Digital service taxes: Are they here to stay?

Digital Service Taxes, or DSTs, have been permeating the trade environment since 2018, but COVID-19 and the OECD’s digitalization of the economy project, commonly referred to as BEPS 2.0, have accelerated the focus on DSTs. The stated aim of DSTs is to ensure that “market” countries get increased taxing rights over the profits of tech-based multinational companies that sell into their local market, and collect data from and target advertisements at local audiences, regardless of their physical presence. 

The current geopolitical landscape 

The OECD hopes to get nearly 140 countries to agree to an overhaul of international tax principles, including a unified approach to digital taxes, by mid-2021. If that effort fails, still more countries are preparing to launch unilateral digital tax measures aimed at tech giants.

Already, 15 of 37 OECD countries have DST laws in place or proposed, with several (including France, Italy, Spain, and the UK) having already implemented DSTs. Outside of the OECD countries, Argentina, India, Brazil, Indonesia, Kenya, Nigeria and Vietnam are among the dozen non-OECD countries with either existing or proposed DSTs. The EU is also planning to pursue new digital tax measures by year end.

Closer to home, several U.S. states have proposals for imposing gross revenue taxes on certain digital activities. Given the widespread and evolving nature of these measures, this blog seeks to address some key questions: what are DSTs, how critical they will be in the future, and how should the C-suite prepare.

DSTs: What are they? Who should be prepared?

First, we need to understand what DSTs are not - they are not an income (profits) tax, not an online sales tax, nor are they a VAT. They are generally a tax on gross revenues occurring outside of any treaties. 

Who should be preparing for DSTs? Not just companies offering primarily digital services or goods. DSTs can be very broad in scope, covering not only online sales, but also digital advertising, data usage, e-commerce, streaming/downloading, SaaS, and more. The time to assess and prepare is now for companies regardless of sector given the growing digitalization of commerce. 

So, are digital taxes here to stay? And if so, what should be done to prepare for the different outcomes?

DSTs will be with us for the foreseeable future

One thing is pretty certain: DSTs are not going away in the short term. They merit careful consideration and preparation, not just a glance from tax leadership. Since they started to appear, DSTs have always mattered, but they are at the forefront of concern for companies at this moment for several reasons.

First, as a matter of timing, G-20 finance ministers have reaffirmed that the middle of 2021 is still the timetable to reach an agreement on a global tax deal -- a deal that would include the conclusion of the OECD’s digitalization of the economy project, along with measures like a global minimum tax. 

There is enthusiasm to get to the finish line of the digitalization question, but we still don’t have a clear picture of what that finish line will look like. Notwithstanding the high level of political enthusiasm for arranging a global consensus, the relevant question for companies is what that endgame is going to look like. So, while the final outcome with respect to the unified approach to DSTs is still unclear, the timeline is fast approaching and worrisome given the unresolved issues. 

Even as countries attempt to negotiate a solution at the OECD, several key OECD countries and developing countries have already put forward proposals and finalized legislation to collect various taxes on digital activities through unilateral approaches. The growing web of unilateral DSTs is becoming more complicated and will be difficult to disentangle if and when an OECD solution arrives. And that’s before we get to the tricky question of what the trigger for “rollback” will be.  Agreement? Legislative package?  Given the need for 67 votes in the US Senate for the proposed treaty, that could take some time.

How to prepare the C-suite for what lies ahead

So we know DSTs are here and not likely to go away soon. More may be coming, and we still don’t know how they may change over time. So the question is: how should tax directors prepare the C-suite for a conversation around DSTs? What do companies need to know about DSTs, and why do they matter now?

Companies will need to prepare for a range of possible outcomes of the OECD negotiations. It remains to be seen whether this is no agreement, a detailed agreement or a high level blueprint. 

If there is an agreement between the members of the OECD framework, it will not wash away the reality of DSTs. There are significant compliance and reporting requirements that companies need to start considering. If the level of agreement is not significant around many of the undecided issues (thresholds, sourcing, and allocation methods), questions will remain that may cause inconsistent implementation by countries and burdensome compliance obligations for companies. 

In addition, it is unclear where and who within the supply chain will bear the cost. For example, if a user in France accesses a platform made available by a US company, and there is a third country displaying paid-for ads on the platform, who in the value chain should bear the cost? The presence of DSTs for the foreseeable future makes it imperative for businesses to examine their value chains and address these issues with their suppliers and customers. 

Further complicating the world of DSTs, U.S. states, like Maryland, have begun to include DSTs in their state tax codes. In Maryland, the taxable “retail sale” now includes a sale of a digital product that is sold with rights to use (including subscriptions) and the sale of subscriptions themselves. If other states follow suit, U.S. companies should be aware of the implications of DSTs on their state taxes as well. 

Plan, don’t panic, about DSTs

The best way to prepare the C-suite for DSTs is to model the impact of DSTs. Companies need to concern themselves with DSTs and related taxes now, and the best way to do that is by looking at dollars and cents. If your company is or may be subject to DSTs in more than 1-2 countries where it does business, there is DST modeling to be done. The modeling can be fairly simple; we do not need all of the detail on what DSTs will look like, we just need some idea of what may be coming in the next 6, 12 and 18 months. 

If you are a multinational, there is a strong chance this will affect you one way or another, no matter what kind of agreement materializes (or does not materialize). 

Be proactive and engaged with the political and business community

U.S. companies should keep in mind that their interests may have an ally in their government; and that may pose a fundamental stumbling block to a unified approach to DSTs. The U.S. does not want the digital economy ringfenced and has already pushed back against DST proposals from France, Austria, India, Italy, Spain, Turkey, and the UK, calling them discriminatory against U.S. digital companies. The USTR is exploring possible trade actions to preserve procedural options with respect to these taxes - in fact, the U.S. is weighing retaliatory tariffs of up to 25% on certain goods from those countries.

The U.S. government’s line on this issue has been consistent, from the Obama administration through the Trump administration and now into the Biden administration. While the USTR has reiterated its commitment to an OECD consensus on international tax issues, it has also made clear it will protect U.S. interests until such a consensus is reached. So, U.S. multinationals should keep an eye on news from the White House and USTR. 

The takeaway 

Just like recent economic developments related to the COVID-19 pandemic, the world of DSTs isn’t going away. Don’t let senior leadership get caught off guard. DSTs may not be affecting your company today, but they are populating and evolving. Adopting a proactive approach will help you  be ready for a continuing uncertain tax environment.