The Office of the U.S. Trade Representative (USTR) issued a report
on Dec. 2 concluding that the recently enacted French digital services tax (DST) discriminates against U.S. companies and has indicated it may impose a tax on French goods in response.
The French DST is imposed at a 3% rate on digital advertising and data-driven revenue earned in France and is effective for all of 2019. It applies to companies with more than €750 million ($833 million) of global revenue and French-sourced revenue of at least €25 million ($28 million).
The USTR report found that the tax is burdensome and contravenes prevailing international tax principles because it is retroactive, affects a small group of digital companies and applies to revenue rather than income, including that which is unconnected to a physical presence in France.
The report proposes an additional custom duty of up to 100% on certain French products including wine, cheese and handbags. This tariff could have a significant impact on intercompany transfer pricing since it represents an additional cost of products sold from France to U.S.-affiliated companies. Typically the United States would be the importer and would bear the cost of the new tariff. Transfer pricing would need to be adjusted to account for the cost such that the U.S. affiliate continues to earn arm’s length profits. Without accounting for this tariff the U.S. affiliate could be operating at a loss or significantly reduced profits.
Other countries and the EU are considering enacting similar unilateral measures. This type of response to the digital economy is likely to continue until a consensus is reached on the pillars one and two proposals under the OECD’s Base Erosion and Profit Shifting (BEPS) Action 1 plan
The interim EU DST would only apply to companies meeting both of these requirements:
- Worldwide revenues exceeding €750 million ($833 million) for the latest complete financial year
- EU revenues within that year from taxable digital activities exceed €50 million ($56 million)
Application of the tax would thus be limited to cases where there is a significant digital footprint within the EU in relation to the revenues covered by the DST.
The EU DST would be imposed on gross revenue where users play a major role in value creation including revenues derived from: the selling online advertising space, selling data generated from user-provided information, and digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them.
The supply of digital content, payment services, online sales goods or services, and certain regulated financial and crowdfunding services are specifically excluded.
If the business belongs to a consolidated group for financial accounting purposes, the thresholds are applied in respect of total consolidated group revenues. The EU DST would apply irrespective of whether a business has a physical presence within the EU. Further, as a gross revenue-based tax, no provisions are provided for companies generating losses. Based on these parameters, the Commission has estimated up to 150 companies would be subject to the DST, and could generate up to €5 billion ($5.5 billion) in annual tax revenues across the EU.
The DST would only apply until the longer term solution regarding significant digital presence (SDP) is implemented.
As a longer-term solution, this proposal would amend corporate tax rules to include a new concept of digital permanent establishment (PE), accompanied by revised profit attribution rules.
The revised rules would require a company to pay income tax in an EU member state where it is deemed to have a SDP by fulfilling any of the following requirements in that member state:
- Revenues from digital services exceed €7 million in a taxable year
- Users of digital services in a taxable year exceed 100,000
- Business contracts for digital services created between the company and business users in a taxable year exceed 3,000
Given these parameters, many more companies could become subject to increased corporate tax in the EU than the number of companies subject to the interim DST. The SDP proposal does not provide the rate of tax to be applied by an EU member state to the resulting profits.
The EU Parliament will be consulted on the proposals, with the proposals then provided to the EU Council for deliberation and potential adoption. The Commission hopes that adoption will occur by Dec. 31, 2019, for transposition into the national laws of EU member states by Jan. 1, 2020, with respect to tax periods beginning on or after that date.
As tax legislation, the unanimous approval by all 28 EU member states is required. In a joint statement released on March 21, 2018, the Ministries of Finance of five member states (France, Germany, Italy, Spain and the United Kingdom) provided support for the proposals. Ireland, the Netherlands and Luxembourg, on the other hand, have expressed strong opposition to the proposals. If unanimous approval is not obtained, the EU’s enhanced cooperation mechanism, in which a subgroup of nine or more member states proceed together but without the mandatory inclusion of other member states, is a possibility. Some member states, for example, have already stated that enhanced cooperation would make sense if at least 20 member states joined, with reportedly 19 member states already having agreed with the proposals.
It should be noted that certain member states may potentially move forward unilaterally with their own national implementation of a DST or similar tax. For example, on March 13, 2018, the U.K. Chancellor of the Exchequer presented the Spring Statement 2018 to Parliament, which contained digital economy tax measures including a tax levy on the revenue of digital companies as an interim measure.
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