US expands digital services tax investigation to cover UK and EU

"This turn of events should surprise no-one," said Eloise Walker, a tax expert at Pinsent Masons, the law firm behind Out-law. "The US administration has been sending shots across the bow since last year and the Treasury has been well aware that the threat of tariffs is on the cards for months now. That has not stopped the UK proceeding with its digital services tax; but then, faced with post-Brexit trade negotiations with the US, the UK was never going to give away a playing card before that process truly gets going." 

In January, US treasury secretary Steve Mnuchin threatened new tariffs on UK car manufacturers if the UK went ahead with its digital services tax. However, the UK went ahead with its tax which came into force on 1 April.

"President Trump is concerned that many of our trading partners are adopting tax schemes designed to unfairly target our companies," said Robert Lighthizer. "We are prepared to take all appropriate action to defend our businesses and workers against any such discrimination."

Last year the US investigated France's introduction of a digital services tax and threatened to impose 100% tariffs on champagne and a number of French luxury goods. France has since agreed to suspend collection of its digital tax, in return for the US not increasing tariffs and continuing to engage with the Organisation for Economic Cooperation and Development (OECD).

The US's 'section 301' investigation system enables the US trade representative to investigate whether an act of policy of a foreign country is unreasonable or discriminatory and burdens or restricts US commerce. The digital services tax investigation will cover digital services taxes  adopted or under consideration by Austria, Brazil, the Czech Republic, the EU, India, Indonesia, Italy, Spain, Turkey, and the UK.

Digital services taxes (DSTs) are being introduced by a number of countries that are concerned that tax is not being paid by digital companies in the countries where digital activity takes place. The US is concerned about these taxes as they are expected to have a significant impact on large US-based tech companies.

The UK's new digital services tax is charged at 2% on the UK-derived revenue of social media platforms, search engines and online marketplaces. It is payable by businesses whose global revenue from in-scope business activities is greater than £500 million and where more than £25m of that revenue is derived from UK users.

In May 2019 the OECD agreed with the G20 a programme of work to come up with proposals to reform the international tax system to address the challenges of the digitalisation of the economy. This programme of work was divided into two 'pillars'.

Pillar one addresses the allocation of taxing rights between jurisdictions and considers proposals for new profit allocation and nexus rules. Pillar two is the 'global anti-base erosion' (GloBE) proposal which seeks to develop rules that would provide jurisdictions with a right to tax where other jurisdictions have not exercised their primary taxing rights or the payment is otherwise subject to low levels of effective taxation.

The original aim was for the OECD to reach international agreement on its proposals by the end of 2020. Work is continuing on the project, and the OECD says that it still hopes to reach agreement by the end of 2020, although it will present its latest proposals to governments in October, rather than July as originally planned.

"But it remains to be seen how much headway the OECD can truly make with pillar 1 in light of continuing US resistance," said Walker. "The OECD cannot force the US to do anything, and with the US safe-harbour proposals still sitting – an elephant in the room – in the pillar one negotiations we must wait to see if the OECD can find any agreement on even the auto-digital plank of pillar one, never mind the wider, and trickier, consumer-facing business angle."

The OECD's pillar one proposal adds new taxing rights on top of the existing system, targeting all multinational enterprises with consumer facing businesses and not just technology companies.

In a surprise move last December, Steven Mnuchin wrote to the OECD secretary-general suggesting a ‘safe-harbour regime’ in place of the OECD’s pillar one proposal, because of concerns about the impact of the proposal on US owned technology businesses.

The OECD responded expressing surprise that this had not been mentioned earlier by the US and concern that this late proposal would make it harder to reach agreement by the end of 2020.

In April the OECD said that the coronavirus crisis was likely to result in an increased focus on addressing the tax challenges of the digitalisation of the economy and ensuring that multinationals pay a minimum level of tax. It said that increased use of digital services and the need to expand revenue raising as a result of the pandemic "could provide new impetus" to efforts to reach agreement on international proposals to change the way multinationals are taxed.

However, it made it clear that the OECD was proceeding with the existing pillar one proposals although some had hoped for a carve out for  consumer facing brands which have been hard hit by the pandemic. The OECD said that "companies running losses would be less likely to be impacted" by the pillar one proposals.