech Republic, Hungary, Austria and, even perhaps, the UK. The disagreement centres on the levying of a new type of tax on digital revenue. This may escalate into a wider conflict, since the EU and the Organisation for Economic Co-operation and Development (OECD) are looking at framing such taxes. This will be one of the largest areas of concern at the upcoming Davos Meet. 

France has started levying a digital tax retrospectively with effect from January last year. Any entity providing a range of specified online services with revenues of 25 million euros in France and global revenues of 750 million euros will have to pay 3 per cent of its French revenues under this new tax. The services include “Provision of a digital interface, targeted advertising, transmission of user data for advertising purposes”, and so on. The other nations have either imposed similar taxes, or propose to do so soon with local variations on revenue thresholds and defined services. The EU hopes to have a uniform framework for such taxes in place by end-2020, and the OECD has started discussions among its members.

There are several unusual aspects to this tax. For one, it is levied on revenue and not on profit. It is also proposed to be applicable to any entity that performs such digital services, regardless of its physical presence. The application of relatively high thresholds in terms of revenue is meant to insulate small businesses and start-ups. The idea is to capture tax revenue from companies that incorporate in tax havens, and then supply digital services in large markets without maintaining an official physical presence. Where physical exports are concerned, the EU’s laws on “inter-community acquisition of goods” mean that no VAT is payable, and profits, if any, are taxed in the nation of incorporation. This enables free movements of goods and services across the EU but using such provisions also enables digital service providers to substantially escape the tax net.

This is called the GAFA tax in French discourse because it would directly affect Google, Amazon, Facebook, and Apple. It would also impact other companies smaller in size. The EU reckoned that a flat tax across its member nations could generate roughly 5 billion euros in annual revenue. Since the GAFA are US-based digital giants, the US government has naturally taken an interest. Equally predictably, President Donald Trump has threatened countervailing sanctions on France, whose exports to the US are worth roughly 25 billion euros. Logically speaking, if the situation is not resolved, those sanctions would be extended to other EU nations with similar taxes, and perhaps to the entire eurozone. Talks at Davos between the US treasury secretary and the French finance minister could obviate such a possibility.

It’s unusual to levy a tax on revenue. However, the very fact that large international bodies are considering this, and major countries have imposed such taxes, indicates that this has been a gigantic loophole for internet-based services. Indeed, the EU has spent several years debating such a tax before individual nations started imposing it. But several EU nations including Sweden, Finland, and Poland have expressed reservations about this sort of tax. But the OECD is even larger in terms of membership, and it has a bigger geographical spread and could suggest a tax that was global in scope. Clearly, the concept of such a tax is not going to disappear. It remains to be seen if it morphs in format, given American objections, but something akin to this is very likely to stay on the table. The digital economy has benefited from three decades of tax avoidance. Attempts to bring it under the tax net could lead to a trade war.