Taxation within the EU of digital companies: options and implications
In a communication it published on 21 September 2017, the European Commission set out several options for taxing companies that are active in the digital economy. What would these options mean for your business? This ‘Tax Bit’ is the first in a series in which we assess all the options the Commission has put forward.
Please also see our note, "EU Commission sets out options for fair taxation of digital economy“, for more background information.
Option I – Equalisation Tax
A tax on the turnover of digital economy businesses
The French-led proposal is to apply in each EU Member State a 2%-6% levy on the turnover realised by digital means in that State. This so-called equalisation tax would target companies that do not have a taxable presence under current rules despite significant (virtual) interactions with clients and users. Based on the Commission’s communication, such tax would be levied on ‘all untaxed or insufficiently taxed income generated from all internet-based business activities, including business-to-business and business-to-consumer’. An existing example is India’s 6% levy on payments made to non-resident service providers for the use of internet advertising space or related services.
Taxing turnover and not profits would depart from current international tax rules and may result in taxing loss-making businesses. Furthermore, it is unclear whether the equalisation tax would be covered by tax treaties – this depends on whether it is ‘identical or substantially similar’ to the taxes covered by the applicable treaty – and whether it would be creditable against the corporate income tax in the country of residence of the company. As the Commission acknowledges, the compatibility with WTO rules and other trade agreements is also uncertain.
Depending on the structure of the equalisation tax, a series of issues would also need to be solved regarding the compatibility with EU law, like the freedom to provide services and the EU State aid rules.
Which companies of the digital economy will be impacted?
The impact of this option is difficult to assess until certain parameters are revealed, e.g., as from which turnover thresholds (if any), and to which cross-border activities and services the equalisation tax would apply. Furthermore, it is unclear whether all digitally active companies will be affected or only those active in specific branches of the digital economy (digital taxi services, digital house rentals, digital advertisements, etc.). It is also unclear whether the tax will be imposed both on domestic and foreign entities. The reference in the Commission’s communication to ‘untaxed or insufficiently taxed income’ may be an indication that the equalisation tax mainly targets non-EU tax resident entities.
Digital business model
The impact of an equalisation tax based on turnover instead of profits largely depends on the digital business model. Low-margin online businesses, e.g., online retailers, could see the viability of their business model questioned by an equalisation tax. Businesses with largely fixed costs, which can achieve sizeable profit margins once a certain scale is reached, would in principle be less harshly impacted.
No alternative equalisation tax bases
Unlike the OECD BEPS Action 1 report, the EU Commission does not mention alternative equalisation tax bases. In other words, a levy proportional to the average number of monthly active users or the amount of data collected from ‘in-country customers and users’. If introduced, these options would raise even more issues, amongst others because they presume that these variables are adequate indicators of revenues.
This French-led proposal is supported by 9 other Member States, including Germany, Italy and Spain. Several Member States have clearly expressed reservations.
Please contact your trusted adviser at Loyens & Loeff in case you have any queries.
Pierre-Antoine KlethiSenior Associate Attorney at law / Avocat / Tax Adviser
Pierre-Antoine Klethi, senior associate, is a member of the Tax and Investment Management Practice Groups in our Luxembourg office. He focuses on corporate taxation (including relevant international developments), fund structuring and EU State Aid investigations.T: +352 466 230 429 E: [email protected]
Dennis SchäferSenior associate Tax adviser
Dennis Schäfer is a tax adviser in our Investment Management group in our Amsterdam office. His work focusses on investment funds, both from a manager’s and investor’s perspective, real estate investments and international taxation.T: +31 205 785 456 M: +31 6 12 47 60 89 E: [email protected]