INSIGHT: Global Taxation and the Digital Economy—Where Do We Stand?

Whilst every country has the right to set its own domestic tax policies, globalization is making it difficult for them to be designed in isolation. Policies are increasingly having to interact with each other, especially in the digital economy where businesses have a presence in multiple jurisdictions across the world.

With so many varying factors in play affecting how tax works in different countries, including political and economic consequences, it is more necessary than ever to consider the value of multilateral legislation.

The World Stage

There has been a lot of talk over the course of the last year around the need for a new Digital Services Tax (DST). Criticism of the current tax rules has stemmed from the opinion that the current system does not accurately reflect the relationship between where a business’s profits are taxed, and the location where the value has been created.

The Organization for Economic Co-operation and Development (OECD) has been working to level the tax playing field in all areas from a global perspective, and its BEPS Action Plan outlines the need to support existing legislation that prevents double taxation with measures that prevent low tax, or in some cases, none at all. Put simply, it aims to tackle the fact that a business might have a digital presence in another country, without being liable to taxation there.

It is easier to see how this applies to digital businesses like social media platforms or search engines, as they generate revenue in jurisdictions outside of where they are headquartered. However, given the changes to the economy and the resulting impact on business models, in order for this tax to be effective, it should not be limited solely to the “digital economy” in its most traditional sense. This tax should also apply to certain corporations that might not necessarily be labeled as “digital” in the first instance.

The OECD has set out a “two-pillar” approach which is focused on achieving a long-term solution.

Pillar One addresses a jurisdiction’s right to tax digital businesses that they would not have been able to previously, if the business was not physically present in their region. The proposals under Pillar One would bite, for example, on a U.S. retailer who only had physical department stores in the U.S. but allowed U.K. shoppers to buy their products online. If the revenue from these sales surpassed the threshold, it would be liable under the incoming U.K. Digital Services Tax (U.K. DST), despite not being thought of as a traditionally “digital” business.

Pillar Two looks at having an overall minimum level of taxation for digital businesses. This would give jurisdictions the right to “tax back” when the business has not met the required minimum, and has in essence been undertaxed. The rule would also allow jurisdictions to tax a business when other jurisdictions have not exercised their primary taxing rights.

The aim was for there to be a multilateral consensus on a long-term solution by 2020. However, whilst the OECD continues to work on the details of such a measure, jurisdictions such as the U.K. have taken matters into their own hands by introducing an interim DST.

Focus on the U.K.

Coming into effect from April 2, 2020, the U.K. DST will be charged at a rate of 2% and will apply to all enterprises deriving revenue from the provision of social media platforms, search engines or online marketplaces to U.K. users. As it stands, the issue for the U.K. is much the same as it is globally—the U.K. corporation tax provisions leave a discrepancy as to where the actual value is created and where a business’s profits are taxed.

The U.K. DST also aims to address the fact that some national enterprises are allegedly paying smaller amounts of tax in the U.K. by funneling business through low-tax countries such as Luxembourg. To put it into perspective, the legislation is expected to raise at least 275 million pounds ($357 million) in the 2020–21 tax year alone.

However, it has not come without criticism. There is a minimum revenue threshold that must be met before the U.K. DST applies: a firm’s global revenue must exceed 500 million pounds, and any revenue attributable to U.K. users alone must exceed 25 million pounds. The concern is that these minimum figures are too low, and risk small companies falling within the scope of the legislation alongside the multinational enterprises it is actually aimed at.

For the U.K.’s tech start-ups, as an example, this may mean any investment in their businesses could fall under the DST’s scope and make them liable to pay additional tax. Not only could this suppress innovative future plans, it could also put the U.K.’s reputation as a leading start-up hub at risk.

The tax also comes at a critical time politically. The U.S. has already made its position clear when it comes to the taxation of its tech behemoths. France has made great strides in the implementation of its own digital tax, which was met by an instant threat of retaliation measures on French products, including a 100% tariff on certain French goods. Therefore, it comes as no huge surprise that the U.K. DST has not been welcomed by the Trump administration either.

Other jurisdictions, such as Spain and Italy, have also followed suit and are implementing their own unilateral measures. It’s unclear what the reaction to these will be, but it would not be surprising if the EU stepped forward in 2020 with a directive to reduce the risk of its members implementing multiple different versions of the same legislation.

2020 Vision

Mirroring the concerns of the U.S., certain commentators worry that the imposition of a global DST will hinder international trade. Due to the nature of the current economy, such a tax may also be wide reaching and catch multinational corporations from all sectors and industries. As such, there already needs to be further clarification from the OECD as to which businesses will be included, and indeed excluded, from such a tax.

Currently, the proposals include “highly digital business models,” but also aim to focus on “consumer-facing businesses,” so more understanding is required on what this means in practical terms. Further questions also remain on how existing tax rules will be modified to allow the taxation of nonresident companies.

In practice, this tax must also balance the needs of businesses against legislation that would work for the jurisdictions in question. Digital businesses may themselves prefer a centralized approach, rather than having to comply with an array of different regimes in each jurisdiction they operate in.

On the other hand, each country might have a different set of needs, and a global policy might not fulfill these. Achieving a consensus by the end of 2020, as the OECD suggests, seems too ambitious. Setting out a global policy will require a lot of thought regarding the political, legal and administrative complexities, so undoubtedly more time is required.

The process of tackling this issue is complex, not least because everyone involved would prefer a different solution. The OECD must balance the concerns of smaller businesses so as not to stifle innovation and investment in tech start-ups, but also has to address the fact that some multi-billion-dollar businesses are not paying enough tax in countries in which they generate a significant amount of revenue. The long-term solution is a streamlined implementation of a global DST and reform of global tax rules through the G-7 and G-20, but until then, it is likely more countries will follow in the U.K.’s footsteps.

Arun Birla is a Tax Partner and Chair of the London Office at Paul Hastings, the international law firm.

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