ABSTRACT

Nowadays, while companies are digitalizing, their way of doing business is shifting from classical corporate methods to digital corporate methods. As a result of digitalization, the products and services sold in the digital world, and advertising services related to these products and services have led to emergence of new markets and new sources of income. Since the mentioned services cannot be taxed with classical taxation methods, there is need for a new type of tax which will be collected on the values created in the digital world. This new tax is called digital services tax. The article is about why digital services cannot be taxed by classical taxation methods, and it also includes discussions on the fairness of the digital services tax.

Key Words: Digital Services Tax, DST, European Union, OECD, USA, France

INTRODUCTION

Today, in addition to the digitalization of companies that used classical business models in the past, there is a rapid increase in the number of companies offering digital products and services. As a result of digitalization, the products and services sold in the digital world, and advertising services related to these products and services have led to emergence of new markets and new sources of income. Sales of digital products and services and advertising services related to these products and services can be carried out in a country without having a permanent establishment in that specific country. Therefore, companies which sell digital products and services have chosen to carry out their activities from a business center in a single country, and to carry out their activities in the digital world, instead of establishing a permanent workplace in each country. This situation causes companies that generate income through digital activities to be taxed only by the country where the business center is located. (Corporate tax is type of a tax collected only on the corporate earnings of businesses which have permanent establishment located in that country.) Therefore, there is a need for new type of a tax, which will be collected on the value created in the digital world. This new type of tax is called the digital services tax.

Although which activities are covered by the digital service tax, and how much of the digital activity gross revenue will be taxed under the name of digital services tax varies from country to country, it is generally a tax levied on the gross revenue generated from digital marketplace activities, digital advertising, and sales of user data.

  1. Views of the European Commission on Digital Services Tax

The European Commission, which convened on 21st March 2018, stated that today's international tax system is insufficient in taxing the income generated from activities in the digital world. Companies offering digital products and services can generate income all over the world with one business center in a specific country, without having permanent establishment in all countries. In this case, product and service sales activities, and advertising activities regarding to these products and services are only taxed in the country in which the company locates its permanent establishment. The European Commission has presented two proposals to set rules for taxation of the income generated from digital services. In related proposals, The European Commission set rules that enables to tax not only the country in which the digital service provider company is located, but also to tax companies which do not have permanent establishment in that country but provide sales of products and services.1

The first proposal of European Commission is to acknowledge companies that meet certain criteria and sell digital products and services to EU member states without having permanent establishment as taxpayer in the relevant EU member states. According to the relevant proposal, companies that meet at least one of the following conditions will be accepted as tax resident for the digital services tax in the relevant EU member state. The conditions are as follows: Digital product/service companies whose annual revenue from European Union member countries exceed 7 million Euro, digital platforms which has more than 100 million subscribers in an EU member state, companies that make more than 3000 business contacts regarding digital services between users and the company within a tax period. With this proposal, it is aimed to tax the revenue generated by companies offering digital product/service sales from EU member states.

The European Commission stated that the first proposal could be detrimental to the European Common Market, thresholds set for digital services tax could hinder the growth of small entrepreneurial companies, and made a second proposal for a more comprehensive tax model for taxation of companies in which users play a major role in value creation. In its second proposal, the European Commission proposed that for companies which provide online placement services, companies which sell the collected user information, and digital platforms that allow interaction between users generating 750 million Euro or above revenue around the world, and generating 50 million Euro or more within EU member states, 3% digital services tax should be levied on the revenue they generate.

The most important thing that distinguishes the second proposal of the European Commission from the first proposal is that the second proposal of the European Commission focuses on the value created by users in the respective member states. The European Commission made the second proposal to be a temporary digital services tax until consensus is reached among the member states. Unanimity between the member states has not been achieved yet, and each state decides what constitutes the subject of digital services tax, and the tax rate to be applied.

  1. Views of OECD on the Digital Services Tax

OECD, updated the notes on the pillar one of the Base Erosion and Profit Distribution Action Plan stating that tax should be collected on the countries where permanent establishment is located, in the notes of the Secretariat Proposal for a 'Unified Approach' Under Pillar One, and declared that only taxing companies which have permanent establishment in the relevant countries is insufficient in taxing the revenue generated by the sales of digital products and services. OECD advocated that deciding on where to tax, what should be looked for is not where the company located its permanent establishment, but rather whether a "significant economic presence" is created or not.2

  1. Digital Services Tax Around the World

As mentioned above, subject of the digital services tax, and the rate of digital services tax to be applied varies from country to country. OECD member European Countries that bring digital services tax into effect are Austria, France, UK, Italy, Hungary, Poland, and Turkey. In Austria, subject of the digital services tax is online advertising, and the digital service tax rate applied by the country is 5%. The subject of the digital services tax in France is usage of digital interfaces and digital advertising services. The digital services tax rate applied by France is 3%. In the UK, the subject of the digital service tax is social media platforms, internet search engines, and online marketplace applications. The digital service tax rate applied by the UK is 2%. In Italy, subject of the digital services tax is advertising services realized through a digital interface, services that enable users to buy and sell products or services through a multi-layered interface, and the transfer of data created for the use of digital interfaces. The digital services tax rate applied in Italy is 3%. In Hungary, the subject of the digital service tax is revenue generated from digital advertising. The digital services tax applied in Hungary is 7.5%, but this rate has been temporarily reduced to 0%. In Poland, the subject of digital services tax is audio-visual media services, audio-visual commercial communication. The digital services tax rate applied in Poland is 1.5%. The subject of digital services tax in Turkey is digital advertising activities, sales of digital content, and paid services in social media. The digital services tax rate applied in Turkey is 7.5%.3

  1. Tension between France and USA on Digital Services Tax

Among the countries I listed above, I would like to particularly analyze France, which draws attention with tension it has with USA regarding the digital services tax. The Senate of French Parliament approved the law draft on digital services tax on 11th July, 2019.4France imposed digital tax services liability at a rate of 3% for service providers whose worldwide gross revenue is 750 million Euro or more and whose gross revenue from France is over 250 million Euro in a calendar year from the services provided through the digital interface and digital advertising services based on user data.

For the reasons listed below, the US Trade Representative launched an investigation into France's digital services tax implementation on 16th July 2019, and the investigation report was shared with public on 2nd December 2019.5 The first criticism made by the US Trade Representative on the injustice of France's digital services tax implementation is that the threshold France set for the digital services tax liability is too high. The US Trade Representative stated that, this situation excludes French companies with low gross revenue from the scope of the digital services tax, while taxing many digital services companies of USA, which are leaders in the digital market. Second, US Trade Representative stated that it does not approve the digital services tax to be collected retrospectively on the gross revenue generated from the digital activities as of 1st January, 2019, and continued that it does not seem possible to calculate the potential taxpayer amount accurately. Finally, the US Trade Representative stated that it is unfair for the digital services tax to be levied on gross revenue, rather than income, and this situation will punish certain big technology companies for their commercial success. Following the publication of the investigation report, the USA threatened France to impose import restrictions and additional tax on champagne and cheese products imported from France.6France had to postpone the digital services tax. Finally, France announced that it will impose the digital services tax before the end of 2020. 7After this announcement, the USA retaliated and declared that from 6th January, 2021 onwards, it will impose tariff at the rate of 25% for the luxury bags, cosmetics, etc. imported from France.8

CONCLUSION

Criticism against the digital services tax can be grouped into two main subjects. The first criticism is that, thresholds determined by countries for digital services tax liability are too high, and these amounts are determined that high specifically to target certain US companies that are leaders in the digital market. The second criticism is that it is unfair that the digital services tax is not levied on income, but rather it is levied on gross revenue. I agree with the criticism that thresholds determined for the digital services tax liability are too high, and these amounts are determined such high to target certain American companies that are leaders in the digital market. Most of the countries implementing the digital services tax set a tax liability threshold of 750 million Euro. There are very few companies operating in the digital market making more than 750 million Euro annual global gross revenue, and most of them are certain companies based in the USA. In order to prevent this situation, and to create a fairer digital service tax policy, threshold for the digital services tax liability can be reduced to the average annual income level of medium-sized companies operating in the digital market. I also agree with the criticism that since the digital services tax is not levied on income, but rather it is levied on gross revenue, it is an unfair tax. I believe that this situation adversely affects especially digital companies that make considerable amounts of investment in R&D expenditures. A fairer taxation system can be established if companies' taxes are levied on income rather than gross revenue.

US Trade Representative launched an investigation against European Union, Austria, Brazil, Czech Republic, Indonesia, India, UK, Spain, Italy and Turkey for determining the digital services tax liability threshold too high with the purpose of targeting certain leading US-based companies operating in the digital market.9 It is important to note that while some of the countries under the investigation are countries that implemented their digital services tax proposal, some of them are countries that have just made proposals for digital services tax. Probable outcome of the investigation is implementation of additional tariffs on the relevant countries' certain product groups, and implementation of import restrictions on the relevant countries' certain products groups. If the world economy which has drawn into economic recession with the COVID-19, encounters with retaliations against the digital service tax practices implemented/proposed to be implemented, such as trade restrictions, this would drag the world economy into greater dilemmas. In taxation of digital services, instead of determining a digital services tax liability threshold that targets certain US-based market leader digital companies, countries can reduce the threshold for the digital services tax liability to the average annual income level of medium-sized companies operating in the digital market. Additionally, a fairer taxation system can be achieved if the digital services tax is levied on income, rather than gross revenue. In this way, international trade can be protected from possible trade-restrictive retaliation against digital services tax practices.

Footnotes

1. "Fair Taxation of the Digital Economy", European Commission, https://ec.europa.eu/taxation_customs/business/company-tax/fair-taxation-digital-economy_en

2. "Secretariat Proposal for a 'Unified Approach' under Pillar One", OECD, 9 October 2019-12 November 2019

3. "What European OECD Countries are Doing about Digital Services Tax", Tax Foundation, Elke Asen, https://taxfoundation.org/digital-tax-europe-2020/#:~:text=As%20of%20June%2022%2C%20Austria,to%20implement%20such%20a%20tax

4. "France: Digital Services Tax (%3) Is Enacted",KPMG, 25 July 2019, https://home.kpmg/us/en/home/insights/2019/07/tnf-france-digital-services-tax-enacted.html#:~:text=The%20digital%20services%20tax%20is,more%20generally%2C%20digital%20business%20models

5. "Report on France's Digital Service Tax, Section 301 Investigation", United States Trade Representative, 2 December 2019, https://ustr.gov/sites/default/files/Report_On_France%27s_Digital_Services_Tax.pdf

6. "US Threatens Tax on Champagne and French Cheese", BBC News, 3 December 2019, https://www.bbc.com/news/business-50636521

7. "France to Impose Digital Tax This Year Regardless of any New International Levy", Reuters, Leigh Thomas, 14 May 2020, https://www.reuters.com/article/us-france-digital-tax/france-to-impose-digital-tax-this-year-regardless-of-any-new-international-levy-idUSKBN22Q25B

8. "Retaliation from the USA to France's Digital Services Tax", Anadolu Agency, Dilara Zengin, https://www.aa.com.tr/tr/dunya/abdden-fransanin-dijital-hizmet-vergisine-misilleme/1906738

9. "What is Behind USTR's New Digital Services Tax Investigation?", Center for Strategic & International Studies, Reinsch, William Alan, Martinez-Don, Carlota, https://www.csis.org/analysis/whats-behind-ustrs-new-digital-services-tax-investigation

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