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Digital Tax Deal Avoids Trade War, But Other Issues Remain

Oct. 21, 2021, 9:39 PM

A deal between the U.S. and five European countries on digital taxes will help avert a trade war—though broader questions remain about rolling back those taxes as countries work to implement a new global tax deal.

The deal will see the U.S. step back from the brink of imposing tariffs on Austria, France, Italy, Spain, and the U.K. over measures those countries have aimed at U.S. tech giants.

According to Thursday’s announcement, the five countries will remove their digital services taxes when the new global agreement goes into effect, and also offer a credit to companies for any digital tax they paid in the interim period above what they would have paid had the new global rules already been in effect.

The U.S. has trade investigations open against Turkey and India, which also have digital taxes, but those countries aren’t part of the deal. The U.S. will drop any pending tariffs against the five countries that signed on, but it’s unclear what will happen in the standoff with the other two. The suspension on those tariffs is set to end Nov. 29.

Thursday’s agreement addresses one of the biggest remaining issues in the global tax talks, but there are still open questions on digital tax rollbacks under the global deal—including which other national digital tax measures will have to be repealed.

The Computer and Communications Industry Association, a trade group representing technology companies, said it would have liked to see an immediate withdrawal of the DSTs, but it welcomed Thursday’s agreement.

“It is encouraging that the new consensus on global tax reform already appears to be reducing international tax and trade tensions,” said Matthew Schruers, the group’s president, in a statement.

How did we get here?

Over the last few years, a number of countries enacted new measures to tax a segment of digital revenues, driven by concerns that tech giants weren’t paying enough tax in some of the countries where they had big user bases.

In return, the U.S. opened trade investigations—and eventually threatened tariffs— against Austria, France, Italy, Spain, and the U.K., as well as Turkey and India.

Meanwhile, after years of negotiations, 136 countries agreed earlier this month to a global tax plan that calls for the immediate freeze and eventual removal of unilateral measures like digital services taxes.

Thursday’s agreement saw the five countries agree to drop their digital taxes when part of the global deal goes into effect—Amount A—which reallocates a portion of the profits of the largest and most profitable multinationals to more countries.

VIDEO: In this video from 2020, Bloomberg Tax’s Isabel Gottlieb explains how digital taxes work and why they became so controversial.

What will happen under the Oct. 21 agreement?

The five countries with DSTs will keep their taxes on the books for the next two years or until the global deal’s Amount A, the reallocation rules, is in place.

Thursday’s deal also outlines a credit system for companies that will go from paying DSTs to paying Amount A taxes.

Companies in-scope of Amount A will receive a credit to apply against future Amount A taxes. The credit represents the difference between what they paid under the DST and what they would have paid under Amount A, if the DST payment is higher.

Which companies—and which taxes—are covered?

Amount A targets the biggest and most profitable multinationals, across most industries: Companies making more than 20 billion euros in annual revenue, and with a greater than 10% profit margin.

The thresholds for inclusions in different countries’ digital taxes vary, but they’re all lower than the Amount A threshold. France, for example, applies the tax to companies making more than 750 million euros in annual revenue worldwide, and more than 25 million euros per year in relevant revenue in France.

That means some companies in-scope of digital taxes won’t be in-scope of Amount A—meaning they likely won’t be able to use the credit, because it only applies against future Amount A taxes. That includes both smaller tech companies, as well as ones that aren’t profitable, or have a low profit margin.

“It’s silent on the treatment of anyone that doesn’t fall in scope,” said Barbara Angus, global tax policy leader at EY. “Now you have companies not in scope under Pillar One who will continue to have DSTs in place until the ultimate implementation.”

For those companies, today’s deal does offer relief: the promise of an end to DSTs, said Daniel Bunn, VP of global projects at the Tax Foundation.

Thursday’s deal does include a provision that allows companies to grow into being in-scope of Amount A for four years after Pillar One comes into effect, before they lose the ability to use the credits.

The six-country agreement also allows companies to carry credits forward, if their amount of credit exceeds their Amount A liability.

What else do we need to know?

The governments involved welcomed Thursday’s agreement, which they said would ease heightening trade tensions.

But negotiators working on the broader global deal—and the U.S.—still have important questions to answer about digital taxes.

Thursday’s deal doesn’t clearly define what an unacceptable “unilateral measure” looks like—a question being debated among countries working out the technical details of the implementation plan.

Negotiators will still have to decide which other national measures could eventually be blocked or targeted for repeal as part of the broader global deal.

What happens next?

This deal puts even more pressure on the ambitious timeline to implement the new rules within two years, especially in the U.S.

The Organization for Economic Cooperation and Development, which is leading the talks, plans to create a multilateral convention—a type of treaty—to implement Pillar One. In the U.S., tax treaties are traditionally passed through the Senate, requiring a two-thirds vote, but the Biden administration could have a difficult time winning enough Republican support. The administration may look to other avenues to implement Pillar One, but those would likely still involve Congress in some capacity, and bipartisan political support for the deal is far from guaranteed.

If the U.S. doesn’t implement the new rules, everything outlined in today’s deal could be in jeopardy: Without the U.S., Amount A rules may not be able to go into effect, countries wouldn’t withdraw their DSTs, and the companies in question wouldn’t get the credits, or see an end to the digital taxes.

To contact the reporters on this story: Isabel Gottlieb in Washington at igottlieb@bloombergtax.com; Michael Rapoport at mrapoport@bloombergindustry.com

To contact the editors responsible for this story: Meg Shreve at mshreve@bloombergindustry.com; Vandana Mathur at vmathur@bloombergtax.com

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