As the OECD/G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) pursues reform of the international tax system, should a third pillar of the reform be classifying Digital Services Taxes (DST), structured as gross receipts taxes in lieu of net income taxes (DS(GR)T), as a harmful tax practice. Such an approach would prevent such DSTs from being imposed by IF members, subject to peer review, thus preventing potential double taxation and increased complexity and compliance costs.
Action 5 of the BEPS Action Plan committed the Forum on Harmful Tax Practice to improve transparency and require substantial activity for any preferential regime. It required compulsory spontaneous exchanges of information between tax administrations for six categories of potentially preferential tax rulings, plus elaborated substantial activity factors to preferential regimes, including IP or “patent box” regimes. As a mandatory action, countries in the Inclusive Framework have repealed or modified non-compliant IP regimes to comply with the prohibition against harmful tax practices.
The OECD Secretariat’s Unified Approach Pillar 1 to expanded economic nexus and greater allocation of taxable net income to market jurisdictions should address many of the concerns of countries with DS(GR)Ts (e.g. France, Italy, Austria, UK, and others) about significant remote sellers not paying corporate income tax on their local economic activity. This alleviates the need for a gross receipts tax to substitute for net income taxation.
Some tax law academics have argued that a DS(GR)T might be justified as a way of taxing corporate rent (“excess profits”), since the marginal cost of expanding digitally and remotely into an additional country is close to zero. Thus, certain incremental gross receipts are close to incremental net income, and those profits are over and above the required return for investment, and thus close to “economic rent” or “excess profits”. While this might be true for incremental expansion into one country, gross receipts greatly overstate net income for the enterprise.
Improving the international tax rules with economic nexus and allocation of consolidated net income among all countries with economic nexus makes much more sense than a DS(GR)T. A complementary pillar to Pillar 1 could be to treat DS(GR)Ts as a harmful tax practice that should be prohibited for IF members.
A digital services tax, however, could be an appropriate complement to countries’ value-added taxes (VAT), where “free” digital services are currently not subject to VAT, thereby placing “free” digital services at a competitive advantage to priced digital services and non-digital goods and services. In a two-sided business model, digital services companies receive advertising revenue to offset the cost of providing free digital services for users’ data and attention. Although a Nov. 2018 blog discussed how these barter transactions might be imputed to digital service users, an alternative approach would be for the digital services company to collect VAT on the advertising revenue as a proxy for the value of the “free” digital services provided to local customers. The DST should apply to the advertising revenue used to finance the provision of “free” services. Arguably, this could apply to non-digital services where subscription fees do not cover the cost of the provision of the services, so could include TV and newspapers. Instead of low tax rates designed to mimic effective income tax rates when applied to gross receipts, such as 3% in France, the DST should be subject to full VAT rates (e.g. 20% in France).
Tom Neubig