Photo by rupixen.com on Unsplash
Joe Schick, Associate Member, University of Cincinnati Law Review
I. Introduction
COVID-19 has exacerbated revenue problems for governments around the world, which has resulted in a push for more consistent taxation of online digital commerce.[1] Digital services taxes (“DST”) offer opportunities for jurisdictions to take advantage of the massive growth of commerce that has shifted online.[2] The Organization for Economic Cooperation and Development (“OECD”) has taken notice of several European countries implementing their own DST, and has been hard at work to develop global standards for its member countries to adopt.[3] While different countries have their own DST structures, most plans proposed to the OECD include a 2-3% tax on specific gross revenue streams generated from consumers within the jurisdiction, which would kick in above a high revenue threshold.[4] The subjected revenue streams are mainly online advertising sales, marketplace transactions, and sales of user data.[5]
The OECD was founded in 1961, primarily by pre-E.U. European countries, the U.S. and Canada with the purpose to “promote policies that will improve the economic and social well-being of people around the world.”[6] The OECD currently has 37 members, including China, India, Brazil, Japan, Mexico, and several other non “western” countries. One of the OECD’s top responsibilities within the international community is to create global tax standards.[7] These standards reduce uncertainty and compliance-related costs, which can contribute to economic growth.[8] Creating baseline tax rates reduce the occurrence of tax havens and shelters, which encourage corporations to participate in evasive tax behaviors.[9] Corporations that move operations to tax havens[10] contribute to “base erosion” of their home countries, a race to the bottom of tax rates,[11] thus inhibiting governments’ ability to efficiently raise and maintain revenues.
The OECD was hoping to pass its plan in December of 2020, however, OECD head of tax policy Pascal Saint-Amans believes an agreement will not pass until “sometime in 2021.”[12] The main detractor thus far has been the U.S., where uncoincidentally, the primary corporate targets of DST reside.[13] The U.S. has threatened retaliation if European countries unilaterally continue to implement DST.[14]
The U.S. has a long history of protecting digital commerce from the burdens of stringent taxation since it passed the Internet Tax Freedom Act (“ITFA”) of 1998.[15] The ITFA prevents state and local governments from taxing internet access, and well as “multiple or discriminatory taxes on electronic commerce.”[16] The U.S. domestic policy goals of fostering internet growth and protecting its domestically-based tech companies likely play a role in its hesitations with the OECD plans.
II. The OECD Proposal
The OECD’s plan to improve and standardize multinational corporate taxes involves a two “pillar” approach. The goal of Pillar One is to give jurisdictions better means to tax foreign corporations for the benefits they incur from being able to do business within their borders.[17] For instance, if Twitter collected and sold personal data it gathers from its users in Italy, but maintained no offices, subsidiaries, or contractors physically in Italy, Twitter would have incurred a large benefit directly from the Italian market while avoiding several tax liabilities. Pillar One seeks to solve this issue largely by allowing gross revenue streams driven by digital commerce or the data economy to be taxed.
The goal of Pillar Two is to establish a global minimum corporate tax rate to combat domestic tax base erosion and profit shifting (“BEPS”) from multinational corporations that take advantage of lower tax rates across jurisdictions. These tax practices cost countries between 100 to 240 billion USD or 4-10% of the world’s corporate income tax revenue.[18] There are many different loopholes that enable BEPS, most of which are not illegal, but do have the effect of eroding the public’s belief in the fairness of the tax system.[19]
An example of base erosion (the “BE” in “BEPS”) would be for an American corporation to loan money to its subsidiary in the U.K. The U.K. subsidiary would then repay this loan with interest. The U.K. subsidiary could then deduct these interest payments, reducing its tax burden in the UK, while essentially paying itself (the U.S. based company) back. Thus, the U.K. loses out on taxing the profits of the subsidiary.
An example of profit shifting (the “PS” in “BEPS”) would be a US corporation transferring ownership of intellectual property, which produces income from royalties, to a low tax jurisdiction like the Cayman Islands. By definition, intellectual property is not physical in nature, so it can legally “reside” in any jurisdiction that allows it. The income from the royalties are then taxed at much lower rates, if at all.
Pillar One must be agreed to before Pillar Two is formally considered, as the two are “intrinsically tied up with the other.”[20] Generally, the domestic DST plans countries are enforcing currently would be subordinate to any OECD agreement. However, France’s law currently does not contain a sunset clause that would phase the tax out.[21] Pillar One is where problems have arisen with the U.S., which will be discussed at length in the next section.
III. The U.S. Response
Despite no consensus from OECD discussions, several large U.S. trade partners have already established their own versions of DST, including the U.K., France, and India. The Trump administration responded this past June by launching trade probes into several of those countries, investigating whether these DST measures discriminate against U.S. based companies.[22] Section 301 of the Trade of Act of 1974 grants the President the power to levy tariffs and other penalties on countries if the administration believes unfair trade practices are taking place.[23] These probes are conducted by an interagency committee within the Office of the United States Trade Representative.[24] The committee conducts public hearings and receives written submissions from interested parties, to formulate recommendations to the President.[25] As a result, the U.S. has placed a 25% tariff on specific French luxury goods, such as wine, handbags, and cosmetics for the foreseeable future.[26]
The U.S. has a history of being hesitant to tax the digital economy, and feels that subjecting its technology firms to a foreign digital tax could cause unfair double taxation of revenue streams.[27] The ITFA was renewed eight times since 1998 before being made permanent in the Trade Facilitation and Trade Enforcement Act of 2015.[28] This demonstrates Congress has repeatedly expressed its desire to shelter digital commerce from excessive taxation.
To the contrary, several U.S. states and localities have been considering their own versions of digital taxation, due in part to the massive revenue shortfalls they will be experiencing from the COVID-19 economic downturn.[29] Nearly half of U.S. states began taxing streaming services in 2020, as people cutting cable has caused a reduction in tax receipts from citizens not having a cable bill to pay.[30] Constitutional issues arise when state laws, such as Maryland’s House Bill 732, seek to single out digital revenue streams.[31] The Maryland bill sought to tax digital advertising revenue streams above a certain threshold. Governor Larry Hogan vetoed the bill earlier this year, but not without it raising several constitutional issues.[32]
First, the Maryland bill likely violates Section 1105 of the ITFA, which prohibits the singling out of online services for taxation.[33] For instance, if the bill taxed all forms of advertising generally instead of singling out digital advertising, the collection of tax on digital advertising would not violate the ITFA.
Second, the Maryland bill provides a threshold amount of digital advertising revenue, once met, creates a tax burden for the corporation.[34] Notably, the vast majority of corporations that meet this threshold would not be Maryland corporations.[35] Thus, the tax would work as a de facto tariff against corporations from other states and countries, as it would make it more expensive for consumers to engage in commerce with those non-Maryland corporations. States do not have the power to levy tariffs under the Commerce Clause because they are regulations on interstate and international commerce, a power expressly granted to Congress.[36] As the Supreme Court in West Lynn Creamery, Inc. v. Healy explained: “[t]ariffs are the paradigmatic example of a law discriminating against interstate commerce.”[37] Therefore, the tax likely violates the Commerce Clause, as the tax would apply disproportionally to corporations located outside of Maryland.
Finally, the Maryland bill violates the constitutional principle that it is solely the federal government’s duty to negotiate with foreign countries on commercial matters.[38] The Supreme Court discussed the principle in Michelin Tire Corp. v. Wages “[a] court must also inquire…whether the tax prevents the Federal Government from “speak[ing] with one voice when regulating commercial relations with foreign governments.”[39] The federal government has been clear about its intentions to shape DST, is currently engaged in negotiations with the OECD, and in the middle of a potential trade war with France. These factors make the Maryland bill more than likely unconstitutional.
IV. Conclusion
The outcome of the U.S. election is likely the deciding factor as to how timely the OECD proposals are passed. A potential Biden administration has been clear on its intentions of increasing taxes on corporations, and ending the “artificial trade war” with the EU.[40] Attempts by individual states will be stymied by the constitutional difficulties of passing substantial digital tax laws. The U.S. will have to come to terms with foreign countries imposing more forms of digital taxes on U.S. corporations if they are going to continue to enjoy the benefit of operating there. Governments around the world, including the U.S. at the federal, state, and local levels, are struggling with ways to fund themselves during this widespread economic downturn.[41] The largest tech companies in the U.S. appeared to do even better financially because of the COVID-19 pandemic, and there is little reason to suspect their successes will not continue.[42] Inevitably, governments are going to want a larger piece of that success during these difficult times.
[1] Roger Russell, Digital services taxes face barriers, Accounting Today (Jul. 7, 2020) https://www.accountingtoday.com/news/digital-services-taxes-face-barriers.
[2] Id.
[3] Id.
[4] Id.
[5] Id.
[6] OECD – Organisation for Economic Co-operation and Development, European Commission (accessed Nov. 3, 2020) https://ec.europa.eu/knowledge4policy/organisation/oecd-organisation-economic-co-operation-development_en#:~:text=.oecd.org%2F,The%20mission%20of%20the%20Organisation%20for%20Economic%20Co%2Doperation%20and,seek%20solutions%20to%20common%20problems.
[7] OECD Work on Taxation, OECD (accessed Nov. 8, 2020) https://www.oecd.org/tax/centre-for-tax-policy-and-administration-brochure.pdf.
[8] Scott Hodge, The Compliance Costs of IRS Regulations, Tax Foundation (Jun. 15, 2016) https://taxfoundation.org/compliance-costs-irs-regulations/#:~:text=The%20growing%20complexity%20of%20the,costs%20for%20households%20and%20businesses.&text=Americans%20will%20spend%20more%20than,economy%20%24409%20billion%20this%20year.
[9] Nicholas Shaxson, Tackling Tax Havens, International Monetary Fund (accessed Nov. 8, 2020) https://www.imf.org/external/pubs/ft/fandd/2019/09/tackling-global-tax-havens-shaxon.htm.
[10] Tax havens colloquially refer to jurisdictions with effectively negligible tax rates.
[11] “Race to the bottom” refers to the phenomenon of jurisdictions competitively lowering their tax rates to attract capital.
[12] OECD warns of delay to global digital tax deal, DW News (accessed Nov. 3, 2020) https://www.dw.com/en/oecd-warns-of-delay-to-global-digital-tax-deal/a 55240899#:~:text=The%20Paris%2Dbased%20OCED%20has,the%20OECD%20said%20on%20Monday.
[13] Russel, supra note 1.
[14] Id.
[15] 47 U.S.C. § 151.
[16] Jeffrey Stupack, The Internet Tax Freedom Act: In Brief, Congressional Research Service (Apr. 13, 2016) https://fas.org/sgp/crs/misc/R43772.pdf.
[17] Daniel Bunn, Summary and Analysis of the OECD’s Work Program for BEPS 2.0, Tax Foundation (Jun. 18, 2019) https://taxfoundation.org/oecd-work-program-beps-analysis/.
[18] Understanding tax avoidance, OECD (accessed Nov. 3, 2020) https://www.oecd.org/tax/beps/.
[19] Base Erosion and Profit Shifting (BEPS) – What Is It and How Does It Affect Your Business?, Sciarabba Walker (Jan. 23, 2018) https://swcllp.com/base-erosion-and-profit-shifting-beps-what-is-it-and-how-does-it-affect-your-business/#:~:text=These%20tactics%20are%20referred%20to,and%20profit%20shifting%20(BEPS).&text=Some%20BEPS%20schemes%20are%20illegal,operate%20on%20a%20domestic%20level.
[20] Russel, supra note 1.
[21] Elke Asen, FAQ on Digital Services Taxes and the OECD’s BEPS Project, Tax Foundation (Jan. 30, 2020) https://taxfoundation.org/oecd-beps-digital-tax/.
[22] David Lawder, U.S. launches trade probe into digital taxes, plowing ground for new tariffs, Reuters (Jun. 2, 2020) https://in.reuters.com/article/instant-article/idUSKBN2392PH.
[23] Nitish Pawha, The United States Begins a Trade Probe Into China, Global Edge (Aug. 25, 2017) https://globaledge.msu.edu/blog/post/54448/the-united-states-begins-a-trade-probe-i.
[24] Section 301 Investigation Fact Sheet, Office of the United States Trade Representative (accessed Nov. 4, 2020) https://ustr.gov/about-us/policy-offices/press-office/fact-sheets/2018/june/section-301-investigation-fact-sheet#:~:text=Under%20Section%20301%20of%20the,burden%20or%20restrict%20U.S.%20commerce.
[25] Id.
[26] US announces new tariffs on French goods in digital tax row, The Economist (Jul. 16, 2020) https://www.eiu.com/n/us-announces-new-tariffs-on-french-goods-in-digital-tax-row/.
[27] Ruth Mason, Maryland’s Proposed Digital Tax May Be Unconstitutional, Medium (Jan. 30, 2020) https://medium.com/@ProfRuthMason/marylands-proposed-digital-tax-may-be-unconstitutional-9be58831315b.
[28] Internet Tax Freedom Act’s prohibition against taxing internet access applies to all states beginning July 1, 2020, EY (Jun. 1, 2020) https://taxnews.ey.com/news/2020-1436-internet-tax-freedom-acts-prohibition-against-taxing-internet-access-applies-to-all-states-beginning-july-1-2020.
[29] Jeffrey Clemons, New estimates of state and local government revenue shortfalls, American Enterprise Institute (Sep. 8, 2020) https://www.aei.org/economics/new-estimates-of-state-and-local-government-revenue-shortfalls/#:~:text=We%20estimate%20that%20state%20government,likely%20have%20projected%20in%20January.&text=We%20estimate%20an%20overall%20revenue,for%20the%202021%20fiscal%20year.
[30] Greg Iacurci, The Netflix and Spotify tax: States are making streaming services more expensive, CNBC (Feb. 24, 2020) https://www.cnbc.com/2020/02/24/states-are-imposing-a-netflix-and-spotify-tax-to-raise-money.html.
[31] S.B. 2, 2020 Gen. Assemb. § 1-101 (Mar. 2020).
[32] Jared Walczak, Gov. Hogan Vetoes Maryland Digital Advertising Tax Legislation, Tax Foundation (May 7, 2020) https://taxfoundation.org/governor-hogan-vetoes-maryland-digital-advertising-tax-legislation/.
[33] 47 U.S.C. § 151.
[34] S.B. 2, 2020 Gen. Assemb. § 1-101 (Mar. 2020).
[35] Mason, supra note 27.
[36] U.S. Constitution, Art. 1, §8, cl. 3.
[37] West Lynn Creamery, Inc. v. Healy, 512 U.S. 186, 196 (2005)
[38] Mason, supra note 27.
[39] Michelin Tire Corp. v. Wages, 423 U.S. 276, 285 (1976).
[40] Michelle Scott, Explaining Biden’s Tax Plan, Investopedia (Oct. 28, 2020). https://www.investopedia.com/explaining-biden-s-tax-plan-5080766; Aime Williams, Biden will end ‘artificial trade war’ with the EU, Financial Times (Sep. 22, 2020) https://www.ft.com/content/25d54717-2803-45f3-b54a-9b147e9a8951.
[41] Clemons, supra note 29.
[42] Rani Molla, As Covid-19 surges, the world’s biggest tech companies report staggering profits, Vox (Oct. 30, 2020) https://www.vox.com/recode/2020/10/30/21541699/big-tech-google-facebook-amazon-apple-coronavirus-profits.
