13 Sept 2018
EU Finance Ministers Debate Digital Services Tax
In March this year, the Commission had suggested a two-step approach: a common EU solution for digital activities in the long run, and the introduction of an interim tax of 3% on digital services in the meantime. The measures aim at establishing fair corporate taxation, fostering a competitive economy and generating sustainable tax revenues in the EU’s Single Market.
At their September meeting in Vienna, EU finance ministers argued over the introduction of the tax as such, and over details such as the rate and scope of the measures. While France and Spain are keen on the tax, Ireland and Luxembourg are against the proposals.
The Commission’s proposals are based on the consideration that digital businesses such as Google, Amazon, Facebook and Apple pay too little tax in Europe. According to the Commission’s statistics, the average effective tax rate of the top companies with digital business models is 9.5%, while multinationals with more traditional business models, which trade in physical goods and services, pay 23.2% on average.
Furthermore, current corporate tax rules that were designed during the pre-internet era are believed to no longer be fit for the realities of the modern global economy, where companies make profits from digital services in a raft of countries, through the provision of online services, but without being physically present. Current tax rules fail to recognise the new ways in which profits are created in the digital world, in particular the role that users play in generating value for digital companies. As a remedy, the Commission’s proposals pave the way for the following:
(1) the proposed Directive laying down rules relating to the corporate taxation of a significant digital presence contains a permanent solution for the taxation of the digital economy in the EU, achieved by extending the concept of permanent establishment so as to include a significant digital presence through which a business is maintained. This enables Member States to tax profits made in their territory, even if a company does not have a physical presence there, provided that businesses have a significant digital presence. This shall be the case if the company reaches at least one of the following thresholds: (i) revenues from the supply of digital services exceed EUR 7 million, (ii) the number of users exceeds 100,000, or (iii) the number of online business contracts exceeds 3,000.
The proposed rules aim to ensure that online businesses contribute to public finances at the same level as traditional 'brick-and-mortar' companies. Hong Kong companies should note that this proposal is accompanied by a Recommendation (EU Recommendations are non-binding instruments) to Member States to amend their double taxation treaties with third countries so that identical rules apply to EU and non-EU companies.
(2) the proposed Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services proposes an interim tax, aimed at ensuring that those activities which are not currently effectively taxed would begin to generate immediate revenues for Member States. This interim tax is only to apply until the comprehensive reform has been implemented in order to prevent Member States taking unilateral measures. The interim tax, of a proposed 3%, would apply to revenues made from three main types of services, where the main value is created through user participation: (i) the sale of online advertising space, (ii) the sale of user generated data, and (iii) digital intermediary activities which facilitate user interaction, i.e., which allow users to interact with other users and which can facilitate the sale of goods and services between them.
Regarding the second proposal above, the companies concerned would have to pay the 3% tax to the Member State where their users are located, but the issue is particularly complex for several reasons, e.g., the location of the user can be hidden by virtual private network (VPN) clients or other applications. Also, the location of the turnover might not be so easy to determine, e.g., in cases of cross-border advertising services.
The tax would only be applicable to businesses which fulfil both the following criteria: global annual revenue of more than EUR 750 million and annual EU revenue of more than EUR 50 million. According to preliminary estimates, approximately 120 to 150 businesses would be affected by the interim tax.
It has been reported that the proposals are being backed by France and Spain, while Ireland and Luxemburg, where Google, Apple, Facebook and Amazon have their respective European headquarters, are among the opponents of the proposals since they fear loss of revenue. These Member States received criticism for protecting privileges of digital giants at the expense of the public interest. They argue that it is preferable to wait for a general overhaul of the tax system on companies at European level, instead of introducing a specific tax on the digital sector.
The Nordic countries also oppose the European Commission’s plans. The governments of Denmark, Finland and Sweden are concerned that the tax could stifle innovation in the sector, and fear retaliation from the US, as half of the businesses affected by the tax are American tech giants.
Germany, too, has adopted a cautious approach to the issue, possibly with a view to avoiding potential retaliatory measures against German car manufacturers from international partners.
It has been reported that France proposed a compromise with a sunset clause, opting for a clear expiry date ending the new tax and also looking for ways to compensate Ireland for possible revenue loss. Austria, currently holding the rotating presidency of the EU, proposed by way of compromise to reduce the scope of the tax by exempting the sale of user data from the scope.
The technical work on the 3% tax enters an intense phase pursuant to the meeting of the EU finance ministers. Despite their diverging opinions, according to Austrian Finance Minister Hartwig Loeger, EU finance ministers did agree to come to an agreement by the end of the year. He stated that settling the issue quickly is essential, as 11 EU Member States have already adopted or are planning national digital taxes. If no EU solution is reached, this might lead to the creation of a legal patchwork fragmenting the Single Market.