The question of whether large digital companies should pay tax where they reside and produce (e.g. in the United States) or where they sell their digital products online (e.g. in Europe) is the subject of a major debate. There is also a move by the OECD and the G20 to establish a “minimum tax” irrespective of the location of a company, but agreement is far from clear.
Convoco talked to Prof. Wolfgang Schön of the Max Planck Institute about:
Digital tax initiatives and other potential reforms to global corporate taxation
Convoco: The reform of the global tax regime is usually presented as an issue of “justice.” In your opin-ion, what does justice mean for global taxation?
Wolfgang Schön: There are at least three different notions of “justice” which come to mind when we speak about international taxation. In the context of the taxation of the digital economy, many people ad-dress “justice” in the sense that large multinational companies should not have a fiscal ad-vantage when compared to small and medium-sized enterprises. A major example is Amazon, which pays less tax on its profits than many local booksellers. Moreover, people think of rising inequality and the fact that a low tax burden on corporate profits benefits the shareholders who tend to belong to the “rich” part of society. Last but not least, international tax justice refers to countries and their shares in the international tax pie. This is where developing countries come to the fore, as they claim that the current international tax system allocates insufficient revenue to them.
C: One controversial idea is the “digital services tax” which aims to tax digital companies regardless of where they are located, but rather where value is created. What do you think of this approach?
WS: I do not think this is a good idea. First, it is hard to carve out the “digital sector” of the economy given the pervasive nature of digitalization. Second, we should think more about the right way to tax profits (corporate tax) and turnover (VAT) in a general way that does not add a new layer of taxation. Such specific taxes are mostly employed when the legislator tries to control behav-ior and reduce economically or socially negative activities (taxes on petrol, alcohol, or tobacco). Digitalization is in principle a good thing and should not suffer a fiscal disincentive.
C: Given that there is still no agreement in the EU on a new corporate taxation policy, France has taken the step to enact a digital services tax unilaterally…
WS: It is not only France but also Spain, Italy, the United Kingdom, and many more countries inside and outside Europe who are trying to tax foreign businesses by introducing a dedicated tax on digital services. I do not support this movement at all. It will cause a lot of political damage in-ternationally, in particular with regard to the United States and their fiscal reaction to this pro-posal. Europeans should instead think about improving the competitiveness and attractiveness of their own digital companies. Taxing foreign companies is not equivalent to fostering competi-tive domestic companies. Moreover, there are some legal issues with these digital services taxes. They are framed in such a way that only or mainly foreign companies fall within the scope of the tax. This can amount to a prohibited extra tax on foreign providers which runs foul of WTO law or becomes a subsidy for local providers which is also prohibited. There may be some serious trade disputes coming up which erode the position of the European Union in the context of free trade negotiations with the United States and other countries.
"In my view, one should use VAT to cover digital services to a larger extent then under current practice. This would shift revenue to market countries without upsetting the international tax system"
C: Is there a fundamental problem with the idea of digital tax allowing states to tax operations in their jurisdictions even if companies are not based there?
WS: This issue goes far beyond the digital world. It is about a global consensus dating back to the 1920s when the League of Nations agreed that (corporate) income taxes should be paid where a company resides or maintains a “permanent establishment.” The factual assumptions underlying this consensus have been eroded not only by digital services but also by all forms of remote selling and servicing and by the increased reliance on intangible assets that can easily be shifted between jurisdictions. Therefore many countries (in particular developing countries) press for a larger share of the corporate tax base going to “market countries” where the consumers reside. The United States supports this move to a limited extent as a general trend towards market tax-ation would not only cover (digital) US firms but also major exporters from Europe and Asia. The OECD has recently put forward a proposal to adjust tax treaties around the world for the benefit of “market states” in such a general fashion. The word “digital” doesn’t even show up in their recent publications. But it is also clear that a general move of taxing rights towards market countries without any physical presence is very hard to apply in practice. Looking at the big picture, one should not forget the fact that remote sellers or digital providers have to pay VAT on their deliveries wherever they have customers. To that extent, one should not assume that these companies pay no tax at all in the “market countries” where the con-sumers reside. In my view, one should use VAT to cover digital services to a larger extent then under current practice. This would shift revenue to market countries without upsetting the in-ternational tax system.
C: An alternative proposal to the digital tax is the global minimum corporate tax rate. Is that a better approach?
WS: The idea of a global minimum tax, which would allow other countries to tax profits if the country where the firm resides doesn’t apply a sensible tax rate, is a good idea insofar as it does not distinguish between digital and non-digital business. Moreover it addresses specific issues of tax competition, namely undertaxation due to tax avoidance structures and undertaxation due to aggressive tax policies by some jurisdictions. But it does not address the fundamental issue of whether the international rules on the allocation of fiscal revenue need a fundamental reset. Over the last few months, however, it has become clear that a global minimum tax might turn into a bureaucratic nightmare, as the residence country of a large multinational company would be obliged to make shadow assessments concerning all subsidiaries of this company around the world—irrespective of what they do and where they reside. A German tax office (“Finanzamt”) would have to calculate the profit of each foreign subsidiary on the basis of German tax law and compare the resulting effective tax rate with the actual tax paid abroad. Nobody knows how that could be enforced in an efficient and non-arbitrary fashion.
C: Do you believe taxation is a legitimate instrument to increase competition and break up monopolies?
WS: This question goes to the heart of the conflict. Many people (including many politicians) try to fight the market power of the large digital companies by all means possible. And it looks very attractive for countries to kill two birds with one stone: raising revenue by taxing digital companies while reducing their competitive advantages at the same time. It would be much better to identify more closely the anti-competitive structures that have evolved over the years and to use antitrust law to force large digital companies to deliver benefits to consumers and strength-en local competitors.
C: Is Europe powerful enough to stand up to the US? The US has reacted to the French digital tax by threatening steep tariffs on French imports…
WS: This is hard to say. The United States has been willing to apply tariffs to European and Asian goods for some years now. But these tariffs not only hit foreign exporters, they also increase prices to US consumers. And we do not know at what point domestic industry and domestic consumers in the United States will start to press the US government to loosen their grip on crossborder trade. As 2020 is an election year in the United States, anything can happen…
Prof. Dr. Dr. h.c. Wolfgang Schön is Director and Scientific Member of the Max Planck Institute for Intellectual Property, Competition, and Tax Law in Munich. He is Honorary Professor at Ludwig Maximilian University Munich; member of the Global Law Faculty, New York University; and International Research Fellow, University of Oxford Centre of Business Taxation.Since 2014 he has been Vice-President of the German Research Foundation (DFG).