The news that the Trump administration is threatening France with 100 per cent duties on certain goods and services following France’s introduction of a Digital Services Tax (DST) has given rise to a great deal of comment, much of it around the timing of the announcement and the politics behind the move.
This article will focus on two aspects; what are the implications for the UK, given the UK is planning to bring in a DST in 2020; and how does this relate to the multilateral talks taking place in Paris under the auspices of the OECD to reform the international tax system, especially in light of letters exchanged in recent days between the US and the OECD.
The implications for the UK
The French DST imposes a tax of three per cent on revenues generated by certain companies on digital services. The services in question are “digital interface” and “targeted advertising” services, and the tax is imposed on revenues from these services being provided in France. However, the tax only applies to companies with global revenues from such services in excess of €750m of which at least €25m is generated in France.
The US administration argues that the selection of activities covered by the tax and the thresholds stipulated mean that the tax falls predominantly on US companies and excludes French companies. The tax is therefore, in their view, discriminatory.
The French DST applies from 1 January 2019, although the DST proposal was only formally tabled in March 2019 and only signed into law in July 2019. The US argues that the tax is retrospective, and puts unfair burdens on US companies. Furthermore, the fact that the tax is based on revenues is considered by the US to be in contravention with existing international tax “norms” and is again an unfair burden on US companies. The fact that the tax can apply to revenues unconnected with a presence in France and the effective application of the tax to a small number of “digital companies” are also regarded by the US as against prevailing international tax practice and thus burdensome and discriminatory.
The UK DST covers a slightly different range of activities, being the provision of a social media platform, a search engine or an online marketplace (‘in scope activities’); and the tax is at two per cent on revenues arising from the provision of in scope activities to UK users. As in France thresholds apply; global revenues from in scope activities need to be £500m and UK revenues £25m.
Even though the activities covered are slightly different, the tightly defined nature of activities, and the dominance of US companies in these areas suggest it would be surprising if the US did not conclude that the UK DST was also discriminatory. The UK DST is not intended to be retrospective; it will only come in from 1 April 2020 and no doubt whoever wins the election is hoping to have had a Budget and passed a Finance Act by then (although timing could be tight). However, the other aspects of the French DST criticised by the US appear to be equally apparent in UK DST.
Accordingly, it appears very likely that if the Office of the US Trade Representative undertook an investigation into UK DST they would reach a similar conclusion to that in respect of French DST – that the tax is discriminatory – and that would open up the possibility of retaliatory tariffs on UK products.
The OECD Process
The Organisation of Economic Co-operation and Development (OECD) has been running a project since 2012 to reform the international tax system. This project initially focussed on the elimination of techniques designed to reduce the profits of multi-nationals through exploiting differences in national tax systems and shifting profits from high to low tax jurisdictions – Base Erosion and Profit Shifting (BEPS). The “second phase” of that project is now underway, and whilst there are some further anti-BEPS measures, this phase also contains proposals to change the underlying architecture of the international tax system in so far as it applies to the largest companies.
DST’s are largely a response to the fact that large companies in the digital space can have a significant impact on the lives of citizens in a country out of proportion to any physical presence or actual operations they have in that country. Because the way corporate taxes are levied is tied to a physical presence or operations, the impact on citizens’ lives and the corporate taxes paid in the relevant jurisdiction can seem way out of kilter. DST’s are unilateral attempts to rectify that situation; but the US is correct in noting they are not in line with how taxes have been previously levied; and a proliferation of DST’s, all with their own scope, rate, thresholds etc, would prove extremely burdensome to companies affected, lead to double taxation of profits, disputes between taxpayers and tax authorities and – as we can already see- between nations themselves. At a recent CIOT event, Richard Collier of the OECD noted that in Europe alone 15 countries were considering bringing in a DST.
The OECD is seeking to avoid the chaos that “tax wars” caused by such a proliferation of DSTs would bring. Their proposals – which they call “Pillar One” of this phase of their project – would reallocate a portion of profits arising to “consumer facing” multi-nationals away from where those profits are currently taxed. Typically profits are currently taxed where products are made, or where the multi-national is headquartered or where holds its intellectual property, and only small amounts are taxed according to where products are sold. Under the Pillar One proposals, some profits would be reallocated to “market” jurisdictions, essentially where the multi-national makes sales or otherwise derives revenues. The Pillar One proposals would affect a much larger number of companies than DST’s, which the OECD hopes will address the discriminatory concerns raised by the US in respect of DSTs. Furthermore, the proposals remain based on taxing profits, not revenues.
Together with the further anti-BEPS measures in “Pillar Two” of the OECD project, the OECD proposals should result in multi-national companies paying at least a minimum level of tax (something around 10-12.5 per cent is thought likely) on all of their profits; and paying more tax in countries where they have sales – or in the case of some digital companies where they have users – than has previously been the case.
The potential imposition of tariffs on French companies by the US proves a very timely reminder of the consequences of the failure of the negotiations currently taking place around the OECD proposals. Some of us have doubts that Pillar One and Pillar Two will bring the process of reform of the international system to a close – whilst the proposals will ensure a minimum level of tax on all large multi-nationals, they would seem to leave companies deriving profits from intangibles still probably paying lower rates of tax than others, and will only result in a modest change in tax base for some companies, and thus only relatively small changes in the allocation of tax revenues.
However, the process of international tax reform can be likened to a long journey at sea being undertaken solely under sail; at any one time, you can only go as far as the winds and your supplies allow. The “next port of call” must surely be completing Pillar One and Pillar Two, before we contemplate another voyage. If we do not reach that port, as current events show, the alternative is not being becalmed at sea, but being buffeted on all sides by winds of storm force; with companies and tax authorities alike struggling to keep the ship afloat.
It is thus concerning that in recent days, the US Secretary of the Treasury, Steven Mnuchin has written to the OECD expressing doubts around the Pillar One proposals, and essentially suggesting they suffer from the same issues as DSTs. This is despite the fact that the US has been closely involved with their development to date. Secretary Mnuchin made a somewhat enigmatic proposal that Pillar One could be recast as a “safe harbour regime” without giving further detail of what that might look like. The Secretary of the Treasury did give guarded support for Pillar Two, which is the Pillar which should ensure multi-nationals pay a minimum amount of tax somewhere. There is a theoretical view that this is actually the most important result; however, in practical and political terms, European governments in particular need to demonstrate they have obtained greater taxing rights over the US digital companies in particular. An agreement on Pillar One is thus vital; otherwise we will see full on tax wars with a proliferation of DSTs and counter-measures from the US and possibly others. Accordingly, it is to be hoped that the US will accept the OECD’s offer of further discussions before Christmas.
By Glyn Fullelove, CIOT President