Why the French digital tax deal is not good enough

Why the French digital tax deal is not good enough
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The G-7 summit failed to generate workable plans on several critical global issues, including climate change, fire in the Amazon rainforest and trade. Important but overlooked was President TrumpDonald John TrumpMost Americans break with Trump on Ukraine, but just 45 percent think he should be removed: poll Judge orders Democrats to give notice if they request Trump's NY tax returns Trump's doctor issues letter addressing 'speculation' about visit to Walter Reed MORE and French President Emmanuel MacronEmmanuel Jean-Michel MacronRussia vows to return seized warships to Ukraine NATO is not brain dead yet Trump, NATO chief to meet at White House MORE’s joint statement that their countries have reached a deal to address the French digital tax on large tech companies such as Facebook, Amazon and Google.

But this deal does not provide much relief for U.S. companies affected. The urgent need for a global solution is now more obvious than ever.

France enacted the Digital Services Tax (DST) in July. It subjects large tech companies with digital revenue of 750 million euros ($830 million) globally and 25 million euros ($28 million) in France to a 3 percent revenue tax. Digital revenue includes revenue from digital advertising, online intermediary activities (transactions on e-marketplaces, for example) and sale of user data. The DST applies retroactively from January of this year and the first payment is due in November.

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Parallel to the DST, the Organisation for Economic Co-operation and Development (OECD) has committed to coming up with a final plan to tax digital economy in 2020. But France has been frustrated with the slow progress and reiterated these tech giants did not pay their fair shares of taxes in France. but the DST did not occur in a vacuum; it was modeled after a March 2018 European Commission proposal that failed to generate consensus among member countries. Both OECD and the European Union recognized the harmful economic consequences of DST and did not view it as a viable solution.

The U.S. ferociously opposes the DST: Trump has threatened to impose a tariff on French wine, and the Senate Finance Committee proposed to double the U.S. tax rates on French companies and citizens residing in the U.S. The U.S. Trade Representative Office initiated a formal investigation on the tax and held a hearing immediately before the G-7 meeting to explore whether the tax is unreasonable and discriminatory against U.S. companies. With the imminent risk of retaliatory measures, many U.S. and French businesses hoped a deal would be reached at the G-7 meeting, and one was.

In this touted deal, France agrees that when OECD reaches an international consensus, it will adhere to that global resolution, unwind the DST and refund the amount overpaid to the tech companies. In other words, the French DST could last less than two years.

Is this compromise a relief for U.S. tech companies? Not necessarily.

First, the deal did not address the issue of compliance costs. An Amazon executive indicated that in order to calculate the tax owed, it would cost the company millions of dollars to reprogram its system and track user data to ascertain digital revenue generated in France. Facebook stated its commercial relationship is with advertisers instead of directly with users, so it does not track user locations in its normal course of business. Google raised the difficulties of location tracking when people use a virtual private network (VPN), which disguises users’ location.

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In addition, the retroactivity essentially means companies need to calculate tax liabilities based on records they may not have been keeping and did not know they needed to keep before DST’s passage in July. With less than three months to prepare their first payments, the time and resources involved further burden to these companies.

Second and related, although the tax is transient, uncertainty posts great risks and challenges for business operations. According to a recent OECD announcement regarding the status of consensus development, none of the leading proposals remotely resembles the DST. This means tech companies could rush to spend millions to comply with the DST, and there would be limited residual value for these resources incurred after two years. These costs do not even constitute tax revenue in the French government’s coffer — they are just administrative costs that generate no productive results.

Another element of uncertainty is whether other governments that are considering their own unilateral measures, including in the United Kingdom, Italy, Spain and Australia, will follow France’s lead to impose their own DST. Compliance costs, and potentially double taxation, would increase exponentially if the U.S. fails to deter this from happening. 

Finally, the base of DST is revenue instead of profits, which means the costs associated with the creation of revenue are not considered. Practitioners have been questioning whether existing income tax treaties are applicable to DST if any dispute arises, and whether U.S. companies can get tax credits for DST paid. 

In addition, although the French DST seeks to equalize the tax disparity between foreign and similarly situated domestic business, it has had the opposite effect so far: Amazon already announced it would pass the 3 percent tax on to French-based small and medium-size businesses that utilize its online marketplace. This means French merchants and consumers will incur higher expenses.

France’s unilateral action, although somewhat expected, does generate economic distortion and increase uncertainty for businesses. The only silver lining is that the DST sends a strong message to the OECD that a global consensus is overdue, and to large tech companies that the international tax rules may soon be revamped and a new sheriff will be in town as early as next year.

Today’s companies are increasingly digital, which means companies – tech and traditional alike – increasingly rely on intellectual property such as proprietary algorithms or platforms to reach international customers without establishing anything physical in the destination country. The OECD has an opportunity to generate a solution that is less distortionary and prevents the unilateral measures from expanding. With the G-7 deal yielding no substantial improvement and companies still needing to endure tedious and unproductive procedures to comply with the French DST, the stakes are higher than ever.

Joyce Beebe is an economist and fellow in public finance at Rice University’s Baker Institute for Public Policy,