Many countries around the world are currently considering or implementing changes to their tax frameworks to make them fit for the digital age. In the European Union (EU) alone, nine Member States are currently advancing national approaches. On the EU level, the European Commission (EC) is also consulting stakeholders on two interrelated issues: how to approach business taxation in the 21st century and whether or not to implement a digital levy. And numerous other governments around the world, along with leading multinational fora such as the Organization for Economic Cooperation and Development (OECD), are examining the issue and negotiating solutions as well. Since many small app development companies are practically micro-multinationals, international taxation is an essential issue for them. While app stores mostly shield them from the complexity of international taxation, taxation directly impacts the bottom line of even the smallest app makers. Due to the rise of the digital economy, international taxation may require some changes. This blog will answer some of the questions surrounding recent efforts to modernise business taxation.
Why is the EU considering changes to its tax framework?
In light of issues like COVID-19, climate change, ageing populations, and the transitions to a more digitised and globalised society, the EC wants to ensure fair and efficient taxation. Additionally, the EC hopes to increase tax certainty, incentivise investments, and enhance competitiveness by modernising the EU’s current tax framework. Concerning digital companies, in particular, the EC claims that they do not pay their ‘fair share’ of taxes. Therefore, the EC is exploring options to implement a digital tax.
How could a digital tax hurt small European businesses?
European policymakers broadly assume that the characteristics of digital businesses allow them to side-step paying their ‘fair share’ of taxes. These characteristics include strong network effects, achieving ‘scale without mass’, and the ability to create value from anywhere. EU tech SMEs have been able to thrive in the digital economy and create countless jobs across Europe exactly because of these factors. A digital tax for all companies engaged in the digital economy could directly hurt SMEs’ ability to continue growing. Even if such a tax only applies to larger players or platforms, they will likely simply pass the cost on to their business users or consumers. This happened in France last year, where several big tech companies responded to a new digital tax by increasing fees for their business users.
How could a digital tax impact the internet economy?
Taxes, levies, or customs duties on digital exports and imports directly impact the most innovative services, including software development and connected devices. The effective ‘tolling’ of data crossing political borders to collect taxes directly contributes to the fragmentation of the global internet. Fragmentation is even a risk within the EU, considering that several Member States are advancing national digital levies. These practices jeopardise the efficiency of the internet and effectively block innovative products and services from market entry. The damage such taxes could cause to the European business community could overtake the revenue generated by digital service taxes. In addition to such financial strains, a digital tax could also increase companies’ administrative burden.
How do the EU’s efforts relate to other international tax treaties?
The OECD is currently working with a broad diversity of stakeholders to develop a long-term solution for global taxation, with discussions seeing significant progress of late. If the EU moves forward with changing its tax framework unilaterally, it would undermine the OECD’s efforts. The outcomes of the OECD discussions are poised to provide a globally coordinated path forward for fair taxation in the digital economy. Besides, digital service taxes typically violate tax treaties that assess tax liability based on an entity’s permanent location. The EU has also already made commitments under the World Trade Organization’s (WTO) that a digital services tax would likely conflict with, specifically the General Agreement on Trade in Services (GATS) Articles II and XVII. Similarly, such a tax effectively contradicts the 1998 WTO moratorium on customs duties on electronic transmissions.
What could a digital tax mean for the broader European economy?
Without question, a digital tax constitutes a trade barrier that would impede small businesses’ growth and their ability to create jobs. Trade barriers– laws, regulations, policies, or practices – can take many forms (such as tariffs on imports, or discriminatory taxes imposed on technology firms only), but all result in the restriction of imports and exports. Such barriers are often enacted with good intentions. Policymakers want to protect the domestic economy from foreign competition or artificially stimulate exports of certain domestic goods or services. However, unilateral and uncoordinated measures like a digital tax directly contribute to the fragmentation of the digital economy. Consequently, such policies impede European exports and investment across Europe. Digital taxes represent one of the most concerning forms of trade barriers that will fracture the digital economy and undermine the European Digital Single Market. Further, enacting digital taxes would violate the EU’s longstanding WTO obligations, which would undercut the EU’s global leadership in the digital economy policy space.
Conclusion
The EC has good intentions in considering digital economy taxes, such as advancing the Digital Single Market, avoiding fragmentation, and evening the playing field. However, unilateral measures by the Member States or the Commission will fragment the global digital economy that has enabled SMEs to grow and create jobs across the EU. Coordination with other key trading partners is essential to advancing a multilateral and collaborative tax foundation that responsibly addresses the changing global economy.
Further, while the digital age may justify changes to global tax rules, a discriminatory tax against businesses participating in the digital economy is worrisome. Attempts to tax larger companies will likely affect SMEs as well, and we are concerned that an approach based on paying a ‘fair’ share is overly subjective. In facilitating digital trade and growth of the digital economy, cooperation among policymakers will allow small European businesses innovators to continue growing into new markets and generate more jobs across Europe.