Podcast: The Digital Economy and Tax
In the second episode of our Public Policy & Regulation Group's "The First 100 Days of the Biden Administration" podcast series, Trade Partner Nasim Fussell leads a discussion with Tax Partners Alan Granwell and Joshua Odintz on the current state of the digital economy and digital services taxes (DST). They provide a comprehensive overview of DSTs and look at the United States' current relationships with other Organisation for Economic Co-operation and Development (OECD) countries, particularly through the administrational changes.
For an update on these topics, listen to Episode 3: An Update on the Digital Economy and DSTs.
Nasim Fussell: Welcome, everyone, to the first in a series of podcasts on the digital economy and digital services taxes with Holland & Knight. My name is Nasim Fussell and I am a partner in the international trade group at Holland & Knight. I work with our Public Policy Group extensively, and particularly in this area of digital economy and digital services taxes with two of my colleagues and partners that I have here with me today who are key to knowledge and the pathway on this topic. So in this podcast, we're going to provide an overview for you on what is going on with digital services taxes today, not just domestically, abroad and at the multilateral forum. We're also going to talk about why the trade and tax aspects of DSTs, as they are known, are such important issues for companies engaging in international commerce. In latter podcasts, which will follow in the coming weeks, we will delve more into the technical detail and invite other experts to join us for a discussion to update you on the current developments in these areas. So, let me start by introducing you to my colleagues. Alan Granwell is a tax attorney with more than 50 years' experience in the area of international taxation. Alan is a former international tax counsel at the Treasury Department and brings a wealth of knowledge and perspective to these issues. Joshua Odintz is a tax attorney in our D.C. office, where he focuses on tax policy, tax controversy and tax planning. Josh also served at Treasury, as well as the Senate Finance Committee, which has jurisdiction over all things tax. So, thank you both for being here today.
What are the Digital Economy and Digital Services Taxes (DST)?
Nasim Fussell: Let's start with some basics. What is the digital economy? An economy based on digital computing technologies, although in our world today, it is commonly perceived as conducting business through market based on the Internet and using the World Wide Web. Here are some fast facts. The digital economy is equivalent to 15 and a half percent of global GDP, and it's growing two and a half times faster than global GDP over the past 15 years, according to the World Bank. Governments in which digital economy customers are located want to tax revenues derived from the digital economy through a new form of tax that we are discussing today known as digital services taxes. Why? We'll get to that in this podcast today where we plan to lay the groundwork for you. What is a DST? I'm going to hand that over to Josh to tell us a little bit more about this, and then we're going to dove into why all of this is happening. So, Josh, over to you. What is a DST?
Joshua Odintz: Thanks, Nasim. So, a DST is basically a tax that applies to businesses selling digital services to consumers located within a jurisdiction. There are roughly more than 40 DSTs in effect or under consideration, but there are some common themes or elements to it. The first is it's generally imposed on gross revenues and second, it's generally imposed on companies or entities that meet a certain revenue threshold, either in a jurisdiction or globally. DSTs are also targeted at a small number of large digital companies, so think of it as social media companies, e-commerce marketplace companies, cloud services and web-based service platforms. So looking by example, the European Commission proposed a DST back in 2018 that would have imposed a temporary DST of a three percent rate on revenues derived from online advertising services, receipts from digital intermediary service activities and sales of user collected data. So the European Commission version would have applied to businesses with worldwide revenues of 750 million euros in taxable revenues within the EU exceeding 50 million euros. Ultimately, the EU did not adopt that proposal, but several EU countries have gone off and created their bespoke versions of a DST.
A DST is basically a tax that applies to businesses selling digital services to consumers located within a jurisdiction.
How Do DSTs Work?
Joshua Odintz: So there's a range of flavors of DSTs from the tax rate, ranging from 1.5 to 7.5 percent on receipts from sale of advertising space, the provision of digital intermediary services such as the operation of online marketplaces and the sale of data collected from users. So generally, what we've seen is a common theme that there must be a group level threshold and then a domestic level threshold, and then the taxes are designed to hit certain services that, once again, involve the collection of data. Alan will get into in a minute how we ended up here, but it's just worth observing that there's a lack of understanding of how digital economy companies make their money. It's generally through data collection and use of data, and so the DSTs are targeted at those companies that you collect and are able to manipulate that data. So DSTs are theoretically temporary taxes until there's a global consensus at the OECD, and we'll get into the details of the work at the OECD, but certainly these taxes are growing and, like I said, the number has exceeded 40 in number. So as far as criticisms - from the U.S. perspective, DSTs are targeted at U.S. multinationals. That is certainly a view that has been raised to USTR, and Nasim will get into that later in our broadcast, and these are taxes that are targeted at large U.S. multinationals and provide an advantage to home country businesses that fall beneath the threshold. These are also taxes that are likely to be passed on to customers, and some businesses in the digital economy will be able to pass this along to customers, while other businesses will not be able to because of the competition and the business models. We've seen that some of the digital economy businesses have increased their costs and prices and will pass those along to the consumers of their services. There's also a significant theme that we will touch upon in subsequent podcasts, but there's the potential with the DST for double taxation, and that could occur where two or more countries consider a certain revenue, stream a source there and seek to tax the same revenue stream. Only the UK has a provision that would address double taxation. So there is a true risk that if countries are not coordinated, they could seek to tax the same stream of revenue more than once.
Nasim Fussell: That was a really helpful foundation and raises a question for me as not a tax person, and Alan, I'm going to pose this to you. Why can't the current international tax system simply apply to digital services? Why are we where we are today?
Why Digital Services Are Taxed Differently
Alan Granwell: Thank you, Nasim. I think that's really the crux of the issue and the simple answer is, and then I'll get into it a bit more, is that digital is a virtual type of methodology. You don't have a physical presence. It all goes through the computer or the Internet or something which is not physically situated in the particular country. When we examine our international tax system and the norms that apply to our international tax system, which incidentally are followed by most of the world through the OECD documentation and studies and model treaties and commentaries, we find that under non-digital situations for a tax payer, not resident in the local country, the source country, in order to be taxable in that source country, the same U.S. taxpayer has to have a form of physical presence in the country and do business in that country. The physical presence can either be an office/fixed place of business, or it could be an agent which has certain authorities to bind the principal in that country and if you do not have that nexus with the particular country, income from transactions related to that country generally are not subject to taxation in that country. There obviously are exceptions, but that is the general rule. When we think of the digital economy, we are thinking of something which doesn't have that fixed presence, and if you don't have the fixed presence, then under our bilateral tax treaty system, a U.S. company which doesn't have a presence but is doing things in that other country generally would not be subject to local country taxation. So we have this conundrum in terms of the source countries, where various of the major U.S. companies who have digitized their business can undertake transactions in that country. Based on our current system of treaties and also the local laws of the country, the U.S. entity would not be subject to tax. Because of the growth in this area, through the statistics you had mentioned, these local countries are seeking to find a way to tax income from what they perceive should be taxable because of value creation in their countries. I think at this stage, let me just sort of turn it back to Josh to describe what is going on in terms of the OECD considerations of that issue and the initial studies. This is sort of the birth of this whole inquiry as to how to more appropriately tax the digitization economy.
When we think of the digital economy, we are thinking of something which doesn't have that fixed presence, and if you don't have the fixed presence, then under our bilateral tax treaty system, a U.S. company which doesn't have a presence but is doing things in that other country generally would not be subject to local country taxation.
Joshua Odintz: Thanks, Alan. Let's go back a little bit in history to 2013. So the OECD, which is an organization that is comprised of 37 members and was formed after World War II, back in 2013, focused on base erosion and profit shifting, or the BEPS Project. There were 15 action items that the OECD explored. Action item number one was the digital economy, and the question at that time was whether the digital economy should be ring fenced, or should it be taxed in a way that is consistent with norms? Do the norms have to be changed? So that was action item one. Within the other 14 action items, the OECD issued a series of reports and, in some cases, model legislation. It also updated the multilateral instrument. So those items were adopted by countries and are continuing to be adopted by countries. The OECD issued a report in 2015 on action item one, the digital economy. That report noted that because the digital economy is increasingly becoming the economy itself, it's not possible to ring-fence the digital economy from the rest of the economy for tax purposes. The United States was pretty firm in that position during the Obama Administration, and the work continued behind the scenes and there was a change in administration in the United States. Then in 2018, the G20 and the Inclusive Framework, which involves more than 130 countries, continued to work on the issue and deliver an interim report in March 2018. Then in 2019, the members of the Inclusive Framework, that includes the 37 OECD countries, plus almost 100 countries that normally are not involved in these matters, so the OECD brought them into the tent to try to drive or create consensus. In 2019, the Inclusive Framework agreed to examine the digital economy and unresolved tax issues from BAPS in two pillars, and that could lead to a consensus solution to tax challenges arising from the digital economy.
Alan Granwell: Josh, just to interject, what you are describing with this Inclusive Framework is really an undertaking by the nearly 140 countries to recalibrate our basic international tax system. So this is really a fundamental change in how countries can impose tax on entities from other countries which don't have a physical presence in the local country.
This Inclusive Framework is really an undertaking by the nearly 140 countries to recalibrate our basic international tax system.
Joshua Odintz: I think another way of putting it, is that it would take us away in transfer pricing from the arm's length standard. In the case of Pillar One, it would say that a digital company would have to cede some of its profits to a market-based country. This reflects the view of the marketplace countries that it's the market, and not the technology or the intellectual property, that is responsible for profits.
Alan Granwell: Indeed. So that's where we are.
The Trade Impact of DSTs
Nasim Fussell: Wow. Well, thank you both for really laying out what is a fascinating, though clearly very complicated issue. Let me say a little bit now that we've discussed the tax side of this issue about why I'm here. For our audience, you may be wondering now that we're deeply ingrained in tax, why is this trade person here? Well, let's think about the trade impacts of these DSTs and also talk a little bit about how the United States has responded to the proliferation of beasties around the world. So we talked a bit about the digital economy and Alan, thank you for answering my question about why we are where we are. I think that the way you answer the question really hit the nail on the head from a trade perspective as well. You know, historically, when we talked about trade, we were talking about the trade in goods, the movement of goods across borders, while increasingly we're talking about trade in services and even more increasingly, trade in digital services. So put simply, the movement of these digital services around the world by virtue of what these services provide.
Nasim Fussell: The issue here now is that these DSTs essentially serve as a trade barrier to these services trades and, in particular, with the increasing number of DSTs popping up around the world and the way that they have been set up, there has been a strong perception that these unilaterally enacted DSTs unfairly target and discriminate against large U.S. technology companies. During the last administration, there were a number of Section 301 investigations launched into DSTs in Austria, Brazil, the Czech Republic, the European Union, France, India, Indonesia, Italy, Spain, Turkey and the United Kingdom. There was a lot of bipartisan support for the Trump Administration launching the Section 301 investigations, which is really noteworthy because they were launched in a period of time during which the Trump Administration had launched and taken terrorist action on imports from China under the purview of Section 301. A lot of retaliation had been put in place by the Chinese as a result. The Trump administration had taken action under a number of other statutory authorities to impose tariffs as well, all of which had also invited retaliation. So while there was a lot of bipartisan consternation about tariffs, there was a lot of bipartisan support for these Section 301 investigations into these DSTs. Again, I think it has a lot to do with this very strong and again, very bipartisan perception that these DSTs were unfairly targeting and discriminating against these large U.S. technology companies.
So, you know there, as I said, were a number of these investigations and just at the end of 2020 - and I must add that these investigations were going on while all of the processes that Alan and Josh described for you at the OECD were taking place. While this is all taking place, the administration conducted its investigations and at the end of 2020, there was an expectation with heading into the New Year, the Biden Administration coming in and all of the bipartisan support that I noted earlier, that the Trump Administration would likely take action if not on all of the investigations, then at least on the French DST, which is where it started its Section 301 investigation process. In fact, I'm going to take a moment to speak about the French investigation and how that unfolded, because I think it'll provide a good illustration of some of the decision making that occurred in parallel with the talks at the OECD. So in July 2020, the Trump Administration, after going through its process investigation under Section 301 and determining that the French DST was in fact discriminatory and unfairly targeting U.S. companies decided to impose tariffs. Under Section 301, it also has the authority to consult with the other party and that is what it chose to do with the French government. The two governments, the U.S. government and the French government agreed to pause on the tariffs and to allow the OECD process to unfold in an effort to try to reach a deal there so that there would not have to be forward movement on Paris. Well, that process unfolded a bit, and we reached July 2020 when a conclusion had not been reached yet and the Trump Administration announced that they were going to impose tariffs on the French, but that they would wait another 180 days before imposing them. So I'm going to stop there for just a moment, to see if Alan and Josh want to provide some parallel input on what was happening in Paris at the OECD at the time, and some insight into why that pause might have been taken by USTR.
I think it has a lot to do with this very strong and very bipartisan perception that these DSTs were unfairly targeting and discriminating against these large U.S. technology companies.
The United States and the OECD Inclusive Framework
Joshua Odintz: Absolutely. So a few things. One, Congress - and this was bipartisan, bicameral - supported the OECD Inclusive Framework process, but it did not support necessarily the outcome because as we'll discuss the later podcasts, the outcome would require potentially legislation and a modified model U.S. tax treaty. So the United States supports a process but does not support the outcome that is reserved for a later date. The United States participated in the Inclusive Framework, sat at the table, the then deputy assistant secretary for International Tax Affairs was actively involved in the negotiations, but there was a letter from Secretary Mnuchin on one of the pillars that provided that Pillar One and specifically Amount A, which goes to the IP returns in the digital economy, that that would be a safe harbor. That was viewed as not constructive by the Inclusive Framework and created some problems in negotiations. Its second, different countries were focused on different pieces of the Inclusive Framework. Some of the countries wanted to adopt Pillar Two and were less interested in Pillar One. Some of the market countries were focused like a laser on Pillar One. So the negotiations led to two reports for which we have received comments. There have been public consultations, but there are two reports that were issued by the secretariat at the OECD. So they do not reflect the views of the countries, they just reflect the view of the OECD. That is currently where we are with respect to documents. The United States recently indicated with the new Biden Administration that it is changing its position with respect to Pillar One. The United States is willing to consider Pillar One not as a safe harbor, but as part of a broader package for the Inclusive Framework that would be mandatory.
Alan Granwell: I just wanted to make a very brief comment. First, Pillar One is dealing with DSTs as Josh had described, Pillar Two is dealing with global minimum taxes and the interaction with our U.S. minimum tax under the guilty regime. Why is all of this important for U.S. multinationals? The reason is, it could change the way these multinationals are taxed abroad and whether they will get what we call foreign tax credit for any local taxes imposed. We will get to all of this in future podcasts and go through the current mind numbing sort of analysis of these two pillars, but best to do that for another day.
Why is all of this important for U.S. multinationals? The reason is, it could change the way these multinationals are taxed abroad and whether they will get foreign tax credit for any local taxes imposed.
Nasim Fussell: Thanks, Alan. So let me pick back up on trade, because the way the story ended in early 2021 with the Trump Administration is a determination not to take action after concluding all of these investigations and determining across the board that there was, in fact, targeted discrimination against U.S. companies. Why? You know, it was highly speculated that perhaps focus should remain at the OECD. What USTR indicated, however, was that it would not take immediate action, but would continue to evaluate all available options and leave it for the Biden Administration to determine what steps to take.
Where the Biden Administration Is Now
Nasim Fussell: So where are we now? We have a new Treasury Secretary, Janet Yellen, and we have a new USTR, Katherine Tai. Secretary Yellen has already engaged at the OECD and had bilateral discussions with key counterparts like French Finance Minister Bruno Le Maire. Ambassador Tai said in her Senate confirmation hearing that she will work closely with Treasury to address digital services taxes at the OECD, signaling that our focus really is going to be on getting this resolved multilaterally. However, notably on March 26, Tai's USTR made its first big announcement regarding next steps in its investigation of digital services taxes. USTR announced that it would be preserving its procedural options under Section 301 for taking possible trade actions on the investigations conducted on Austria, India, Italy, Spain, Turkey and the United Kingdom. As we noted earlier, the previous USTR found that the DSTs adopted by these trading partners do discriminate against U.S. digital companies. In its announcement, USTR also, however, noted once again that it's committed to finding a solution on the multilateral level, signaling that there will continue to be a focus on finding a solution at the OECD with our trading partners. USTR also announced that it would be terminating the investigations that the previous USTR did regarding the DSTs proposed by Brazil, the Czech Republic, the European Union and Indonesia. It indicated that none of these had adopted or implemented the DSTs that were under consideration when the investigations were conducted last year. So if any of these countries do proceed with adopting or implementing a DST, USTR may very well initiate new investigations. I think very notably, this announcement on March 26 was silent on the French DSTs, which we have discussed today and the taxes in place. One can speculate whether that is because any action taken now would be outside of the statutory period permitted under Section 301 or just a really a firm commitment perhaps between the United States and France in trying to resolve this multilaterally, but we shall see. This is something that we will be able to dove into and analyze a bit more deeply on a future podcast.