Digital services taxes face barriers
The digital services tax, or DST, is attractive not just to countries but also to smaller political subdivisions around the world. And the revenue shortfalls generated by the COVID-19 pandemic have made the attraction even more intense, according to George Salis, principal economist and tax policy advisor at Vertex.
The DST was conceived as a way to tax U.S. technology companies that don’t have a physical presence in a jurisdiction yet earn significant revenue in the jurisdiction.
Internationally, discussions focus on getting U.S. involvement in the OECD efforts to forge a consensus on taxing the digital economy, he explained: “The OECD has a two-pronged approach to global taxation of digital companies, spelled out in two ‘pillars’ — Pillar One and Pillar Two. The problem is they have to agree to Pillar One to move forward on Pillar two. They want to be finished with Pillar One by the end of 2020, but in reality discussions on Pillar Two have been going faster, but they can’t finish without Pillar One. One is intrinsically tied up with the other.”
Pillar One concerns actual taxation of digital services companies. It involves reallocation of profit and revised nexus rules. It will explore where tax should be paid and on what basis, as well as what portion of profits should be taxed in the jurisdictions where clients or users are located.
Pillar Two contains an anti-base erosion mechanism, in order to ensure that multinational enterprises pay a minimum level of tax.
Other countries want the U.S. to become more involved in discussions of digital services taxes under the OECD unified approach, according to Salis.
“Recently the U.S. attempted to walk away from these discussions, particularly because they continued to insist on a safe harbor, and the Europeans don’t want a safe harbor for certain types of digital service companies,” he said. “In the meantime, several European countries decided to move ahead with their own digital tax regimes.”
“Of course, we know that the danger is that if the U.S. walks away from the global OECD table, then unilateral regimes will go into effect, some as early as October 2020,” he continued. “It will be the beginning of a very complicated trade war.”
At the heart of the dispute is the fact that the entities targeted under the various proposals are all U.S.-based multinationals. Section 301 of the Trade Act of 1974 grants the U.S. Trade Representative a number of responsibilities and authorities to investigate and take action to enforce U.S. rights under trade agreements. The U.S. has begun such actions under Section 301 regarding the levying of different kinds of tariffs on European goods, according to Salis.
“There’s a lot at stake for everyone,” he said. “If the U.S. drops out of talks, the EU and four main countries will enact unilateral digital tax regimes, but if the U.S. remains and we have a uniform approach, that carries less risk for American companies. Otherwise you’re left with individual national regimes, an increase of risk and also increases in the cost of doing business.”
It’s not just countries
“Digital taxes are coming, maybe to a neighborhood near you,” Salis said. “States and cities are considering the revenue possibilities from a DST. It’s still a tax on the digital economy, but it’s a different situation because states in the U.S. want to place a particular focus on certain digital services. So far Maryland, New York, Nebraska, and Kansas have all proposed digital taxes. Not one of them have been able to enact it yet. The one that came closest is Maryland, where the Democrat-controlled Assembly passed it but the governor vetoed it.”
“In the post-COVID fiscal situations, they will renew their consideration of how to draft these digital tax laws,” he noted. “This has to be done in a very careful manner if they don’t want to be challenged. They’re going to need the revenue when they try to fill out their budget offsets and gaps, but they face a constitutional minefield if they discriminate against digital media versus print or other types of media advertising. In addition, the Permanent Internet Tax Freedom Act is a potential barrier.”
“Traditionally, states have attempted to redefine or expand the state tax base by different types of sales and use taxes,” Salis said. “Other states already tax digital goods such as streaming, but within the parameters of sales and use tax. What’s different is crafting a new tax focused on digital advertising. That’s when they begin to encounter constitutional issues. In January 2020, Kansas proposed that marketplace facilitators collect tax on online sales from digital goods and streaming services, but they’re doing it within the purview of the sales and use tax regime so they can sidestep the constitutional challenges that the other three states will face.”
It is a mistake for states to model their proposed legislation after that of a foreign country, Salis advised. “Those countries don’t have the constitutional constraints or regulatory requirements the U.S. states have,” he said. “And there’s no guarantee that if the U.S. coordinates a global solution with the OECD that the challenges for U.S. states will go away. I would discourage U.S. states from modeling their legislation after foreign digital services taxes.”