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Congress Must Confront Europe’s Punitive Targeting of U.S. Digital Firms

Sept. 17, 2021, 7:00 AM

Washington is see-sawing back and forth right now on a wide array of issues, including infrastructure investment, Buy American policy, and even electric vehicles.

But amidst the usual partisan gridlock, it appears that both Democratic and Republican lawmakers agree on one issue—the problem of foreign digital service taxes (DSTs).

DSTs are a feature of the internet age—a tax on sales made across digital platforms. This includes any product or service that’s transferable across the internet. The issue quickly becomes complicated, however, since tangible consumer goods are often intertwined with digital services. As a result, disagreements can arise as to where the sale of one product begins and an accompanying service ends.

As arcane as all of this may sound, digital taxation could soon have an outsized impact on the U.S. economy. That’s because the largest digital companies in the world are primarily headquartered in the U.S. And so, with European nations threatening to impose large-scale digital service taxes, the real-world consequence is a potential threat to the competitiveness of U.S. companies.

Europe has a clever rationale for imposing DSTs. It notes that America’s digital companies overwhelmingly shift profits to tax havens in order to avoid paying EU taxes. Such profit shifting is a well-worn tactic, however, and plenty of global firms—including pharmaceutical producers—use similar tactics to avoid paying U.S. taxes. But since taxation of global multinationals has become such a thorny problem, the Organization for Economic Cooperation and Development (OECD) has even waded into the issue. In fact, the OECD recently agreed that countries should be able to reclaim taxes from the largest profit shifters. As a solution, the OECD has proposed switching to a global system that taxes profits based on location of sales and end user.

It’s good that the OECD has worked to mediate such a contentious dispute between some of the world’s largest industrial nations. But it hasn’t solved the DST issue. It was agreed that, in exchange for participation in the OECD’s new tax framework, countries would drop their unilateral DSTs. However, many of those countries are hinting that they might persist with DSTs—they claim that they’re waiting to be sure the OECD agreement works. Realistically, however, this means that Europe wants to keep taxing U.S. digital companies in the near term. And that’s something U.S. lawmakers rightly find unacceptable.

If Europe and the rest of the world persists with its DSTs, the U.S. Trade Representative (USTR) could respond with tariffs. Imposing such tariffs would be complicated, though. And realistically, the U.S. simply needs better tools to address taxation in the digital arena.

One helpful aspect of the OECD’s tax agreement is that countries now accept the merits of “sales factor apportionment.” In the wider picture, this is helpful, since it could motivate the U.S. and other countries to finally tackle large-scale profit shifting. But if Washington is looking to eliminate the problem of DSTs, a lot of work remains.

It would be a good thing if Washington opts to use unilateral sales factor apportionment to tackle other countries’ one-sided DST taxation. That’s because Europe sees the U.S.’s digital companies as an easy target, and yet it still wants to protect its own tax avoiders. Essentially, Europe is saying “We want to target your tax avoiders, but our tax avoiders can keep doing what they’re doing.” Congress is right to be frustrated by such self-serving behavior. And so, a U.S. response that uses sales factor apportionment would be particularly fitting—a leveling of the playing field that says, “If you tax our companies for profit shifting, we’ll tax your companies for the same thing.”

All of this is strong medicine, of course. And Washington likely would only take action in response to other countries’ continued, unilateral efforts. But if the OECD can’t solve the current squabbling, Washington must take action in response to countries that choose to proceed with punitive DSTs on U.S. companies.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

David Morse is tax policy director at the Coalition for a Prosperous America Education Fund. Follow him on Twitter @CentristinIdaho.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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