Multilateral agreement on digital service taxes needed to plug unilateral measures

With the increased digitalisation of the global economy, there is growing international focus on how to tax multinational corporations (MNCs) in the digital sector. While OECD/G20 Integrated Framework negotiations have been taking place for several years, some European and Asian countries have already proposed or enacted unilateral digital service taxes (DSTs) — highlighting concerns that digital sector MNCs are not being taxed appropriately and that efforts at the OECD have stalled.

DSTs apply to companies that sell digital services to consumers in a particular jurisdiction, and they are generally imposed on the gross revenues of companies that meet a certain revenue threshold. According to KPMG, over 40 countries have enacted or are considering DST measures. Given the size of US multinational companies, the US Trade Representative (USTR) Katherine Tai is concerned that DSTs might not only disproportionately impact US companies, but also may lead to double, or even triple, taxation without receiving any foreign tax credits for paid DSTs.

US President Joe Biden, who shares some of Europe’s concerns over digital MNCs, has been pushing for the MNCs to pay their fair share of taxes based on their sales in each country as part of a proposal for a global minimum tax. Furthermore, the Biden administration has increasingly tied the OECD negotiations to the domestic debate.

Nonetheless, the Biden administration announced in March 2021 the next steps in its investigations under Section 301 of the US Trade Act of DSTs implemented by several US trading partners. According to the proposal, the USTR is considering whether to impose a 25 per cent tariff on goods totalling US$880 million from Austria, India, Italy, Spain, Turkey, and the United Kingdom. In early May, the USTR held several hearings where many US industry groups urged the US government to resolve the issue at the OECD instead of imposing retaliatory tariffs.

The USTR also suspended tariffs on US$1.3 billion worth of French goods set to take effect in January 2021 in retaliation for France’s DSTs, the subject of the USTR’s first DST investigation in 2019. The USTR has noted that suspending Section 301 tariffs on France is a way to coordinate the response for the ongoing six investigations. There was also bipartisan support in Congress for the Trump administration initiating the investigation into DSTs.

In January 2021, USTR issued the findings of its investigation into the DST measures adopted by the six countries. The Section 301 report provided similar results in each of its inquiries, and concluded the DSTs were actionable under Section 301 for the following reasons: (1) discrimination against US digital companies, (2) inconsistencies with the principles of international taxation, and (3) burdens or restricts US commerce.

While both US Treasury Secretary Janet Yellen and USTR Katherine Tai have expressed their commitment to focus on ongoing OECD negotiations, the latest action can be seen as the Biden administration preserving options under US law to impose additional tariffs. An important indicator for possible tariff hikes is whether the OECD misses its mid-2021 deadline to reach an agreement.

The USTR also terminated four other investigations against Brazil, the Czech Republic, the European Union, and Indonesia, finding that none had implemented an actionable DST. Those investigations could be launched anew if countries were to impose DSTs.

Considering that Section 301 measures were meant to go out of style with the creation of an enforceable dispute settlement mechanism at the World Trade Organization (WTO), the Biden administration’s approach of threatening tariffs for leverage while simultaneously negotiating a trade deal shows some similarities with Trump’s playbook, and such a tactic may be here to stay.

While the USTR has yet to initiate a consultation at the WTO, it is plausible that the United States could prevail in a WTO case challenging France’s DSTs. On the other hand, while dispute settlement panel procedures are still progressing at the WTO, given that the Appellate Body is still missing judges due to the United States having blocked appointments, and that countries have not been able to agree on a solution that could fix some critical issues, appeals could remain unresolved in perpetuity.

US and EU interests have increasingly converged since President Biden took office. In February 2021, Secretary Yellen made concessions related to ‘safe harbour’ rules, which were seen as a major obstacle in the negotiations at the OECD. Furthermore, the European Union seems to be backing Secretary Yellen’s proposal for a global minimum corporate tax.

While it is unclear how the agreement at the OECD will take shape, it seems as though the Biden administration is playing a two-level game. Attempts to push forward an agenda that would require other countries to increase their corporate taxes would, in turn, manifest a similar push in the United States to better effectuate domestic tax policy.

With both the United States and Europe staggering to find more tax revenue to offset the mounting debt in response to the COVID-19 pandemic, it seems likely that digital sector MNCs will see tax hikes in the near future — whether through unilateral DSTs and retaliatory tariffs or a multilateral agreement. Countries need to hold off on further unilateral escalation that could hamper economic recovery and opt instead for the multilateral solution.

Source: East Asia Forum