PLUS – What Are Other Countries Doing?
From a variety of tabled proposals in the European Union (EU) Parliament to the US Supreme Court’s 2018 Wayfair sales tax ruling, nations have been struggling for years to come up with equitable taxation rules for the digital age. Most recently, France has drawn international attention and criticism by levying a new tax aimed at big tech companies.
Most tax codes still primarily tax companies based on the location of their physical facilities, rather than on where a business actually generates revenue. Because digital transactions such as ad hosting or selling user data are not anchored to any specific place, tech giants can exploit loopholes in the current system.
After years of intense debate, it seems that several nations are determined to overhaul their tax laws to close the loopholes. And at least one country is willing to fight the battle alone.
In July of this year, France implemented the most aggressive tax crackdown to date on major digital companies, in the form of wide-ranging 3% tax on revenues. With that, President Emmanuel Macron stood by his 2017 vow to start making digital tech giants pay their fair share of taxes.
How digital commerce created a need to modernize the tax system
Companies don’t necessarily need a physical presence in a country in order to do business there. This reality has made it possible for multinational corporations of all types to sneak through tax code cracks for years. However, tech companies can operate outside of traditional taxation boundaries with far greater ease than traditional businesses.
By operating in virtual spaces, many tech companies are able to channel revenues generated by user activity in high-tax countries into lower-tax jurisdictions. According to 2018 figures from the European Commission, global tech giants pay a 9.5% average tax rate, compared with 23.2% for traditional firms.
To combat this inequity, the European Commission has proposed various taxation systems based on where a company’s users are. This approach would allow countries to tax businesses where they actually operate, rather than just where the companies are officially headquartered.
One tax law proposed by the European Commission also includes another key component: ensuring that there is a minimum tax rate across the union. By narrowing the tax gap between various jurisdictions, the law would reduce the incentive to transfer sales to a region with lower tax rates.
“Your click triggers a whole chain of commercial transactions and therefore generates substantial profits that most economies do not tax,” said Pierre Moscovici, the EU Commissioner for Economic and Financial Affairs, Taxation and Customs. “This legal loophole is no longer acceptable.”
France leads the charge for reform
France has been pushing for tax reforms that force tech giants to pay more since at least May of 2017, when Macron took office. Macron pledged to pursue broader taxes on digital commerce as a centerpiece of his presidency. At the same time, he has also championed tax law changes favorable to French businesses and entrepreneurs, including dramatically cutting the nation’s wealth tax and replacing a progressive capital gains tax structure with a flat rate.
In 2018, Macron told a large crowd at the annual VivaTech conference that, “A lot of [France’s] startups are competing with large corporates, and [the startups] tell me, ‘I pay tax in France.’ We are decreasing taxes, fine. But it’s not fair with somebody else paying no tax… I will fight till the end for this European Digital Tax for big players. I think it’s fair.”
In an effort to achieve that fairness, the French government suggested an EU-wide 3% tax on digital revenues from activities like ad sales and the sale of user information. The proposed tax is novel in multiple ways – most notably, the 3% rate is applied to revenues (without expenses deducted), rather than to profits.
French officials characterized the proposed digital tax as an interim measure that would run until 2025, with the hope that by then, an equitable global tax system for tech giants would be put into effect.
Desiring a united front within the EU, France proposed this plan to all 28 European Council members and their finance ministers in early 2018. Under EU law, implementing the policy would have required unanimous agreement among all council members. Generating that agreement proved to be a hurdle that France could not surmount.
Resistance within the EU to the French tax plan
Smaller nations such as Ireland and Luxembourg had misgivings about the 3% levy from the outset. Both these nations are ranked among the world’s top tax havens. Ireland, for example, has a base corporate tax rate of 12.5%, 10% lower than the average rate in Europe. This disparity acts as an incentive for tech giants to channel revenues through the Irish economy.
As a result, Ireland serves as the European headquarters for several tech giants, including Google and Facebook. So far, landing these big fish has been well worth taxing companies at a lower rate overall – Facebook reportedly paid 38 million euros in taxes in Ireland last year.
However, increased government revenue is not the only factor that makes it attractive for a country to host a major tech company. Big companies bring a lot of jobs to any region where they set up shop, and governments often value job growth above almost all else. It is reported that Apple and Ireland struck a deal in the early 90s, under which Apple would maintain its operations in Ireland as long as the country only taxed a portion of the company’s earnings.
At the time the alleged agreement was reached, Apple had already hired 1,500 employees, contractors and subcontractors in the small Irish city of Cork. The situation is now being investigated by the European Commission, which alleges that the deal allowed Apple to receive 13 billion euros in illegal tax aid over two decades.
In their public opposition to the French tax proposal, Ireland and several other nations have warned that the tax would further escalate trade tensions between the US and EU. Those tensions have ramped up significantly since US President Donald Trump imposed on European goods in June of 2018.
The Swedish, Danish and Finnish governments also questioned the fairness of taxing revenues. “A digital services tax deviates from fundamental principles of income taxation by applying the tax on gross income, i.e. without regard to whether the taxpayer is making a profit or not”, the nations said in a joint statement in mid 2018.
France issues an ultimatum, then unilaterally enacts digital tax
In response to the pushback from within the Bruno Le Maire said in December 2018 that France would give the EU “…until March [of 2019] to reach a deal on a European tax on the digital giants.” Le Maire went on, “If the European states do not take their responsibilities on taxing the GAFA [Google, Apple, Facebook, Amazon], we will do it at a national level in 2019.”
This aggressive push came around the same time as the Gilets Jaunes, or Yellow Vests mass demonstrations in France. The movement arose in protest to France’s high cost of living and the tax burden borne in the country by the working and middle classes.
Meanwhile, other nations around the world joined the push for tax reform for the digital age. Early in 2018, the Finance Ministers requested that the present an interim report on “the implications of digitalization for taxation” by mid 2018.
In July 2019, France’s Senate approved the 3% digital tax for companies that generate global digital service revenues of at least 750 million euros ($845 million US).
The tax will impact roughly 30 major companies, mostly based in the US.
“France is sovereign, and France decides its own tax rules. And this will continue to be the case,” Le Maire said in an official statement. However, the newly enacted law specifies that the tax is to act as only an interim measure until a unified taxation system is adopted by OECD members.
The US reaction – Trump threatens retaliation
Shortly after French Senate’s initial vote on the law, Trump ordered US trade representative Robert Lighthizer to investigate the French tax, claiming that it was “discriminatory” against the US and US companies. He also threatened to retaliate by imposing a tax on French goods, including wine. The US market accounts for 20% of French wine sales worldwide.
Alarmed by the threat of a tax on the country’s second-largest export, Le Maire responded by urging Trump to “…not mix the two issues.” Le Maire then told senators ahead of a final vote on the tax, “Between allies we can and should solve our disputes not by threats but through other ways.”
US-based Amazon “applauded” and “thanked” the Trump Administration, publicly stating that the French tax is “poorly constructed” and “discriminatory.” A company spokesperson added that it would lead to “significant harm to American and French consumers alike.” Amazon has recently come under heavy scrutiny within the US, after the public caught on that the $793-billion dollar company once again did not pay a single dollar in US corporate taxes in 2018.
Other tech giants such as Facebook, Airbnb, Google and Twitter publicly expressed their agreement that the levy is “discriminatory” and “retroactive” (since the tax applies from the beginning of 2019, despite being enacted midway through the year). In mid August, representatives from Google, Amazon, Facebook and other companies testified in a government hearing as part of the US investigation of the levy.
In the hearing, Alan Lee of Facebook stated that taxing companies for previous earnings is something they have “…never seen.” Google’s Nicholas Bramble claimed that the tax only applies to a handful of internet businesses, even though every economic sector is being digitized. In his view, only taxing one part of the digital economy “doesn’t make sense.”
Meanwhile, Austria, Spain, Italy and the UK have now announced plans to implement digital taxes.
The OECD report and the global picture for digital services taxes
In late March of 2018, the OECD released the interim report previously requested by the G20 on the various digital tax options available to members. The report was then agreed to by 110 members of the Inclusive Framework – a framework established in the hope of bringing together 130 countries and jurisdictions to reduce tax avoidance worldwide.
The central goal of the framework is to ensure that profits are taxed based on where business activity truly occurs, and thus where revenues are generated. Strategies outlined in the OECD report include implementing various standards and practices to mitigate the effects of existing gaps in tax rules.
However, the report also acknowledged that OECD members do not all agree on how to best combat tax loopholes, stating that “…at present, there are divergent views on how the issue should be approached.” Stressing the need for continuing research and negotiation, the report noted that it has been “… agreed that the Inclusive Framework would carry out this work with the goal of producing a final report in 2020, with an update to the G20 in 2019.”
The OECD also expressed reservations about the desire of France and other governments to adopt interim measures, stating that “There is no consensus on the need for, or merits of, interim measures.”
Earlier attempts by the European Commission for EU-wide tax reform
It is important to remember that France undertook unilateral action to tax large digital companies only after multiple failed attempts to enact a similar plan throughout the EU.
In early February 2018, Commissioner Moscovici of the EU announced his plan to “create a consensus and an electroshock” on taxing digital firms. As with the French measure later enacted, Moscovici’s interim plan would have placed a 3% tax on revenue generated from digital activity, including online advertising and the sale of user data. Also like France’s new law, the tax would have only applied to companies with a global revenue of €750 million ($920 million US at the time).
A second measure, described as the “preferred long-term solution“, was introduced into the EU debate in March 2018. This proposal involves taxing digital profits wherever they are generated, regardless of whether the company has a physical presence in that particular country.
In order for any such measure to be adopted, it must be approved by both Parliament and the EU Council. While members of the European Parliament (MEPs) agreed to these interim tax measures by an overwhelming majority, there was far less unity within the Council.
France, Italy and Spain remain in favor of implementing one or both EU-wide reforms, but other members such as Ireland, Finland, Sweden and Denmark still maintain their opposing stance.
Developments at the 2018 G20
At their Buenos Aires Summit on November 30-December 1, 2018, G20 leaders expressed their political support for adopting greater tax transparency standards. In a communiqué, they stated that they “will continue to work together to seek a consensus-based solution to address the impacts of the digitalisation of the economy on the international tax system, with an update in 2019 and a final report by 2020.”
The G20 met again in June of this year in Osaka, Japan, and as expected, one of the first items on the agenda was a more effective digital taxation system. The summit report stated that “Agreeing on a sustainable and workable solution will demand political engagement and compromise and the G20 leadership can be instrumental in this process. In order to meet the G20’s deadline of 2020, political agreement needs to be reached soon on the fundamentals of the solution.”
The report included several proposed initiatives to modernize the global taxation system through enhanced financial data sharing. Recommendations including automatic exchange of information (AEOI) and exchange of information on request (EOIR) are now awaiting member endorsement.
Macron announces a US-France compromise at the 2019 G7
After the Group of Seven Summit (G7) in late August 2019, Macron announced through a translator that he and Trump had arrived at a compromise regarding the controversial tax. The announcement came amidst tense trade negotiations, and only a week after Trump announced his confidence that the EU would give the US anything it wants, since all the US needs to do to force Europe’s submission is tax European cars.
It was not the first time that Trump has joked about or mentioned a tariff on automobiles imported from the EU.
Just prior to attending the G7, Trump also criticized the French tax once again, reiterating his intention to tax French wines.
The details of any Trump-Macron compromise remain unclear, but France is promising to terminate its big tech tax as soon as a more effective tax system is implemented by the OECD. Macron has also pledged that once the shift to an OECD-wide tax plan occurs, France will reimburse any company that has overpaid under the French system.
In other words, if Google ends up paying more under the current 3% French tax than it would have paid under whatever framework the OECD later puts in place, the French government will refund the difference to the company.
While Macron expressed his satisfaction with the agreement with Trump, Trump didn’t confirm that the US and France had reached any agreement at all. When replying to a CNN reporter’s question about the status of the French tax, Trump responded only by saying, “I can confirm that the first lady loved your French wine. She loved your French wine. So thank you very much. That’s fine.”
For now, France remains a lone wolf in the realm of digital-age tax reform, although a few other countries might join the movement soon. Both Spain and the UK are in the midst of adopting interim measures. However, most other countries appear content to wait for decisions to be made at the OECD level.