Analysis

Digital Taxes Face International Legal Gantlet

By Alex M. Parker
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Law360 (May 29, 2020, 7:14 PM EDT) -- Special taxes on digital companies seem almost inevitable as the novel pandemic heightens focus on the tech sector, but they could face legal challenges under both international trade and tax rules as countries begin to collect.

Despite the OECD's efforts to negotiate multilateral changes to international taxing norms, individual countries have begun exploring national taxes to target digital businesses. (AP)

With most of the world relying on the web to survive and conduct business for the past few months, the dynamics of the debate on how to best tax digital enterprises have fundamentally shifted. A project at the Organization for Economic Cooperation and Development to negotiate a multilateral agreement among nations faces long odds, and officials in Europe and elsewhere have heightened the focus on technology companies as a new source of revenue for cash-strapped governments.

National taxes on revenue from digital activities, such as those enacted by countries ranging from France to Indonesia, are poised to go into effect next year. But the companies affected by the tax — by and large, based in the U.S. — could seek relief under bilateral treaties against double taxation as well as free trade agreements protecting against discriminatory taxation.

With both global tax and trade norms in flux, the legal questions add yet another layer of uncertainty in the digital debate.

Anger at supposed tax avoidance by multinational corporations has steadily risen around the world since the 2008 financial crisis. As the economy rebounded, a new class of internet giants replaced the brick-and-mortar behemoths of old, and their business models put increasing strain on the international tax system. Companies that earn money online — whether through sales, advertising or collecting valuable data — work around the rules of decades-old bilateral treaties, which look to physical activities as the basis for taxation. And tech companies earn much of their income through intellectual property, which can be more easily moved from jurisdiction to jurisdiction in a chase for lower tax rates.

Despite efforts to negotiate multilateral changes to international taxing norms at the OECD, individual countries began to explore national taxes on digital commerce. Last year France enacted a 3% digital services tax, largely modeled on a failed European Commission proposal. The tax hits revenue from online activities, such as e-retail and advertising, that are linked to French users. It applies only to companies with more than €750 million in annual global revenue.

U.S. officials have blasted France's digital services tax, as well as similar laws that have sprouted across Europe, Africa and Asia, claiming they are narrowly targeted at the U.S. technology industry. France has agreed to hold off on collection of its tax until 2021 as the OECD makes a last-ditch effort to find a multilateral solution and the U.S. readies potential retaliatory tariffs.

Meanwhile, the discussion has begun to move on to looking at how businesses can operate in a world with digital services taxes — and what options they may have to combat them.

Global commerce is governed by a network of bilateral and multilateral treaties and agreements, most of them seeking to ensure a level playing field for trade and business. A tax that singles out companies of a certain size and specific types of activities could be seen as a violation of those rules — or a clever way of complying with them while dealing with a new type of enterprise.

Tax experts disagree on that question, or whether companies or countries could successfully challenge the digital services taxes through these international laws.

"The problematic thing is that with this high-revenue threshold, you're basically ensuring that the tax is being collected from companies that are mostly nonresidents of the countries that are proposing the tax," said Leopoldo Parada, a lecturer of tax law at the University of Leeds.

Parada and Ruth Mason, a professor of tax at the University of Virginia School of Law, wrote a journal article in 2019 arguing that the French tax does single out U.S. companies and could be considered discriminatory. They contend that the digital services tax could be challenged under European Union laws that bar member states from hindering a business from operating, as well as those that bar a state from favoring one industry over another. Ironically, the latter rules, against illegal state aid, have been used to mount aggressive investigations of the tax practices of many global multinational corporations.

Aside from the law itself, Parada and Mason looked at statements from French officials and lawmakers promising that it would not fall on French companies. They noted that France's finance minister, Bruno Le Maire, has often referred to the digital services tax as a GAFA tax — referring to Google LLC, Amazon.com Inc., Facebook Inc. and Apple Inc.

The Tax Foundation, a conservative-leaning economic research group, published a study Tuesday also looking at whether the tax violates EU law, as well as France's bilateral tax treaties and international trade laws under the World Trade Organization. The study finds potential issues in all of those areas — though whether a challenge would be successful could hinge on a host of technical and legal questions.

"Countries considering enacting DSTs of their own may be well-advised to consider carefully if and how they go about doing so," wrote Chris Forsgren, Sixian Song and Dora Horváth for the Tax Foundation. "Otherwise, those states may find themselves before courts and international tribunals grappling with many of the same issues raised here."

The authors noted that the French law includes a €25 million ($27.8 million) threshold for annual revenue in France, as well as a global threshold. Because France's local threshold would be enough to ensure that the law applies only to big companies, the larger global threshold is "essentially an irrelevant factor included solely for the purpose of distinguishing" between French and non-French companies, they argued.

But not everyone agrees that the digital services taxes are either uncalled for or discriminatory.

"It's not unreasonable for the EU countries to want to get some tax revenue from huge multinationals that pay little tax to them, and also little to other countries, by interacting very profitably with their own domestic consumers," said Daniel Shaviro, a professor of taxation at New York University School of Law. "If this is a reasonable goal, then the fact that a lot of the firms are American — and that perhaps for some people in the EU this adds insult to injury — does not, to my mind, make what they are doing illegitimate."

In a 2019 research article, Shaviro noted other reasons, aside from nationality, that tax administrations would want to focus on larger companies.

"Large digital firms may be especially likely to earn rents, have low marginal costs of operating in particular markets, and be well situated to avoid or minimize corporate income tax liability," he wrote.

Aside from the size question, the U.S. or its companies could challenge other aspects of the French law. A report from the U.S. Trade Representative, as part of its investigation into retaliatory tariffs, noted that the law exempted online platforms that sell their own services — ensuring that Swedish music streaming services company Spotify Technology SA would not qualify. The tax also exempts data collected by sensors, which many have interpreted as an exclusion designed to protect the German automobile industry.

But appeals for fairness could be lost in the noise as international norms for multilateralism show strain. Ironically, the U.S.'s recent opposition to the World Trade Organization, impeding its ability to hear new trade disputes, could rob it of a venue to challenge the French law. 

"If you don't have a functional WTO, then you're not going to have an opportunity to adjudicate the claims under trade law," noted Daniel Bunn, vice president of global projects at the Tax Foundation.

--Editing by Tim Ruel and John Oudens. 

For a reprint of this article, please contact reprints@law360.com.

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