The Upcoming Chaos in Digital Taxation
San Francisco / January 10, 2020
Later this month, Steve Mnuchin and Bruno Le Maire will have a conversation at Davos that will influence the path of taxation on digital services. Most likely, they will disagree. And we will see chaos in this domain over the next several years.
In June 2019, France passed a tax on digital services. The tax applies to companies that generate more than 25 million euros in revenue from digital services in France and 750 million euros worldwide. Companies that are subject to the tax must pay 3% of digital services revenues generated in France. Macron's government passed this legislation after a similar proposal at the European Union stalled. The French government claims that multinational firms evade taxation in France and this new "digital services tax" is an appropriate response.
The United States thinks the tax discriminates against American firms. The Trump Administration immediately threatened to impose retaliatory tariffs on French goods and specifically targeted the wine industry.
As the dispute simmered, the OECD proposed a framework to harmonize this area. In October, the OECD suggested that countries should be allowed to tax a proportion of the global profits of highly profitable firms, regardless of where the profits are generated (link). This is a departure from the present taxation system, where the location of the profits plays a crucial role in determining the tax bill.
The OECD proposal is a logical response to how large multinationals actually run their operations. In recent decades, multinational firms have gamed the tax codes of nations around the world. They created operations centers in tax-havens and artificially located profits in these havens to avoid paying tax. Multinational firms say they comply with the law and face competitive pressures to pay as little tax as possible.
There was bipartisan support in the US Congress for the OECD proposal. France backed away from its plans to impose their own tax. But in December, US Treasury Secretary Steve Mnuchin indicated that the US did not support the OECD proposal. France responded by reviving their digital services tax. French Finance Minister Bruno Le Maire has warned the United States not to retaliate.
At the World Economic Forum at Davos later this month, Mnuchin and Le Maire will discuss the digital services tax and tariffs on French goods. Le Maire will try to convince Mnuchin to drop the proposed tariffs and Mnuchin will ask Le Maire to drop the digital services tax. This is not just a clash over values. It is true that many Americans prefer lower taxes on corporations and many French citizens think of taxes as the price we pay for a civilized society. The Trump Administration actually believes that the digital services tax discriminates against American firms. In December, the US Trade Representative initiated a Section 301 investigation (link). The report claims that two-thirds of the company groups that are expected to be covered by the digital services tax will be US-based. That assertion is technically true, but it's primarily because the United States leads the world in tech startups.
The best path forward is probably for Mnuchin to accept the OECD proposal. If he does that, Le Maire would quickly drop the digital services tax. Nations around the world would then have simple paths to tax profits. It would be very difficult for multinationals to avoid these taxes.
If Mnuchin rejects the OECD proposal, other European nations will impose digital services taxes based on the French model. This could actually damage US firms because there will be more randomness in how different nations structure their own digital services tax.
It is rumored that Mnuchin changed his mind on the OECD proposal in December after aggressive lobbying from US firms. People who prefer simpler and intuitive taxation should ask Mnuchin to ignore the lobbyists and take a second look at the OECD proposal.