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INSIGHT: Unilateral Measures and the Quest for a Globally Agreeable Digital Tax

March 18, 2020, 7:01 AM

The OECD has been leading multinational efforts to devise a globally acceptable mechanism to tax the digital economy. At its core, the issue relates to the alteration of existing principles of international taxation that rely heavily on physical presence and fail to account for technological developments that allow businesses to serve markets remotely.

The OECD has been working on building consensus towards allocating taxing rights to jurisdictions that host customers or user networks and add value to businesses. On Jan. 31, there was a significant development in this regard, with 137 countries reaffirming their commitment to bridge their differences and reach agreement on a consensus-based solution to address the challenges faced in taxing the digital economy. However, the journey thus far has not been free of roadblocks, and unilateral measures have played a crucial role along the way.

The issue of taxing the digital economy initially got traction when it was identified by the OECD as one of the main areas of focus of the Base Erosion and Profit Shifting Action Plan. In 2015, the OECD acknowledged that the challenges in question required a holistic revaluation of the principles of international taxation, which needed global consensus. Since at the time several countries were of the view that such a measure would ring-fence the digital economy and stifle growth, the OECD called for continued work in the area. While it refrained from making any recommendations at the time, in its report the OECD also enumerated actions that could be taken by states to tax digital businesses in the interim. It was then that the seed of imposing equalization levy as a unilateral measure was planted.

The idea behind unilateral measures was to impose a levy that would equalize the tax burden on foreign and domestic suppliers. However, the international community was divided over the merits of, and the need for, such levies. Given that these levies would operate independently, outside the Income tax landscape, one set of countries opposed their imposition on the grounds that they would lead to double taxation and adversely impact innovation. However, those countries that were in favor of the introduction of interim unilateral measures believed that there is a strong imperative to act pending a consensus on a global solution. Subsequently, several countries including India imposed unilateral measures that aligned with their policy considerations and taxed certain aspects of the digital economy.

India’s equalization levy for instance functions as a standalone tax outside the ambit of the Income Tax Act and focusses on nonresidents providing online advertising services. It does however empower the government to expand its scope to other services by way of notification at a later date if deemed necessary. An equalization levy is charged at the rate of 6% of the consideration for the service. While most such levies imposed across the globe are maintained a low rate and have a specifically identified scope, they have become a popular recourse taken by many countries frustrated with the slow progress in the development of a permanent solution. Countries that have gone ahead and implemented unilateral measures include Australia, Italy, Austria, Malaysia, and many others. In the author’s view, the proliferation of such levies played an important part in propelling the development of a broad consensus towards devising a globally acceptable mechanism to tax the digital economy in 2018.

It is then that international agreement on the market jurisdiction’s contribution to value creation, and the consequent need to reassess existing international tax principles to reallocate taxing rights began to develop. As a way to implement this change, three conflicting proposals were tabled by three distinct sets of countries. The U.K. along with other European nations proposed the User Participation approach, the U.S. proposed the Marketing Intangibles approach, while India, along with other developing nations proposed the Significant Economic Presence approach. These approaches were based on different policy rationales and adopted contradictory views on the scope of the new taxing rights.
In an attempt to bridge the gap and reach a compromise, in October 2019 the OECD Secretariat developed the ”Unified Approach” (UA) which was a non-binding outline of a mechanism to tax the digital economy. The UA was based on commonalities between the three conflicting proposals. It sought to find a middle ground between them to conceptualize a potentially universally agreeable mechanism.

It categorically recognized that a complete absence of consensus would have a catastrophic impact on businesses in the digital ecosystem as it would lead to double taxation and undermine the principles of international taxation. Even though many of the proposals made by the OECD Secretariat in the UA were widely criticized during public consultations, the UA was still generally viewed as a tool that would unlock real negotiations about an actual concrete plan to address the existing tax challenges.

Then in December 2019, when the OECD’s efforts to engage with stakeholders for feedback on the UA were in full swing, the threat of unilateral measures caused another escalation. In an unprecedented move, the U.S. reacted to the French digital services tax with a threat of imposing a tariff of up to 100% on imports from France. This time, instead of catalyzing negotiations, unilateral measures appeared to dampen all hopes of arriving at a consensus.
Eventually, a truce was brokered between the two countries. In January 2020 the U.S., France, and the other 135 countries that constitute the Inclusive Framework reaffirmed their commitment to bridge the remaining differences and reach an agreement on a consensus-based solution to tax the digital economy by the end of 2020.

It is relevant to underscore that building global consensus among stakeholders that have different economies and policy priorities is a mammoth task, especially when it involves limiting a sovereign function such as taxation. Further, the inherent asymmetry between developed and developing nations has been known to compromise international negotiations in the past and the OECD has been popularly branded as the rich country club. However, on the issue of digital taxation, the OECD has been fairly balanced in its approach, and significant progress has been made towards building global consensus. In the author’s view, it is plausible that unilateral measures played a critical part in the state of play.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Vidushi Gupta is a Senior Resident Fellow and the Lead of the Tax Law Vertical at the Vidhi Center for Legal Policy. The views expressed in this article are personal.