The benefits of digitalization are clear and welcome. Yet popular debate is growing worldwide on how best to tax and regulate digital businesses to optimize economic and societal outcomes. Because digital activities are so often borderless, actions taken in one country can spill over into others. These actions heavily influence the trade and investment decisions of many businesses, but all the more for those with geographically mobile digital footprints. Let’s look at six live areas of debate.
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Taxing remote businesses
For a government to levy corporate tax on a foreign firm, tax rules require a “nexus” or link between the taxpayer and the taxing jurisdiction, typically in the form of physical presence such as offices or workers. In our digital world, firms can interact with users and create value in a country without needing to physically set up there. More than 130 countries are discussing new rules, under the OECD’s Inclusive Framework, to change the nexus requirement so it is not dependent on physical presence. The rules will determine how to allocate some taxable profits to (and among) market jurisdictions where users reside. The OECD Secretariat released its proposal on 9 October, to help countries reach consensus by the end of 2020.
Fearing foot-dragging by others, some countries have felt compelled to act unilaterally in the meantime. France, in July 2019, imposed a 3% digital services tax on revenues derived from digital activities where French users play an active role in creating value. India changed its laws so that, as of April 2019, remote business are liable for corporate tax if they have a “significant economic presence” in the country.
Global minimum tax
Another concern that OECD Inclusive Framework countries are tackling is the possibility for businesses to shift profits to low-tax jurisdictions. Tax competition among governments – lowering corporate tax rates to attract investment – also contributes to this problem. New rules could give countries the right to “tax back” where another country has taxed income below an agreed minimum rate. Similar steps are taken in the US’s 2017 Tax Cuts and Jobs Act. These rules are not limited to digital businesses but are seen as particularly relevant to profits related to intangible assets, which are important in a digitalized economy. Countries, typically smaller ones, that rely on low corporate tax rates to attract businesses will be difficult to convince, and much will depend on the minimum rate that’s settled on.
Consumption taxes on cross-border e-commerce
Governments are adapting consumption taxes, like value-added taxes (VAT) and goods and services taxes (GST), for cross-border e-commerce. These are levied on the purchase of goods and services and borne by the final consumer. In the case of physical imports, countries have tended to exempt small-value items from consumption taxes because the cost of collection at the border didn’t make it worth it. However, increased volumes of these low-value imports through e-commerce have raised concerns about revenue loss. Some countries are looking to digital platforms to assist with collection. Australia has introduced a system that requires foreign vendors with more than A$75,000 in sales a year to Australian consumers to register and pay GST. Its simplified procedures have brought in more revenue than expected, enjoyed high compliance and received support from many businesses.
Digital customs duties
Currently, digital products such as e-books or films are not charged customs duties, thanks in part to a temporary agreement among World Trade Organization members not to impose customs duties on “electronic transmissions”. This moratorium expires in December and may not be renewed immediately. Critics ask why digital products should get special treatment at a cost to government revenues and note that developing countries rely more heavily than advanced countries on customs duties. They are also wary of constraining their ability to deal with developments like 3D printing. Supporters argue digital duties would be impractical to implement, stymie innovation and be economically inefficient (like other tariffs).
Cross-border data flow rules
International data flows are estimated to have raised the value of global production by US$2.8 trillion in 2014 and are also important for individual rights and freedoms. However, some countries have moved to restrict these flows, sometimes for good reasons like protecting privacy, supporting law enforcement and safeguarding national security. Given what’s at stake, countries have been trying, through the G20 and elsewhere, to ensure regulations are not overly restrictive or burdensome, that they provide ways for data to be legitimately transferred and that they are not protectionist.
Competition law and enforcement
As digital firms have become among the largest businesses on the planet, they’ve come under increased scrutiny from competition authorities. While they create tremendous value for consumers and other businesses, online platforms are a particular challenge. They benefit from network effects, often offer services at zero price, rely heavily on data and potentially compete with their own users. The dynamic tech space has also seen a high number of acquisitions by leading firms, often bringing better services to consumers, but also removing potential competitors. Germany has amended its law so that more of these transactions are subject to review. The absence of international rules and differences among national approaches raise challenges given the cross-border nature of digital platforms.
The way ahead
The political dynamics in each of these debates are unique. At a time of high trade tension, diverging responses to these questions risk being seen as protectionist and fuelling further division. The US, home of eight of the 10 largest tech companies, has raised concerns these are being unfairly targeted, and threatened retaliatory tariffs, such as on French wine.
Policymakers walk a fine line. Inaction could lead to government revenue loss, market concentration, reduced competition and societal discontent. Applying badly designed or poorly coordinated policies risks complexity, retaliation and hampered innovation. Trade should be driven by economic fundamentals not regulatory arbitrage. Trade policy needs to come out of its silo and help the race for technological progress empower all of us, not create conflict.
Listen to the World Economic Forum’s session on “Trade and Tax: Adapting to Digitalization” at WTO Public Forum 2019.