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Self’s assessment: a digital trade war?

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On 12 June 2020, Steve Mnuchin, US Secretary of the Treasury, wrote a letter to his counterparts in the UK, France, Italy and Spain to suggest that OECD negotiations to reach a multilateral solution to the problem of how to tax digital businesses should be ‘paused’. (The letter has been posted by Professor Allison Christians on her blog.)

The letter lobbed a ticking bomb into the delicate final stages of the OECD’s BEPS project. Since the project started in 2013, significant progress has been made on issues such as anti-hybrids, interest deductibility and the Multilateral Instrument. The last in particular was a major achievement, updating at a stroke the anti-conduit rules of a very large number of bilateral treaties. But the debate about how to tax digital businesses is far from complete.

In January 2020, the OECD/G20 Inclusive Framework on BEPS published a 30-page statement, updating its work in this area. The paper outlined the ‘two pillar approach’: very broadly, pillar one would allocate more profits to the ‘market jurisdiction’ (generally, the location where customers are based), while pillar two provides a route for countries to impose a minimum tax on digital businesses, if the country with primary taxing rights does not exercise them. The OECD reaffirmed its ambitious target of reaching agreement on a ‘consensus-based solution’ by the end of 2020, with the key policy features of the solution due to be announced in early July.

The Mnuchin letter objects to the fact that pillar one would ‘change the most fundamental principles of international taxation, including the taxable nexus threshold of physical presence and the arm’s length principle’. In other words, it would affect both when a state has taxing rights (the permanent establishment threshold) and how much they could tax (by allocating additional profits, beyond the arm’s length principle). Mnuchin went on to say that 2020 is not the right time to devote significant resources to this issue, given the need to focus on Covid-19, and the relatively modest amounts which the pillar one proposals would raise.

Just two days before the Mnuchin letter (and presumably with some knowledge that it was on its way), Angel Gurria, Secretary-General of the OECD, warned of a trade war if talks on digital tax broke down, as the BBC reported. And, on 17 June, the four finance ministers replied to Mnuchin saying that: ‘Reaching a consensus-based approach to the challenges raised by the digital economy is more crucial than ever’, and noting that potential retaliation by the USA would not be in the economic interests of the USA and Europe. On 18 June, Angel Gurria reaffirmed the OECD’s objective of reaching consensus by the end of 2020.

Meanwhile, countries are becoming impatient with the OECD’s approach, and are starting to implement unilateral taxes – including the digital services tax (DST) in the UK, which is effective from 1 April 2020. As explained in this journal (‘The UK’s digital service tax: what’s changed’, (Michael Alliston & Judy Harrison), Tax Journal, 24 April 2020), the UK’s DST is a 2% turnover tax on the largest digital businesses, which will apply to the revenues of search engines, social media platforms and online marketplaces – so the paradigm cases will be Google, Facebook and Amazon. It will be disapplied once an ‘appropriate global solution’ is in place.

The debate over digital taxation is far from new. In an article I wrote in early 2000, I said that ‘concepts such as permanent establishments, based on the underlying assumption that there is a physical presence of an entity carrying out a manufacturing function, do not readily apply to features of the modern world such as websites on servers’. When I wrote that, Amazon was about five years old, Google less than two and Facebook still four years away from being formed. My treasured copy of The rough guide to the internet (2002 edition) recommends using a search engine; it says that of the ‘dozens’ available, only a few are worth trying, and it singles out Google as the one with the ‘most relevant results on top’. Meanwhile, Amazon was said to be ‘the very model of online shopping excellence’, although it had not yet reported a profit.

So why has it taken so long, and why is finding a solution so difficult?

It boils down to the age-old problem: everyone agrees that the current system is far from perfect, but any change will result in winners and losers – and the main loser is likely to be the US, so it is now shouting very loudly and threatening to withdraw from the process.

One point worth emphasising is Mnuchin’s comment that the sums involved are ‘modest’. The projected revenues from the UK’s DST are around £1.5bn over four years: that is, in approximate order of magnitude, around 0.5% of UK corporation tax revenues, or 0.05% of total UK tax revenues. Is it really worth going to all this trouble for such relatively small rewards?

There are two key areas where, in my view, continued focus is worthwhile. 

The first is pillar two: ensuring that all profits of multinationals are charged at least a modest amount of tax somewhere in the world is likely to significantly reduce the heat on the global tax debate, and ensure that overall tax revenues increase to a level which is more likely to be perceived as ‘fair’. 

The second area is to focus on protecting lower income countries, which typically receive a larger share of their tax revenues from corporate taxes, and have fewer resources to challenge multinationals on their transfer pricing. Arguably, putting pillar one aside for now, and considering how to implement some simpler market country revenue-raising measures for the benefit of lower income countries might be a better use of OECD resources in these challenging times.