U.S. Has to Engage in Global Digital Tax Debate

Author: Anjana Haines

Failing to participate in the global digital tax debate would be a mistake the US would regret, says Vertex Chief Tax Officer.

US Secretary of the Treasury Steven Mnuchin has stood by his March statement that the US opposes proposals by any country to single out digital companies. However, analysts say that unilateralism is inevitable and the US should not shy away from the conversation, but instead use its position as an OECD member state to encourage a multilateral approach.

“It’s in the US’s best interest that if there is going to be multilateral action on taxing the digital economy and not just unilateral action, then they [the US] really need to get in there and modify their position to work with the OECD to come up with a workable solution,” said Michael Bernard, chief tax officer at Vertex.

“There is just too much momentum at this point to say that[digital taxation] is not going to happen,” Bernard, who was previously tax counsel at a large technology company, told International Tax Review.

However, the US often prefers to forge its own path. While it has embraced some of the BEPS measures, it has yet to integrate some aspects that conflict with either the principles and provisions in its US model tax treaty, such as Action 15, or other provisions in its tax code. The US also has its own information exchange framework, the Foreign Account Tax Compliance Act (FATCA), which is equivalent to the common reporting standard.

These decisions beg the question of how involved the US truly wants to be on the digital tax debate, the conclusions of which will seriously affect some of its biggest corporations.

But George Salis, principal economist and tax policy advisor at Vertex, said taxing the digital economy is tough because it is a transforming economy that is still in its innovative infancy that is growing at an exponential rate relative to other parts of the economy, in particular the traditional trade-based economy of the past.

The US Bureau of Economic Analysis has estimated that the digital economy has been a “bright spot” in the US economy, growing at an average annual rate of 5.6% per year from 2006 to 2016 compared to 1.5% growth in the overall economy. According to Bloomberg, that is triple the pace of US GDP.

“What governments are trying to do is tap in further, and tax that gap of the economy,” Bernard said. “Obviously there are certain bodies like the OECD and EU that are studying these things more closely and are trying to formalise some positions, but then there are other countries that have every right to do what they're doing to somehow capture a value that's different than transactions. The question among the corporate community is: How are they going to do it?”

David Bradbury, head of the tax policy and statistics division at the OECD, told delegates at a recent closed ITR event about the progress made and challenges ahead in finding a global solution. While those comments cannot be quoted verbatim, many tax officials and taxpayers at the Digital Taxation Summit in London agreed that there is more work to be done on business models and value creation before reaching a multilateral solution.

Bernard said sections 3.40 to 3.7 of the UK Treasury’s updated position paper on corporate tax and the digital economy, gives some indication about what the valuation model may look like.

However, until there is some form of international standard agreement, unilateral measures are inevitable.

Italy is one such country that has chosen to introduce its own web tax and a separate tax on digital transactions, with the initiatives scheduled to apply from 2019 and 2020, respectively.

India has also taken unilateral action with the introduction of an equalisation tax, and the UK is said to be considering a similar move.

"The stalling has to stop. If we cannot reach agreement the UK will go it alone with a 'digital services tax' of its own," UK Chancellor Philip Hammond said during a speech on October 1 at the 2018 Conservative Party Conference.

“Today, politics is hurting the economics debate, the trade debate, and the digital debate,” said Bernard. “One of the problems with that is that this interim taxation of the digital economy and digital activities is bringing us into different models, and that's what's causing this unilateralism that is arising out of different countries.”

“Countries pretty much are saying: until there's more consistency and uniformity around the world, we're going to come out with our own tax – whether it be through a profit tax, digitisation tax, service tax or an increased rate of VAT or GST,” Bernard explained. “But it is all politically driven.”

The issue that arises with unilateralism is the conflict in tax regimes and their application. Salis also pointed out that the promise of temporary, or interim measures such as the EU’s, should not be taken literally – a view that many taxpayers at ITR’s Digital Taxation Summit agreed with.

“An interim tax will usually take the form of a permanent tax – once a tax is in place, especially if it's so successful in being collected and implemented, it is going to be very hard not to turn it into a permanent tax,” Salis said.

As with any new tax regime, there will be uncertainty during the period of adjustment, and that uncertainty is going to create risk. “You have jurisdictional risk, reputational risk, and different kinds of other risks for multinationals, but also for governments and tax administrations because they are expecting to [charge a] tax and, consequently, to avoid fiscal and economic distortions.”

Companies and governments will also face a higher administrative burden from new taxes, and care has to be taken to avoid double taxation or double non-taxation.

“We have to be careful that this transitional period of adjustment doesn't take us in the wrong direction,” warned Salis, which is why every government has to join in the debate.

“The challenge is that with every new economic revolution and ensuing cycles – and this is now being termed as the fourth industrial revolution – new taxes and revenues will emerge. If you don't tax them properly – and that's the key question here – then what you create are some new fiscal distortions and [governments] have to be very careful that the fiscal distortions are addressed properly,” Salis said.

In the case of the US, just because Mnuchin has said – in line with Action 1 – that the digital economy is the economy, and that it should not be “ring-fenced” or treated differently, Salis and Bernard believe that it does not mean that the government would not participate in the global discussions. “The danger of not embracing global uniformity on digital taxation is the fact that if the US were to resist it, then there is a risk that it may take other forms that the US may come to regret later,” Salis said.

Originally published in International Tax Review and TP Week.