Digital services tax sparks controversy between U.S. and EU

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The movement of the United Kingdom, the European Union and other countries toward a digital services tax is in many respects exactly like the progression from Quill to Wayfair in the U.S., when individual states started chipping away at the nexus issue in order to protect their revenue from changing technology.

The U.K. announced on Oct. 29, 2018, that it would roll out a DST, which will impact major tech players like Google and Facebook starting in 2020, to the tune of 2 percent of revenue in the U.K. on search engines, social media platforms and online marketplaces.

In response, House Ways and Means Committee Chairman Kevin Brady, R-Texas, stated on Oct. 31, 2018: “The United Kingdom’s introduction of a new tax targeting cross-border digital services – which mirrors a similar proposal under consideration in the European Union – is troubling. Singling out a key global industry dominated by American companies for taxation that is inconsistent with international norms is a blatant revenue grab.”

“The ongoing global dialogue on the digital economy through the OECD framework should not be pre-empted by unilateral actions that will result in double taxation,” he continued. “If the United Kingdom or other countries proceed, that will prompt a review of our U.S. tax and regulatory approach to determine what actions are appropriate to ensure a level playing field in global markets.”

Countries in the EU are concerned that the growth of digital services is escaping the tax net, according to Richard Asquith, vice president for global indirect tax at Avalara: “The reason is that digital services can be provided across borders from a third country with a lower corporate tax. Services in the U.K., Germany, and France are losing a big slap of revenue to because of digitization.”

“Inevitably with the endless headlines of major U.S. digital giants making minuscule taxable profits on huge sales, the [U.K. chancellor of the exchequer] wants to be seen to act,” said Asquith, who is based in the U.K. and has studied global indirect tax for more than 25 years, including roles with Big Four firms KPMG and EY. “The lack of progress at the EU level is shown by Spain launching a similar proposal – but for 3 percent. But a DST will be difficult to implement practically. In taxing turnover instead of profits, it’s economically uncompetitive. It would also require heavy and intrusive data reporting and measurement – it’s not clear if that would get past the new EU GDRP data protection rules. But the bigger risk is retaliation from the U.S. which could use tariffs or similar taxes on U.K. businesses to greater effect.”

“There’s starting to be a fragmentation of proposals on how to tax digital sales,” he said. “The reason is that it would mean moving away from a corporate regime that taxes a company where it is located, to a regime that taxes where the consumer is. It would create winners and losers. The big countries would be winners, and the small ones, such as Ireland, Cyprus, Malta and Sweden, would lose out, so they can’t reach an agreement. And the U.S. just sees it as a tax grab.”

“The OECD is trying to come up with an agreement that would result in a proposal by March 2019, but there’s a lot of frustration around the slowness of the program and a lot of countries think there’s too much compromise in favor of the U.S.,” Asquith said. “So some countries in the EU, as well as the U.K., are starting to break away and come up with a unilateral measure. They think that pressure from the U.S. will result in a dilution of the OECD program. On top of this, there is the constant negative headlines in the media about the digital multinationals exploiting the weakness of the global tax regime.”

The EU’s draft proposal calls for a 3 percent tax on the sale of digital services that could potentially come into play in 2020, according to Asquith. “The U.K. proposal does not mirror the EU proposal,” he said. “It calls for a lower rate [2 percent] on a narrower range of services.”

“I expect other countries to break off,” he noted. “Other countries are making threats to make sure the U.S. doesn’t water down the proposal at the OECD. It’s a weaponization of tax – some see it as retaliation for tariffs from the U.S. I think of a digital sales tax as a tariff by European counties on U.S.-produced digital services. They don’t call it a tariff, they call it a tax – but if it walks like a tariff and talks like a tariff, it is a tariff.”

For Christiaan van der Valk, vice president of strategy at Sovos, the DST is part of a broader development in which tax administrations in the EU and globally catch up with the digital economy. “This is done both by adjusting direct tax rules to ring a fence around profitable digital business models and by mandating ‘cloud’ technologies to audit business transactions for value-added tax purposes in real time,” said van der Valk. “As tax administrations become more comfortable with modern technologies, we can expect these types of initiatives to accelerate in the coming years.”

Will the U.S. successfully protect its home-grown technology from a DST “revenue grab,” or is the digital services tax the wave of the future, just as remote nexus finally was sanctioned in Wayfair? Stay tuned.

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