Global policy around digital taxation is moving lockstep in one direction: toward higher taxes. At least three distinct policy trends intersect around the complicated issue of how to tax multinational firms at higher effective tax rates.
In mid-October, the Organisation for Economic Co-operation and Development (OECD) released new details on how they would like to rewrite the international rules on taxing corporate profits. With no definitive OECD consensus in sight, France plans to lead the way on reimplementing its temporarily paused digital services tax. And the European Commission is doubling down on its legal actions against countries like Ireland and Luxembourg for offering “state aid” in the form of low taxes. These trends are interconnected, but each is independently setting the stage for higher taxes in the years to come.
Part 1: The OECD agenda
The OECD process is mostly a proxy battle over the entirely political question of where multinational profits should be taxed. Because the appropriate location and tax rate for international profits have no easy or straightforward answer, the organization’s proposed framework will fail to eliminate political tensions surrounding the issue. Consumers and business leaders should not hope for one single consolidated response to these mounting pressures. Higher and more complicated taxes are coming soon.
The OECD has been relentlessly preoccupied with eliminating legal means of lowering tax burdens since the 1990s, and this concern lies at the core of its proposed “inclusive framework.” In this more recent work, the organization has abandoned its historical role of reducing distortionary forms of international double taxation, instead becoming the hub for an entirely political debate about the appropriate level of taxation and division of taxing rights.
The most recent OECD proposal has two pillars, for which an updated version was released in mid-October when the deadline for a global consensus was delayed by about six months until mid-2021. Pillar one of the plan includes a new method of allocating a portion of so-called “consumer-facing” corporate profits, based largely on consumers’ and users’ location, rather than the business’s location as has historically been the case. The framework will overlay, on top of the existing separate accounting rules, a new formula-based system, which applies to a narrow but still largely undefined subset of firms. The second pillar is a new international minimum tax on corporate profits.
These changes are designed to undermine the corporate tax’s connection to a physical location and make it harder for domestic policymakers to design a tax system that attracts business activity through lower taxes. The new OECD system aims to lock every country into a centralized Paris-based minimum tax rate and tax base. The OECD describes the new tax system as “a significant change to the way taxing rights are allocated.” The framework could move about $100 billion of profit to new tax jurisdictions and increase net taxes by as much as another $100 billion per year, or about 4 percent of global corporate tax revenues.
Part 2: Digital taxes here to stay
Ostensibly, the urgency of the OECD process is motivated by the growing prevalence of digital services taxes (DST) that jurisdictions are implementing on a unilateral basis. In 2018, the European Commission proposed a 3 percent digital tax on revenues from online advertising, sale of user data and facilitated user interactions. Although the proposal did not gain consensus support, about half of the EU countries began working toward their own unilateral DST, including Austria, France, Hungary, Italy and Poland. Turkey is also planning regulations, and the United Kingdom has already implemented a DST. After the announcement of the delayed OECD consensus deadline, France (and others) have threatened to reimplement their digital service taxes, which have largely been on hold for the past year. If Paris begins collecting its digital levy, the U.S. will likely proceed with 25 percent tariffs on certain imported French goods early next year, as threatened.
The digital taxes have been used by European countries to force the OECD process forward. Many have promised to repeal the taxes following the agreement and implementation of the new OECD tax rules. Trading unilateral DSTs for a multilateral OECD framework is intended to “stabilize” the international tax system. However, a more likely outcome is that countries will continue to use their newfound tools of unilateral digital taxation to either push for more far-reaching OECD reforms or simply use the taxes to supplement declining revenues. States will be emboldened, knowing they can use unilateral tax measures to raise revenues in the short term and force international action toward their preferred tax system in the medium term.
The European Commission has already proposed a new “digital levy,” for which specifics are conspicuously absent, to fund part of the 750 billion-euro multiannual budget and coronavirus recovery program. This new tax is entirely separate from the OECD process and likely a sign that unilateral digital taxes are here to stay, whether as a continued cudgel for reform at the OECD or simply as another source of revenue.
Part 3: Expanding the definition of state aid
The Commission has also become more aggressive in prosecuting large multinational companies it thinks should pay more taxes to EU countries (despite what the member states themselves think, as in the case of Ireland). In the summer of 2020, the General Court of the European Union overturned a high-profile case against Apple in which the Commission alleged that Ireland had provided 13 billion euros in illegal “state aid” through lenient rules that allowed some profits of Apple’s Irish subsidiaries not to face local tax. The Commission has appealed the most recent General Court dismissal of the case.
On the face of it, it might seem that the court’s ruling is a roadblock to the Commission’s new and expanding role as a self-appointed European corporate tax enforcer. This view focuses too narrowly on the immediate result for Apple and misses the longer-term procedural win for the Commission. While the court rejected the specific definitions used to determine state aid, it confirmed that the Commission could bring state aid cases by challenging the particular interpretations of transfer pricing arrangements, even if it rejected this particular instance.
In the case against Apple, the Commission attempted to create its own standard to assess the impropriety of transfer pricing rules. In future cases, they will have to measure legality against OECD definitions, but they have been given full license to continue prosecuting low-tax arrangements.
Well before the court’s decision in 2020, the Irish government had backed away from its most controversial tax arrangements. In 2014, the year when the Commission launched the investigation that resulted in Apple’s court battle, Ireland declared its well-known “Double Irish” tax maneuver dead. Since then, companies that had benefited from the novel tax structure have also abandoned the planning technique. The Commission’s public crusade against low-tax jurisdictions has succeeded at tightening rules and raising taxes, even if they have yet to win outright in court.
A higher tax future
The OECD consensus plan seeks to add, on top of the existing transfer pricing rules, a new formula-based system that would distribute estimated residual consumer profits and allow countries to levy a minimum tax on international profits. If agreed, the framework will likely not stabilize the current system but instead open the door to repeated rewrites of the business tax system.
In that scenario, unilateral digital taxes and tariffs will still be used as political tools in disagreements. If consensus at the OECD fails, some countries may finish implementing their digital services taxes, but international pressures and the known economic costs of a trade war may provide a moderating check on the worst-case scenarios. The European Commission will continue to independently and aggressively go after high-profile companies and low-tax countries as an additional internal EU enforcement against competition. Each of these forces will most likely result in higher and more burdensome taxes on international business and domestic consumers.
Adam N. Michel focuses on tax policy and the federal budget as a policy analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation. His research focuses on the economics of taxation, international tax competition, and the federal budget.