4 December 2019

Control? Alter? Delete? What to do about the tech tax

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Nato’s birthday celebrations were marred by a row between two of the guests, Presidents Macron and Trump, over both the health of the military alliance and France’s decision to hit US firms with a new digital tax. This row has at least drawn attention to the potential conflict between tech taxes and international rules that prohibit discriminatory tariffs. But the opening of a new front in the global trade wars is only one of several problems with all such taxes, including the UK’s own plan for a Digital Services Tax (DST).

To recap, the DST would be a tax of 2% on the revenues of firms with a large digital presence, where these revenues can be linked to the participation of UK consumers. The main targets are social media platforms, search engines and online marketplaces. The Conservative government has already included the necessary legislation in the latest draft Finance Bill. Labour and the Liberal Democrats would go even further. Nonetheless, the DST would still be a bad tax, based on dodgy economics and flimsy evidence, and costly to implement.

The UK is of course not alone in this plan. The European Commission has proposed a new EU-wide levy on digital revenues. France has already introduced what is colloquially known as a ‘GAFA tax’, which is aimed more or less explicitly at firms such as Google, Apple, Facebook and Amazon. Spain, Italy and Austria are at it too.

All these proposals seek to tap into the popular hostility towards the global tech giants. Often this is based on problems that are nothing to do with the tax system, such as the proliferation of ‘fake news’ or allegations that workers are being treated badly. But a common theme is the presumption that the tech sector does not pay its ‘fair share’ of tax.

The justification for this claim is actually pretty thin. For example, misleading comparisons are often made between the sales that Amazon makes in the UK, and the corporation tax it pays here. This is daft, because corporation tax is paid on profits, not turnover, and certainly not on the value of the business transacted between third parties on an online marketplace.

What’s more, when a company only has a limited physical presence in a country, it is surely not unreasonable to expect it to pay less tax in that country. This is because it’s not making the same demands on local taxpayer-funded public services or infrastructure.

Where tech firms do pay less tax, it is typically for good economic reasons, or a result of tax breaks that governments themselves have promoted, including the more favourable treatment of R&D, software developed in-house and other intangible assets. In the case of Amazon, the company has also made the most of tax breaks for employee share ownership schemes, again something that critics of the company would presumably support.

Officials have therefore also had to come up with a dubious economic justification for targeting the tech sector with additional taxes. The DST seeks to extend the widely accepted principle that the profits of a business should be taxed in the countries in which it creates value, to cover the participation of online customers in the UK.

However, goods and services with user-created value are nothing new, and certainly not restricted to the digital sector. Many traditional businesses, such as airlines and shipping companies, benefit from value contributed by foreign nationals, or have a substantial online element. There is a clear risk that decisions about what is and what is not within the scope of a digital tax become increasingly arbitrary and distortionary.

There are many practical problems too in deciding where and how much value is being created. The DST will require agreement on which activities, which revenues, and which users, come within the scope of the new tax and which do not. This is hard enough for physical businesses, let alone the online world. For example, ‘smart car’ technology relies on collecting information from users, and more and more retailing and banking is now done online.

Indeed, many accountancy firms have raised concerns about the continued lack of clarity about the scope of the DST, including uncertainty over the meaning of ‘UK user’, and the additional compliance burden this will create, especially for smaller businesses who might still be caught up. (No need to take my word for it. You can read the submission from the Chartered Institute of Taxation, here.)

There has also been next to no consideration of the broader economic impact of the DST. Companies, especially US-based tech giants, may be a popular target, but they are only legal entities and cannot bear the economic burden of tax increases themselves. The reality is that all taxes are ultimately paid by people – including employees and customers, as well as shareholders. What’s more, turnover taxes have particularly large deadweight costs, are more likely to be passed on to consumers, and are a major deterrent to investment.

To cap it all, it’s not even certain that digital taxes are allowed in international law – as the spat between the US and France demonstrates. Indeed, even French officials describe their initiative as the ‘GAFA tax’, which is a dead giveaway. As Hufbauer and Lu explain, this appears to be a de facto tariff in breach of WTO rules. The DST certainly wouldn’t make a US-UK trade deal any easier.

In short, additional taxes on the turnover of companies with a large digital presence would be disproportionate and discriminatory, and further complicate the tax system for little benefit. Indeed, the proliferation of national initiatives in this area is adding to the complexity and uncertainty.

Even if the UK government is unwilling to abandon the idea completely, it would still make sense to put any new UK digital tax on hold until agreement is reached at the OECD level to overhaul the taxation of multinational companies generally. But it would be far better to press delete immediately.

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Julian Jessop is an independent economist