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How to tax the invisible

12 March 2020

In a world where developed markets have all but stopped ‘making things’ in the pursuit of economic growth, the increasingly dominant digital services sector has put governments and tax collectors in a quandary. Is a digital services or sales tax now the answer?

For decades, the political and economic discourse in Western economies has bemoaned the lack of manufacturing. The shift to a post-industrial phase – which in the UK has led to 84% of jobs now in services – led to a refocusing of tax revenue policy to target high street concerns from retail to leisure; anything that takes up physical space. All this despite the UK remaining the ninth largest manufacturer in the world.

Cue the rise of digital services, however, and the model for tax has become rather complicated, putting a significant strain on traditional businesses. The e-commerce revolution, particularly in banking, clothes shopping, travel and gambling, has led to a situation where the business rates charged on a high street department store (not including London) could be in the region of £2m compared to an out-of-town warehouse used by an e-commerce giant at under £250,000.

So it is that the FAANG companies – a catch-all term for digital corporates including Facebook, Amazon, Apple, Netflix and Google – have been demonised by many in the media as having an unfair tax advantage as they conduct business across multiple geographies for a relatively small level of tax liability.

Faced with such a dilemma, governments have mooted a digital sales tax that would redefine liability and level the playing field. Though given their US origin, the FAANGs have found allies in Washington who criticise it as an unfair targeting of the American tech sector.

The OECD has been exploring a global solution as part of its Inclusive Framework on Base Erosion and Profit Sharing (BEPS) initiative, with a stated mission to “end tax avoidance strategies that exploit gaps and mismatches in tax rules to avoid paying tax”.

The core ‘tax efficiency’ strategy employed by companies, however, is profit shifting – a completely legal practice that is often a fiduciary requirement to maximise shareholder returns. Nevertheless, the OECD calculates the cost of this practice at up to US$240bn, equivalent to 10% of global corporation tax revenue.

It now sees its job as closing these loopholes and ensuring that a consistent approach to taxing all businesses – including those making money in the digital economy – is implemented across the G7 and G20.

National differences amplify the dilemma

Up to now, however, approaches to the problem have been anything but consistent. As the leading proponent of a digital sales tax, the UK has found itself under pressure from an emboldened USA with a long-term eye on the post-Brexit trade relationship it can now carve out across the pond.

First announced in the UK’s 2018 budget and due to be implemented this April, the proposed legislation triggered a subsequent dispute at the 2020 World Economic Forum in Davos where the now-former UK Chancellor Sajid Javid was given short shrift by the US Treasury Secretary, Steve Mnuchin. “If people want to just arbitrarily put taxes on our digital companies,” he declared, “we’ll consider arbitrarily putting taxes on car companies.”

France, for its part, has held back on its own implementation of similar measures until the end of 2020. Dubbed the Gafa Tax, legislation for a 3% levy on digital services companies was signed by President Macron in late July last year, principally as a stopgap to claw back tax revenue in anticipation of the OECD’s global tax solution.

The proposed turnover threshold there is set at €750m for services supplied globally, and €25m for services supplied within France. Both France and Britain’s position is that such legislation will be repealed upon the OECD’s enactment of sufficient global measures, but the French government has made it abundantly clear that this is just the start of more general regulatory action planned for the digital sector.

Again, Washington expressed its ire at France’s move, threatening significant retaliatory tariffs on flagship sectors including wine and cheese, at an estimated cost of US$2.4bn.

Fellow EU members Spain and Italy are similarly in favour of 3% tax measures but again they differ on the detail, timing and thresholds. Spain, for example, has proposed an unusually low turnover threshold of €3m for digital services supplied in-country.

With the German government currently either undecided or inactive in this space, there is a feeling of ongoing disparity across Europe on how best to maximise digital tax revenue while protecting the integrity of their individual sovereign industrial bases.

UK’s 2% levy on digital sales

Ireland, in particular, has a continuing dilemma with respect to the principle of a digital sales tax. Both the state and Apple are appealing a legal decision by the European Commission to require retrospective payment of €14.3bn in taxes over a decade of the company’s presence in Ireland.

The challenge for the state is how to reconcile the significant economic benefit of having Apple located there while responding to the material shift in attitudes to taxation. With the OECD progressing with its global digital tax initiative, it could take an estimated €2bn out of Ireland’s corporation tax revenue.

Back in the UK, whose own Digital Sales Tax plans amount to a 2% levy, the question is what impact this will have on businesses in the domestic economy. HM Revenue & Customs’ own calculations estimate a boost to the Treasury of £275m in its first full year, rising to £440m by 2023-24.

2018 to 2019

2019 to 2020

2020 to 2021

2021 to 2022

2022 to 2023

2023 to 2024

£0m

£5m

£275m

£370m

£400m

£440m

The official line is that “no significant macroeconomic impact” will be felt as a result of the tax’s introduction. But one possible negative impact is supply chain squeeze, where Amazon’s small-business sellers will ultimately carry the costs incurred by the corporation. Also uncertain is how the US will ultimately react to UK insistence that the legislation will indeed go ahead as planned, colouring the detail of any future trade deal.

Like many revenue-raising initiatives before it, the corporate community may yet fall prey to the law of unintended consequences with Digital Sales Tax.

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