European Commission's Digital Tax Plan Is in for a Fight

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The European Commission (EC), the executive branch of the European Union (EU), on Wednesday issued a proposed taxation plan for digital businesses operating in the EU. Noting that nine of the world’s 20 largest companies by market cap are digital businesses and that these businesses enjoy an effective tax rate that is half that of traditional companies, the EC claims that a balanced approach to taxation “is the only way to ensure that the digital economy is taxed in a fair, growth-friendly and sustainable way.”

As always, the devil is in the details, and the devil this time is taking aim squarely at platform providers like Facebook Inc. (NASDAQ: FB) and Alphabet Inc. (NASDAQ: GOOGL). The proposed plan could add millions, if not hundreds of millions, to the taxes digital companies pay to the countries in which they do business, even if the companies do not have a physical presence in the country.

The proposed plan includes an interim proposal and a long-term reform plan. The interim proposal’s goal is to “generate immediate revenues” for EU member states and help stifle unilateral taxation schemes that the EC says could hurt the single EU market.

The proposal calls for an indirect tax on revenues of companies with total annual global revenues of €750 million and EU revenues of €50 million. If the tax were set at 3%, EU member states could generate €5 billion in tax revenues annually.

The long-term plan is more detailed. From the EC press release:

A digital platform will be deemed to have a taxable ‘digital presence’ or a virtual permanent establishment in a Member State if it fulfils one of the following criteria:

• It exceeds a threshold of €7 million in annual revenues in a Member State

• It has more than 100,000 users in a Member State in a taxable year

• Over 3000 business contracts for digital services are created between the company and business users in a taxable year.

The fundamental difference between current taxation rules and the proposed rules is that current rules are based on a company’s operational base while the new rules are based on where the company’s users are based. Establishing a base in, say, low-tax Ireland would offer no protection against EU-wide tax laws. Ireland and other low-taxation countries certainly will object, while other EU members will welcome the change.

The Trump administration does not support the proposed EC plan. Treasury Secretary Steven Mnuchin is cited in The New York Times as saying: “We think that having gross taxes on internet companies is not fair.” Mnuchin goes on to call the proposal a “two-tiered system where internet companies are taxed under a different standard.”

U.S. objections alone won’t scuttle the EC proposals. What is likely to, however, is the EU requirement that all tax legislation be approved unanimously by its 28 members. Good luck with that.

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