Why ‘Digital Taxes’ Are the New Trade War Flashpoint

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Cables feed into a serial digital interface (SDI) card inside a communications room at an office in London, U.K., on Monday, May 21, 2018. The Department of Culture, Media and Sport will work with the Home Office to publish a white paper later this year setting out legislation, according to a statement, which will also seek to force tech giants to reveal how they target abusive and illegal online material posted by users. Photographer: Bloomberg/Bloomberg (Photographer: Bloomberg/Bloomberg)

By Bloomberg L.P. for Lolwe digital

The U.S. decision to withdraw from international efforts to harmonize global tax rules for digital companies risks triggering a new trade war. The move came after the U.S. and a group of nations failed to agree on the best way to tax revenue from digital companies such as Facebook Inc. and Alphabet Inc.’s Google.

It’s a way for cash-strapped governments to tap deep-pocketed companies whose multinational earnings often escape the taxman’s grip. The U.S. says digital taxes unfairly discriminate against American firms and has threatened retaliatory tariffs that could exacerbate the worst global economic downturn since the Great Depression.

How does a digital tax work?

The idea is to shift taxation to the places where users of online services are located, rather than the usual approach of focusing where companies base their regional headquarters or book their earnings.

Targeting revenue rather than profit gets around techniques used to push earnings into lower-tax jurisdictions. In July 2019, France became the first country to impose a digital tax after wider efforts by the European Union to develop a harmonized approach failed.

Its 3% levy applies to companies with at least 750 million euros ($845 million) in global revenue and digital sales of 25 million euros in France. Of about 30 businesses affected, most are American, but the list also includes Chinese, German, British and even French firms.

Who’s in this battle?

In January, the U.S. and France came close to triggering a transatlantic trade war as the EU said it could retaliate if the U.S. went ahead with planned tariffs on roughly $2.4 billion in signature French products, including wine, cheese, handbags and makeup.

The two countries agreed on a truce whereby the U.S. would back off from tariffs and France would delay collection of its digital tax to the end of 2020 to allow for renewed efforts to reach a multilateral solution.

Since then, the U.S. has launched investigations into the digital taxes proposed or enacted by 10 nations and the EU, citing Section 301 of the U.S. Trade Act of 1974, which allows it to retaliate for trade practices it deems unfair. It’s the same tool used in the dispute with France and to justify U.S. tariffs on Chinese goods due to alleged theft of intellectual property.

Who else is considering a digital tax?

The U.S. Trade Representative says countries that have either adopted or are considering digital taxes include Austria, Brazil, the Czech Republic, France, India, Indonesia, Italy, Spain, Turkey and the U.K.

The U.S. views India’s tax as particularly pernicious because its reach is much broader than what’s being proposed in Europe. In April, India expanded the scope of its 6% “equalization levy” — a withholding tax on foreign online advertising platforms — to include digital companies with a “significant economic presence” that engage with or sell to Indians.

Known in India as the “Google Tax,” the charge deviates from internationally accepted principles because it doesn’t provide credit for tax paid in other countries for the service supplied in India, according to a March report from the USTR.

How did the pandemic change this debate?

Governments are increasingly focusing on digital taxes as a way to raise funds to help pandemic-strike economies, and finance ministers from Indonesia, France and Italy have said the health crisis adds urgency to their plans.

Stay-at-home policies have played to the strengths of companies such as Amazon.com Inc. and Netflix Inc., along with other platforms that compose the nearly $26 trillion global e-commerce marketplace.

France has said it would drop its tax if the U.S. and other countries agree to a global effort for a uniform approach under the stewardship of the Paris-based Organization for Economic Cooperation and Development.

In June U.S. Treasury Secretary Steven Mnuchin told European governments that America would no longer participate in the OECD’s digital tax talks after failing to reach an agreement on the best way to tax revenues of American technology companies.

What happens now?

French Finance Minister Bruno Le Maire said the U.S.’s withdrawal from international talks on digital tax was a provocation and indicated his country will impose a version of the levy this year in keeping with the law.

“Whatever happens, we will apply a tax on digital giants in 2020 because it is a question of justice,” Le Maire said. U.S. Trade Representative Robert Lighthizer told lawmakers June 17 that the U.S. would respond to any “unilateral” digital services taxes with retaliatory tariffs but left room for the possibility of a negotiated settlement.

“The answer is that we need an international regime that not only focuses on certain size and certain industries but where we generally agree as to how we’re going to tax people internationally,” he said. “So I think there is clearly room for a negotiated settlement.”

What’s the case for a digital tax?

Because corporations are often domiciled in other countries — including low-tax jurisdictions such as Ireland or Bermuda — and shift money seamlessly across borders, companies that sell online can easily avoid paying taxes in countries where they nevertheless make significant sales.

More fundamentally, France argues that the structure of the global economy has shifted to one based on data, rendering 20th-century tax systems archaic. According to 2018 figures from the European Commission, global tech companies pay a 9.5% average tax rate compared with 23.2% for traditional firms.

Why tax revenue instead of profit?

The short answer is that it’s simpler to tax revenue. Taxing profits requires establishing where earnings actually accrue, which is hard enough for any global company but even more so in the digital sector; you might book a taxi in London, for instance, but your payment could be settled in Amsterdam.

Politicians also argue that taxing revenue may be the best way to squeeze money out of companies such as Amazon that report large sales but paltry earnings. Still, it’s not straightforward to work out which revenue is linked to a specific country.

To do that, French tax collectors propose to tax internet companies proportionally to their “digital presence” in the country relative to the rest of the world.

Is tax a new front in the trade war?

Transatlantic tax wars aren’t new. Apple Inc. was slapped with a 13 billion-euro bill for back taxes by the European Commission three years ago, which Chief Executive Officer Tim Cook called “political crap.” The U.S. Treasury Department tried and failed to sway the EU’s Apple investigation, which alleged that the company got an illegal subsidy.

The Commission has also probed Google’s Irish tax arrangements and ordered Amazon to pay 250 million euros in back taxes to Luxembourg. Other U.S. companies, including non-technology firms such as Starbucks Corp. and Nike Inc., have also been targeted in tax probes.

The EU insists that the common thread isn’t that they’re American but that they’ve used complex legal structures and intellectual-property licensing to limit tax payments.

How are tech companies responding?

Tax is only part of a bigger EU backlash against big tech. Internet firms have been put on notice over issues ranging from privacy to market dominance — and they’re fighting back with lobbying and court cases.

In 2019, Google agreed to pay 965 million euros to settle two French tax probes. Apple and Amazon are contesting their respective European tax decisions in EU courts, and a legal victory could halt that part of the bloc’s crusade.

Lawmakers are on the lookout for companies that might consider changing their tax structures or moving income outside of the EU to stay ahead of the curve.