If the Juncker Commission wanted to be political, today’s proposal on taxing the digital economy shows it certainly can be. But it takes the risk of causing serious international tensions. And will the reform ever see the light of day?
By Rasmus Corlin Christensen, PhD Fellow, Copenhagen Business School; Benoît Roussel, Partner, and Tim Law, Senior Policy Advisor.
If anybody still wondered what the “political” European Commission proclaimed by Jean-Claude Juncker at the beginning of his mandate might look like, today is a good day to pay attention. The Commission’s package of proposals on digital taxation might indeed be one of the clearest examples to date of the EU executive’s efforts to act almost like a “normal” government: by reacting, very openly and explicitly, to political pressure and public outrage over the fact that “digital companies do not pay their fair share” of tax; but also by ditching a whole range of supposedly fundamental principles along the way.
Let us consider for a moment the sheer ambition of the proposed reforms.
Contrary to the OECD BEPS project, the proposed Directive on the taxation of digital activities – the “structural” solution put forward by the Commission – is not “simply” about updating international tax principles to close loopholes and address aggressive tax optimisation practices. It is about saying that current corporate taxation principles are fundamentally ill-equipped to capture new forms of value creation, which can no longer be linked back to a physical presence, or even, in some cases, a monetary transaction. Hence the introduction of the new concept of “digital permanent establishment” and, more far-reaching still, of a formula-based system to allocate profits to a specific location (i.e. a specific digital permanent establishment).
This might not be a bad idea, but it is a major shift from some of the key principles that have underpinned the international corporate tax system for the past decades – first and foremost the “arm’s length” principle, which has long been the OECD community’s preferred standard and which the BEPS project deliberately decided not to touch. By proposing a partial move to formulary apportionment, the Commission makes its belief clear that the international corporate tax system is out of step with the requirements of the digitalised economy, and thus takes the major gamble of reigniting a century-old debate over the key principles that underpin it.
Interestingly however, the Commission continues to pay at least rhetorical allegiance to the arm’s length principle. Counter-intuitively, it also seems intent on playing down the significance of its proposed reform, arguing that it is merely a sustainable solution “within the corporate tax system”.
This is probably because the Commission is not only departing from international tax principles, but also from international cooperation in the process. For decades the OECD had established itself as the de facto “world tax organisation”, including on issues relating to the digital economy, on which it had recently been tasked by the G20 to develop policy recommendations by 2020. Continuing a trend that could already be perceived in recent years, today’s proposals mark an unmistakable attempt by the Commission to set the international tax agenda outside of the OECD forum, presumably in the hope that raising the stakes will increase the pressure on others to follow suit.
True, the Commission is trying not to position itself entirely outside of the OECD community, explicitly recognising the need for an international solution and noting that the concept of permanent digital presence could be developed further in “appropriate international fora”. But it is also showing more clearly than ever that it is no longer prepared to be held back by the pitfalls of building international consensus. Instead, it tells its partners it is determined to go it alone and essentially to position itself as an alternative tax policy forum to the OECD whenever necessary.
Yet the Commission is naturally well aware that even in the EU, building consensus around tax reforms is a very tall order (unanimity, anyone?). This is why it also proposes an “interim” EU tax on digital services – i.e. a measure, one would expect, that is supposedly less critical and easier to agree on than the structural one.
But ironically enough this interim measure, from the perspective of international tax cooperation at least, might be even more controversial than the structural one: it is explicitly conceived as a compensation for digital companies’ lower average taxation levels and calculated on the basis of revenue instead of profit. In essence, it is a sort of tax penalty aimed at correcting not digital companies’ efforts to game the system, like in usual tax optimisation / transfer pricing situations, but the tax system’s very inability to properly capture their activities.
This is explosive stuff to say the least and several member states have already started voicing their reservations. So what is the common denominator that the Commission hopes will ensure swift passage of the interim digital services tax?
Here too, the Commission’s approach is clear if, for its standards, unorthodox: it hinges on the fact that, thanks to high turnover thresholds and a focus on specific business models (advertising and intermediation services), the new tax will almost exclusively hit big (US) platforms whose political capital is rapidly evaporating. This is probably clever politics in Europe. But from an international perspective, and for all of Donald Trump’s misgivings with Silicon Valley, this is bound to fuel the US government’s scorn over the EU’s perceived attempt to tax what it believes it has the right to tax, further fanning the flames of a potential international “tax war”.
Time will tell whether the interim digital services tax, like the structural proposal, will ever see the light of day (doubts are allowed). And never mind the actual impact of the interim tax’s limited scope – after all this is meant to be, maybe more than anything else, a symbolic political measure.
What matters is the bold and almost radical change of tone embodied in the Commission’s approach. In one go it questions decades-old international tax principles, challenges the OECD’s role as the preferred international tax forum and takes the risk of aggravating a tax (and trade) dispute with the US.
Clearly this reflects a profoundly changed political environment that is emboldening the EU to take a more assertive (some might say protectionist) approach to defending its interests on the world stage: Brexit; transatlantic trade relations and international cooperation under a Trump presidency; and the election of Emmanuel Macron, the real instigator and strongest proponent of the digital services tax, which he sees as an important signal in his bid to strengthen a “Europe that protects” in the run-up to the 2019 European elections.
As so often in EU politics nowadays, the question is whether Macron will get his way or whether the reality of EU politics will catch-up with him. And in an area like taxation, the French president’s and the Commission’s objectives could well fall prey to the EU’s inbuilt institutional inertia. After laying out such bold ideas, being unable to adopt and implement them would certainly risk undermining the EU’s international credibility.
The Commission might not yet be a “normal” government after all.