A Digital Services Tax in Mexico?
- A Mexican political party, Party of the Democratic Revolution (PRD), recently added Mexico to the global debate as to whether or not a digital services tax should be imposed on companies providing digital services, presenting a new legislative initiative under the name "Ley del Impuesto sobre los Ingresos Procedentes de Servicios Digitales" (Digital Tax Law).
- Some Latin American countries, including Argentina, Brazil, Chile and now Mexico, are following the efforts of developed countries such as Australia, Norway, Spain, South Korea and the United Kingdom to tax multinational digital service companies. These unilateral actions, however, directly conflict with international efforts to achieve a comprehensive solution.
- In this Holland & Knight alert, we analyze the draft of the bill of the Digital Tax Law in Mexico and the potential concerns arising from an implementation of such a levy.
The global debate continues as to whether or not a digital services tax should be imposed on companies providing digital services. A Mexican political party, Party of the Democratic Revolution (PRD), recently included Mexico in this debate by presenting a new legislative initiative under the name "Ley del Impuesto sobre los Ingresos Procedentes de Servicios Digitales" (Digital Tax Law).
Some Latin American countries, including Argentina, Brazil, Chile and now Mexico, are following the efforts of developed countries such as Australia, Norway, Spain, South Korea and the United Kingdom to tax multinational digital service companies. These unilateral actions, however, directly conflict with international efforts to achieve a comprehensive solution, most prominently at the Organisation for Economic Co-operation and Development (OECD).
Mexico's proposed Digital Tax Law mimics the proposal of the European Commission to tax revenues from digital business activities.
Specifically, the Digital Tax Law implements a new digital service tax (DST) of 3 percent applicable to: 1) online advertising revenues, 2) seller or buyer fees to transact via online intermediaries and 3) revenues from the sale of user data, so long as the digital company's revenues surpasses a threshold of 100 million Mexican pesos (approximately $5 million).
The rationale being followed by the European Union (EU) and Latin American countries that support a DST – or a value-added tax (VAT) in Argentina or Brazil – has generally been that digital companies are undertaxed and that they are not taxed in the places where the value creation takes place.
However, on closer examination, many of the arguments put forward as justifications for a DST are not necessarily supported by data or tax policy analysis. In fact, issues such as the ones exposed by countries as reasons to impose a DST often could be better solved by aligning corporate income tax payments with the location of value creation through proper transfer pricing regulations, hence limiting artificial profit shifting. This should be feasible given the fact that many of the digital companies has already presence or certain level of nexus within the countries.
In this Holland & Knight alert, we analyze the draft of the bill of the Digital Tax Law in Mexico and the potential concerns arising from an implementation of such a levy.
DST Nature and Merits
The DST is a supplementary tax applied in addition to the regular corporate income tax. It relies on a novel concept that digital users, merely by having or accessing online platforms, should create a taxable economic event for the digital company in favor of the nation where the user is located. It starts from the premise that consumers create value to the platforms when using them.
This principle is not free of controversy. The products create value to society only when being used. But that should not lead us to suggest that driving a car, taking an airplane or entering a shopping mall should be seen as a taxable, income-generating activity.
Actually, no international consensus exists among governments or experts about the idea of users contributing data to certain digital services being defined as a new taxable activity.
A number of observers think that the place where the user is located or where the product is consumed should not be as relevant as the place where production, investments and innovation are taking place. In fact, many think that the idea of establishing digital users' contributions as a tax base has certain deficiencies.
For example, consumers' interactions with online platforms vary from a simple scroll down to substantive purchases and contributions in the form of reviews and detailed data contributions. There will never be a straightforward relationship between the time and effort a user is spending in any given platform in terms of increasing its value. Applying the DST by measuring the value of the user contribution, many say, risks defining the DST tax base on arbitrary and distortive criteria.
Likewise, under the European Commission and Mexico proposal, the DST applicability will depend on the IP address of the user, i.e., Mexico will have the right to tax any given income if the user of the platform is using an IP address in Mexico. However, this way of applying the DST does not consider the effects of Virtual Private Networks (VPNs). By using a VPN server, the VPN's IP address – which could be located in another country – will replace that of the user.
On the other hand, it is said that a DST can help leveling the playing field between online and offline businesses. Yet, digital companies are companies that generally are already or at least should be subject under current provisions to corporate tax rates and VAT rates in one or more countries. Adding another levy to their operations may in fact have the opposite effect.
The sales of third parties' products via a website would be within the scope of the DST, while sales through physical department stores selling clothes in consignation would not be covered by the DST, even when the principle is the same. This could distort the competition between both business models and play to the disadvantage of digital commerce. Similarly, the fact that DST would not apply to all types of digital companies hinders the reach of the intended fair playing field.
Aspects of Mexico's Proposed DST
Compared with taxes applicable to digital businesses in other Latin American countries, the proposed Mexican DST would likely trigger disruptive consequences on digital companies, deterring their competitiveness and increasing their compliance costs. That has led to concerns about the DST's implementation, as well as a lack of clarity on the determination of its tax base.
As opposed to the VAT or ICMS applicable on digital services in Argentina and Brazil, respectively, the DST in Mexico is a tax on revenue and not on value added. This implies that the Mexican DST could distort competition since it will not be a creditable tax such as the VAT in such countries. Instead, the Mexican DST will apply on top of the corporate income tax over the same income, without being able to credit it or deduct it against the latter. Consequently, its cost will ultimately be passed on to final customers in Mexico.
This would not be the case in Chile, for example. Even when that country's DST is a tax on revenue, there the DST replaces any other tax. Therefore, no double taxation arises and customers do not ultimately bear its burden.
In Mexico, the base over which the DST would apply is ambiguous. The Digital Tax Law establishes that the taxable income for purposes of the DST will depend, among other factors, upon the number of times the publicity appears in the platform, the number of users that have concluded operations in the platform and the number of users with an account. Several questions could be posed about this model. For example, it is not clear if both the seller and the buyer would be considered as users concluding operations in order to calculate the DST. If that were to be the case, an illegal double accounting of the income would exist. Also, the number of accounts may not reflect a proportionate use and transactions being carried out through the platform. Many accounts might be dormant.
Compared with other Latin American countries such as Brazil and Chile, where implementation will be facilitated by establishing electronic payment administrators (e.g., credit card companies) as withholding agents, the DST enactment in Mexico is far from easy. Many observers foresee enforcement limits and minimum results derived from the difficulty of its implementation, as well as easy avoidance given the bill's current loopholes.
There is no doubt that a DST would increase compliance costs for service providers in Mexico, and so companies of innovation there may be at a disadvantage when competing against those located in other Latin American countries.
Finally, Mexico's Digital Tax Law is being proposed under the argument that international companies take advantage of their digital models to escape taxation in Mexico. Yet, in plain contradiction of its purpose, the Digital Tax Law – as opposed to what happens in Argentina, Brazil or Chile – would apply only to digital companies that tax residents in Mexico. Foreign tax companies providing intermediary digital services in Mexico, selling publicity in digital platforms or customer data, would still be subject only to any applicable income tax and VAT in Mexico, not to the DST.
Summary of Disadvantages
There are several main disadvantages of a DST:
- The DST costs will ultimately be passed on to the customers.
- DST's tax base calculation is based on arbitrary and distortive criteria and does not consider the effect of technologies like VPNs.
- It distorts competition between businesses that are selling their own products via a website and those making their platforms available for independent sellers. Sales by third parties would fall within the DST scope, placing them at a disadvantage vis-a-vis the own-product sellers not subject to the DST. Similarly, platforms may be biased to insource some of the products that are generally sold by third parties.
- Independent DST initiatives, such as the one in Mexico, could create barriers to integration at a worldwide level, resulting in a Mexican internal market that is less competitive. In addition, when a world consensus is reached, eliminating the tax, adapting new compliance mechanisms and retraining tax administrations may represent unnecessary additional costs.
- The DST would cause exporters in Mexico using an online platform to export goods and services to foreign buyers to be worse off than those companies in foreign countries that are selling similar goods and services to the same foreign buyers using the same online platform. In this case, the users/exporters in Mexico would face additional costs passed through by the online platform as a result of the DST, while exporters in foreign countries would not face any additional tax. This creates a competitive disadvantage.
- Businesses that grow to the threshold of 100 million pesos would be incentivized to lower their valuations or to create other online service companies to divide the income and thus avoid the additional tax and compliance burdens associated with reaching the threshold.
- A DST could affect digital companies' income disproportionally since its tax base does not consider the real profits of the taxpayer by not allowing for any deductions.
- Online intermediaries facilitate services and activities within a certain country. They allow increased productivity across the value chain, and with it, the amount of activities subject to income tax and VAT increase in the country where the platform is being used. An increase in compliance costs and additional levies that could potentially be passed on to clients could cause negative consumer reactions and changes in buying patterns that could ultimately lead to the reduction of taxable activities being performed through the platforms and hence a lesser amount of tax collection by the government.
Takeaways and Considerations
An approval of the Digital Tax Law bill into law by the incoming administration would represent a breach of its promise not to raise any new taxes for the first two years of Andrés Manuel López Obrador's government. However, nothing impedes Morena, the President-Elect's party, as a majority in the Mexican Congress since Sept. 1, 2018, to pass it into law before López Obrador takes office on Dec. 1, 2018. However, this is unlikely. On the other hand, the DST potentially could have low political exposure. Many voters might not care about or even understand such a tax. By enacting a DST, Morena's popularity or approval ratings possibly would not be at risk.
Holland & Knight will provide further updates with respect to the specifics of the new Digital Tax Law as we are informed about its progress on the Mexican House floor. Should you have any inquiries or comments about this matter, please contact Eugenio Grageda.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.