A new EU proposal to temporarily tax tech firms targets large firms that sell online advertising or provide online sales platforms, like Google, Facebook, Uber, and Airbnb, but leaves untouched companies that sell products online.
The proposal, one of two proposed directives released by the EU Commission March 21, provides for a temporary EU tax on digital firm revenues at a 3 percent rate to serve as a stopgap measure until an international agreement is reached on a long-term fix to corporate income tax rules applicable to digital multinational firms.
The second directive sets out the EU’s position on such a long-term fix, proposing changes to international tax rules that allocate digital firm income among nations and advancing new concepts such as “virtual permanent establishment” and “user value creation.”
The EU action follows the release last week of an OECD report that revealed that nations still differ on whether special rules should be developed to address the digital economy. It also follows a statement made by G20 finance ministers this week that the ministers are aiming to resolve this tax issue in 2020.
EU digital services tax
The Commission’s interim digital services tax proposal responds to a February letter written by finance ministers from Germany, France, Italy and Spain. The ministers asked the Commission to design a temporary EU-wide tax on digital firm revenues to make up for perceived losses of EU corporate tax revenue and given the lack of progress at the international level on this issue. Countries have been unable to agree on digital firm taxation since at least 2013. Other EU nations later joined the four ministers in calling for a temporary EU-wide tax.
The Commission proposal subjects only large firms to the EU digital services tax, namely, those with annual worldwide revenues over EUR 750 million and with EU taxable revenues exceeding EUR 50 million.
The tax would only apply to revenues created from selling online advertising space, from digital intermediation activities which allow users to interact and which facilitate sales of and services between them, and from the sale of data generated by user-provided information.
Thus, online sales would not be taxed. The Commission said its goal is for the interim tax is to hit digital firms that heavily rely on the exploitation of user participation or data obtained from users as a way to generate revenues. The value created by user participation is not taken into account under international tax rules for allocating a multinational’s profit between countries.
Place of taxation will depend on where the user’s device is located, identified through the user’s IP address or geolocation, the proposal states.
Revenues subject tax are total gross revenues, net of VAT and other similar taxes. Also, it is expected that the Member States will allow businesses to deduct the digital service tax paid as a cost from the corporate income tax base in their territory, irrespective of whether both taxes are paid in the same Member State or in different ones.
Tax wars
Thanks to the high turnover thresholds and the focus on specific business models of advertising and intermediation services, the new tax will disproportionately hit large US firms, noted Rasmus Corlin Christensen, Ph.D. Fellow, at Copenhagen Business School.
This is bound to fuel the US government’s scorn over the EU’s perceived attempt to tax what it believes it has the right to tax, further fanning the flames of a potential international tax war, Christensen said.
Similarly, Robert J. Kovacev of Steptoe and Johnson LLP said that despite the EU Commission’s claims, it is hard to escape the conclusion that the interim digital tax proposal is, in fact, an anti-US measure.
“Perhaps the EU intends its interim measures as leverage to coerce the US to the bargaining table. That may be a miscalculation considering the policies and attitudes of the current administration,” Kovacev said. He said the EU would be better off working within the OECD framework to reach a long-term consensus.
Kovacev said that the EU decision to go it alone with interim unilateral taxes on digital companies undermines efforts to reach a global consensus on how to deal with the problems of taxing the digitalized economy. The EU’s action may encourage other countries to indulge in unilateral tax measures, making international tax cooperation less likely, he observed.
Dan Neidle of Clifford Chance, London, said that the privacy implications of the EU digital services tax are cause for alarm. Requiring large businesses to track users viewing their advertisements across all their sessions, browsers, and devices may be problematic, he said.
Long-term fix
For a long-term solution to taxing the digital economy, the EU has proposed to extend the concept of a permanent establishment to include a significant digital presence or virtual permanent establishment. Thus, it will no longer be necessary for a multinational to be physically present in a Member State for it to be taxed. This will require amendments to EU tax treaties with non-EU countries.
A taxable digital presence exists under the EU Commission proposal if an MNE exceeds a threshold of EUR 7 million in annual revenues in a Member State, has more than 100,000 users in a Member State in a taxable year, or if more than 3000 business contracts for digital services are created between the company and business users in a taxable year.
The Commission proposal also says that the profit attribution rules as currently set out in Articles 7 and 9 of the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines should be revised to take into account, for example, the contribution of users and data to the creation of value.
In a surprising move, the Commission said that the international tax work should include further consideration of the use of the profit split method to ensure a fair allocation of profits to or in respect of the significant digital presence.
“My sense is this is not going anywhere,” said Neidle, noting that the Commission proposal would require the US to agree to amend its tax treaties with EU countries.
It is implausible for any US administration to amend its double tax treaties so its MNEs are taxed more, and beyond implausible right now, he said. “So, expect the ‘interim’ to be permanent,” Neidle said.
EU State reactions
Officials representing France, Germany, Italy, Spain, and the UK issued a joint statement after the Commission release stating that they welcomed the Commission proposals and intend to study them. In the absence of G20 or OECD agreement, the EU needs to take action on a coordinated approach at the EU level so that the integrity of the single market is ensured, they said.
Irish prime minister Leo Varadkar immediately expressed opposition to the Commission proposal, however, according to a report published the
Financial Times. Ireland may well be joined by Malta, Denmark, Luxembourg, and others which have previously expressed strong reservations to an interim EU tax.
Neidle said that the smaller EU States will be unhappy with the Commission’s interim tax proposal because the tax will very likely cause them to lose revenue. The smaller EU States host businesses that will have a digital service tax liability deductible against local corporate income tax, but don’t have many local users, he explained.
If an agreement among the 28-member States cannot be reached, it is possible for EU states to proceed with a tax on revenue tax under EU enhanced cooperation, which requires only nine States to join. EU states can also impose a temporary tax unilaterally.
The legislative proposals will be submitted to the Council for adoption and to the European Parliament for consultation. The EU will also continue to actively contribute to the global discussions on digital taxation within the G20/OECD, and push for ambitious international solutions, the Commission said.
Julie Martin
Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.
Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.
Julie can be reached at [email protected].
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