Trade Law Analysis of EU’s Digital Tax Proposal

On 21 March 2018, following months of speculation, the European Commission tabled a paradigm shifting proposal to tax digital companies. It comprises a two-phased approach. First, a long-term overhaul of corporate tax rules replacing the “permanent establishment” rule with a “significant digital presence” rule. This comes with a redefinition of traditional concepts of profit attribution for digital business models. Secondly, pending such a tax, the EU, has proposed an interim digital services tax (“DST”).

The interim DST proposal has generated concerns as to vagueness, compatibility with the domestic corporate laws of individual Member States, privacy and data protection, double taxation, and competition law. This post looks at another issue, namely, its trade law aspects.

The DST will be levied on revenues of only those digital companies whose business model is characterised by value creation through users, and levied in the jurisdiction where the users are located (determined through geolocation methods such as IP (internet protocol) address). This means that companies such as Google, Facebook and Uber will be taxable, but companies that do not require significant user inputs, for example providers of online content, fintech services etc. will not be taxable. The proposal sets out two thresholds for an entity to be taxable — the worldwide revenues of the entity for the latest financial year must exceed €750m, and the taxable revenue obtained in the EU during that year must exceed €50m euros. The DST will be applied at a rate of 3% on gross taxable revenues. Furthermore, taxable revenue is restricted to three types of services/business models — (i) advertising (e.g. Google and YouTube), (ii) multi-party interfaces, that is, user interaction enabled services (e.g. Uber and Airbnb), and (iii) transmission of users’ data derived from their activities (e.g. Facebook). On the other hand, services like communication, payment, trading venues, and crowdfunding services have been excluded.

The EU asserts that the proposal is in compliance with its WTO and FTA commitments. The reasoning behind the DST is that the digital economy is inadequately taxed (despite some contrary views). Ireland in particular has been alleged to give subsidies through tax benefits to companies (the Double Irish and Dutch Sandwich being one popular tax planning structure). Some of the biggest technology companies like Google and Facebook have their international headquarters there. Other states, including UK (through its Diverted Profits Tax), and organisations, like the OECD, have also been contemplating alternatives for reorganizing tax norms that are considered to be outdated in the digital age. However, a closer look into the EU’s proposal, especially its delineation between taxable and excluded entities, raises questions in terms of the WTO’s non-discrimination obligations, in particular the national treatment principle embodied in Article XVII of the General Agreement on Trade in Services (“GATS”).

Article XVII GATS prohibits less favourable treatment of “like” services and service suppliers for sectors listed in a Member’s Schedule of Commitments, subject to express limitations. By targeting only the digital sector, the DST could discriminate between online and offline versions of “like” services and service suppliers, “likeness” being determined by end-use, consumers’ tastes and preferences and the competitive relationship, independent of the “medium” or “platform” of supply. For example, advertisements on news websites will be subject to DST, but not advertisements in newspapers. Similarly, online taxi hiring services (Uber) will be subject to DST, but not telephone-based taxi hiring services.

Furthermore, a study by the Peterson Institute for International Economics indicates that the design of the DST is such that US companies will be disproportionately subject to the DST, while the biggest European digital companies will be exempt. For instance, Spotify, the Swedish music streaming company whose business model is based on subscription fees, will be excluded from the scope of taxable revenues, and hence exempted. Additionally, the DST permits subtraction of value-added taxes (“VAT”) from taxable revenue, but not expenses. Since the US does not have VAT, the DST appears to discriminate against US companies. Also, comparatively a very limited number of European companies have worldwide revenues exceeding DST’s thresholds. Even by the EU’s own admission, most of the affected entities are US companies.

GATS jurisprudence hinges the determination of ‘less favourable treatment’ on the modification of conditions of competition to the detriment of the foreign service or service supplier (EC —Bananas III and China — Electronic Payment Services). If a measure could impose significant costs and risks of interruption for the foreign-service supplier and service, even if these do not materialize in the immediate future, there will be a violation since it potentially affects condition of competition (China — Publications and Audiovisual Products). Moreover, discrimination need not be de jure: even if the DST affords formally identical treatment to EU and US companies, there could be a de facto discrimination and violation of national treatment obligation.

As noted above, this obligation only applies to services listed in a Member’s Schedule of Commitments. In its GATS Schedule of Commitments, the EU has liberalized services (considering the relevant modes based on digital business models) that would be captured by the DST, such as advertising services, computer and related services, travel agencies, news and press agency services etc. This means that the EU would not be able to implement a DST that discriminates against, for example, “like” US service suppliers and services in these service sectors. There are of course public policy (and other) exceptions to this obligation, but it is not evident that any apply. On the other hand, the EU has not liberalized audiovisual (Netflix, YouTube) or hotel (arguably Airbnb) services, and hence a claim of national treatment violation cannot be made for such services.
The EU’s unilateral approach may also hinder progress of the WTO’s e-commerce work programme. The EU has long been a proponent of multilateral rule-making for facilitating trade in the digital economy, in the face of opposition from other WTO members such as the African Group. However, the DST could result in retaliatory measures against the EU, which is a significant exporter of digitally enabled trade in goods and services. The US could view the DST as a targeted attack, and in the current political climate this could trigger another tit-for-tat set of unilateral measures creating significant obstacles for the digital economy as a whole.
Written by Nivedita Sen, PhD candidate at the Graduate Institute of International and Development Studies in Geneva.

Edited by the Linklaters Trade Practice. The views and opinions expressed here are the personal opinions of the author(s) and do not necessarily represent the views and opinions of Linklaters.