The world has come a long way from the ‘brick and mortar’ economy and the physical presence of service providers is not necessary due to digitization of the economy.
The United States has unilaterally pulled out from negotiations on OECD’s effort to forge a global consensus on taxation of digital services. The US Secretary of the Treasury, Steven Mnuchin’s letter to finance ministers of four European countries stating that the negotiation has reached an ‘impasse’ and a threat of retaliatory tariff does not augur well for international taxation regime.
What is Digital Service Tax?
Today the global digital space is characterised by tech companies having ‘massive online presence but no physical presence.’ The rationale behind imposing digital service tax (DST) is to reassign the taxing rights - from the country where the headquarters of multi-billion tech companies are situated or some shady tax heaven countries – to the countries where the users are using and creating value. This is based on the principle of fairness and transparency.
At the heart of contention is the claim by European countries to a share in the pie of massive revenue generated by tech companies. The world has come a long way from the ‘brick and mortar’ economy and the physical presence of service providers is not necessary due to digitization of the economy. As the world goes more ‘online’ and tech companies situated in a remote part of the earth amass huge revenue from the rest of the world, a rethinking and remodeling of international taxation laws and ‘revolutionary’ action was needed. France spearheaded this effort when President Emmanuel Macron signed the DST bill into law on July 24, last year. A host of other countries have passed such laws or are in the phase of introducing them. The French DST imposes a three percent levy on gross revenues generated in France, from two categories of digital services — digital interface and targeted advertising — provided by tech companies with global annual turnover of more than Euros 750 million and Euro 25 million turnover in France.
Digital interface services include the provision, by electronic communication, of a digital interface allowing users to be in contact with other users and to interact with them, especially for the purpose of delivering goods or providing services directly between these users. This category includes interfaces like social networks, online gaming sites, Uber (when a driver connects with a passenger and provides a ride), Airbnb (when a tourist books an apartment) etc. Targeted advertising covers services like: (1) the placement of an ad targeted based on data concerning the individual who views the ad, (2) the monitoring of an ad placed based on data concerning the individual who views the ad, and (3) the sale of user data in connection with Internet advertising. The French DST also provides some exemptions or carve outs, to services like direct sale of goods or services online; and making a digital interface available as a primary means to provide users with digital content, communication services and payment services.
Heretofore, due to tax and accounting shenanigans and also due to lack of taxing statues, the norm had been ‘the biggest you are the least you pay.’ But now the companies have to pay in France tax on the world-wide revenue of the companies multiplied by the percentage representing taxable service attributable to France. This is a total game changer for countries that are recipient of services of tech companies and lose out to the taxing rights on these behemoths.
Why the Global Negotiations failed
Overhaul of international taxation regime - to address the tax challenges of the digitalization of the economy - was culminated with the issue of 15 Actions (anti-base erosion and profit shifting (BEPS)). However, value creation across new and changing business models in the context of digitalization and the tax challenges they presented necessitated new rules to deal with the new reality. As the negotiations were sluggish in the OECD and a comprehensive solution was not forthcoming, France and other European nations made a unilateral decision to impose DST, which was temporarily suspended with the hope of a final consensus within OECD, and any decision of DST would be taken under the multilateral aegis OECD.
Wary of the French decision and also to deter other nations from imposing DST, the US had threatened tariffs on French goods and conducted a section 391 investigation under the Trade Act of 1974 which grants the U.S. Trade Representative a range of responsibilities and authorities to investigate and take action to enforce U.S. rights under trade agreements and respond to certain foreign trade practices. DST, also called GAFA or GAFAM tax - because the targeted companies were Google, Apple, Facebook, Alphabet and Microsoft – was viewed by the US as discriminatory. The investigation also found it to be retroactive, inconsistent with tax principles and extraterritorial and taxing revenue rather than income. On June 12, the US hammered the final nail in the coffin when it said, “Attempting to rush such difficult negotiations is a distraction from far more important matters. This is a time when governments around the world should focus their attention on dealing with the economic issues resulting from Covid-19.” The US stalled the talks and has waged a new trade war as other countries are bound to take unilateral action and the US will follow the suit with reciprocal sanctions.
Has Covid-19 raised the pitch for DST?
Covid -19 has forced the economy to go more digital, which will further erode traditional tax bases and pressurise nations. As shutdown is continued or re-imposed, the work from home is bound to create demand for a wide range of online platforms. The French Finance Minister has stated the time was never ‘more legitimate and more necessary’ to levy digital service tax, as the tech companies were showing even stellar growth in this pandemic. Covid -19 has in fact accelerated and upped the tempo for a more broad based, just and transparent digital service tax regime.
A respite for developing countries
Developing countries are feeling a shock due to the slowdown in economic growth and dwindling revenue in the midst of the pandemic and the growth forecasts are also bleak. Tax bases are already saturated and the revenue authorities are desperately searching for ways to augment the limited fiscal space. Digital tax can be a variable that would balance the mismatches in equation in the government budget. Developing countries like Nepal cannot take unilateral action and challenge the goliaths of the world economy on its own. However, we must make our voice heard and our concerns addressed when the heavy weight economies battle it out for their stake in this new game of digital service tax. Even though the US has walked out of the OECD negotiations, there is no alternative to a better negotiation. DST is the new norm in the international taxation landscape and is here to stay; the only question is how to make it more transparent and fairer.
Uprety is a Chartered Accountant.