By Sean J. Brennan, CPA
International tax and trade politics have been center stage for the Trump administration. Many observers believe the present “trade war” is a necessary conflict to correct previous policy; others believe that it is overly aggressive and cynical. Regardless, trade wars are a significant matter of economic struggle. But there is another matter of changing international tax policy that is vying to become an even more important political and economic concern.
The economic clash between international tax authorities and large multinational companies is called base erosion. Base erosion is the concern or consideration that multinational companies have or may have deliberately established foreign headquarters (foreign to the place of the firm’s establishment) to take advantage of those countries’ tax laws, enabling significant effective tax rate reductions. It has been estimated that base erosion and profit shifting (BEPS) schemes have cost the international community 240 billion U.S. dollars, or 10% of global corporate tax revenue.
France recently joined the ever-expanding list of countries that are addressing the ongoing economic struggle of corporate income shifting and effective tax rate reduction schemes by creating a digital services tax (DST). The French enactment of the DST represents a major escalation in tax policy conflict.
DSTs seek to minimize the ability of these firms to avoid paying taxes and to establish a true tax nexus, or tax-paying location. A DST is often referred to as a turn-over tax or gross receipts tax. The United States does not have a true federal gross receipts tax or DST; however, 23 countries presently have some form of DST based on gross receipts.
But why France, and why now? The short answer: timing.
The creation of the French DST comes from a desire to eliminate what is perceived to be the low effective tax rates that some large tech companies are believed to have created, and to manage its substantial tax gap and base erosion issues.
Agreement from every European Union (EU) member would be required to enact a common market DST. However, intransigent EU partners, such as Ireland, Luxembourg, and the Netherlands, continue to block DST enactment. These countries have many large tech companies that would be adversely affected if the tax were enacted, and these governments are being pressured to resist any change to present EU tax laws.
So, France decided to go it alone on the matter of DST enactment, and try to force the rest of the EU and the United States to negotiate faster. The French unilaterally passed a 3% tax on the gross receipts of large tech companies, primarily American.
The United States, vigilant for changing international tax and trade policy, announced on July 10 that it would “launch a probe of the digital services tax … to determine whether the tax is discriminatory or unreasonable and burdens or restricts United States commerce.”
The French have said the unilateral enactment of the DST was not “an attempt at targeting American companies,” and it would “withdraw the tax if an international agreement was created.”
Interestingly, the United States has already agreed in principle to the idea of cooperating with the rest of the world to address the international taxation of large tech companies. The Organisation for Economic Co-operation and Development (OECD), of which the United States is a member, has been tasked with implementing a new strategy for international taxation. On March 5 of this year, the OECD announced that the international community has “agreed on a road map for resolving the tax challenges arising from the digitalization of the economy, and committed to continue working toward a consensus-based, long-term solution by the end of 2020.”
While the timeline for OECD is 2020, the French want to get a deal on the issue at the G7 meeting to be held in France Aug. 24-26. The likelihood of a deal is not great, considering the United States has just opened the aforementioned DST investigation.
The OECD road map calls for “intensifying discussions around two main agreement pillars.” These pillars are:
- Determining where a tax should be paid (nexus)
- A system design for taxing all multinational entities that creates a “minimum tax level”
If a tax system can ultimately be agreed upon (i.e., a gross receipts tax regime), it will become a dog fight to decide where the DST will be paid. Thus, an August agreement would be a bad idea for the United States before all details are understood.
The ramifications for the DST, given the immense complexity, extend well beyond traditional matters of international taxation. Concerns of national sovereignty and autonomy are interwoven into the nexus discussion; given the present international political climate, this should not be ignored.
An additional complication is the nearing U.S. presidential election. Several candidates have embraced the idea of a DST; foremost is Elizabeth Warren, but Bernie Sanders and, to some extent, Donald Trump also envision a DST. Others oppose the tax on grounds of “ceding control of our government to other countries.”
On the surface, it may appear that political candidates are grabbing the low-hanging fruit by adopting such a populist tax theme (the taxation of the largest multinational tech companies as a means for generating tax revenue), but the idea has some business community support and a basis in current tax law.
Detractors say that the DST unfairly targets U.S. companies because the present DST tax begins at relatively high gross revenue amounts, and a disproportionate number would be U.S. companies. Others argue that the claims of large tech companies paying a lower effective EU tax rate (by half) compared with traditional businesses is simply wrong. An analysis by the European Centre for International Political Economy (ECIPE) finds that “digital businesses pay slightly higher average effective tax rates than traditional businesses.”
Here is how an EU commission report and the ECIPE report compare:
EU Commission Report Effective Rate
ECIPE Report Effective Rate
However, the ECIPE study says the authors of the EU report used “hypothetical data” while the ECIPE study used “real industry data.” Regardless, a disparity of this magnitude in the data warrants further research and study.
But a DST already raises significant questions for policymakers: Is it a good idea to start singling out one specific industry for special taxation? Then, if that can be satisfactorily answered, the old problem of national sovereignty arises, especially among smaller national economies.
From a purely political perspective, I think the French were correct in pushing now for some DST agreement. It suits their best economic interest to have a deal now and the timing works as the G7 meeting will be in France. I also believe the French are seeing the big economic picture.
The economic world is fracturing regarding DST. Many countries have a DST, and once these taxes take hold in each international economic domain, undoing those taxes and building an international consensus on a new tax regime will become much harder.
The French may force its recalcitrant EU partners back to the table if they manage to persuade the United States that the timing for DST makes sense now, before an uninhibited United Kingdom implements its own DST.
The DST is a complicated matter that requires intense review and negotiation. However, given the ongoing trade war with China, a recent Chinese currency devaluation, and the approaching U.S. presidential election, a comprehensive DST agreement may simply become a casualty of “too many irons in the fire” for the United States.
Sean J. Brennan, CPA, is president of Brennan and Company CPA PC in Philadelphia and past chair of PICPA’s Federal Taxation Committee.
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