France’s plan to tax tech companies such as Google, Apple, Facebook and Amazon has recently made the news, mainly due to the threats from the United States to impose tariffs in retaliation. But France is not alone. Other countries such as Austria, Australia, Belgium, Spain, Italy, Czech Republic, Poland, Slovenia and the United Kingdom have implemented or announced plans for a similar tax. These levies are expected to directly impact the tech industry worldwide.
As Canada increases its efforts to become a world-leading centre for technology and innovation, the taxation of digital businesses should become one of the most debated tax policy issues for the next few years.
In fact, a recent report by Statistics Canada has shown that Canada’s digital economy is growing at a much faster pace than the rest of the economy. Some Canadian cities such as Toronto, Vancouver, Montreal, Ottawa and Calgary are rapidly moving towards becoming global tech hubs.
Unilateral measures and tax competition
Public concern about taxing tech groups has stemmed from media reports that the biggest of the firms book most of their profits in low-tax jurisdictions. Governments have been discussing ways to update the existing international taxation rules to tax digital businesses that currently go significantly untaxed. However, governments’ failure to achieve a consensus solution for tackling the digital economy has led many of them to come up with unilateral measures.
Such an uncoordinated approach adds another layer of complexity to the already uncertain environment of tax competition among countries, which has caused severe economic distortion and shortage of revenue available to governments around the world. The international tax system has been criticized for many decades due to the lack of proper coordination among states and outdated international tax concepts and rules. These recent legal developments to tax the digital economy have only made it more complicated.
As happens with most contemporary global issues, taxation of the digital economy requires global cooperation. Unilateral tax measures are problematic for businesses, which will be vulnerable to undesirable compliance costs and risks of double taxation. Such unilateral measures also impose a significant burden on governments, which will have to deal with a global power struggle that might lead to lower economic growth and unnecessary costs for tax administrations worldwide.
Heading to a global solution?
A group of more than 130 countries (entitled the “Inclusive Framework”) is currently working, under the technical support of the OECD, to reach a consensus solution on how to tax digital businesses. The project involves complex technical details, but the political challenges might be more difficult to overcome, since a decision on the issue will likely force an overhaul of the international system in place since the 1920s.
More importantly, any changes in how digital business will be taxed internationally will affect how the international tax base is currently allocated among states. Countries today are entitled to tax global business income based on the concepts of residence (where the company is legally incorporated) and source (where the company has a physical presence and the income is generated). Recent discussions on digital services taxation indicate that new criteria might be used, such as: where a company has a significant economic presence (even in the absence of any physical presence); where its users are based; or where its marketing intangibles (such as trademarks, customer lists, and customer data) are located.
The Inclusive Framework group expects to reach a final solution by the end of 2020. However, despite recent optimistic statements by world leaders, a consensus solution seems remote. There are still too many proposals on the table, and each of them will lead to a major shift in how the international tax base is currently divided between governments. The significant distributional consequences of any solution suggest that a political consensus will be hard to achieve.
Three important concerns
Although taxing digital businesses as a way to ensure they pay their “fair share” is desirable, unilateral, uncoordinated measures threaten to double tax these businesses and negatively impact economic growth and technological innovation around the globe. The burden of compliance costs might be even more consequential than the tax burden itself, if governments carry on with unilateral levies, leaving businesses to comply with different rules and administrative procedures. Furthermore, most of these unilateral measures single out digital-only companies, which is problematic because the digital economy is increasingly becoming the overall economy itself, as traditional players transform their businesses with digital technologies.
Second, any solution should also mitigate opportunities for tax-avoidance practices and tax competition among countries, which not only affect the collective revenue available to governments to fund needed public services but also distort economic decisions and add complexity to the tax system. Since tax competition is a collective-action problem, cooperative behaviour by only some governments would allow others a free ride. This is why broad cooperation is necessary for an agreement to be effective.
Third, achieving an international tax system that delivers a balanced allocation of the global tax base among countries is paramount. The current global tax rules are significantly biased toward more developed, capital-rich countries. This is problematic from a perspective of global justice but also as an obstacle to achieving broader cooperation in tax matters. Many of the states engaged in tax competition today are low-income economies, which have often been encouraged by developed countries and international organizations to pursue policies that include low taxation of capital. Designing a tax system that is fair to developing and least developed countries is imperative for ensuring their cooperation.
Cooperation and international fairness
As the OECD and the G20 prepare to address taxation of the digital economy by the end of next year, they should consider these three major concerns: avoiding any unnecessary burden on tech companies, reducing incentives for tax avoidance practices and tax competition, and reaching an international corporate tax system that is balanced and equitable to poorer countries
The best way of tackling the digital economy is through a coordinated effort to achieve a global solution. In a time of considerable disagreement, having a system that provides for an allocation of the international tax base that is particularly fair to low-income countries might be the only way forward, both as a matter of global justice and as a requirement to get these countries on board with reaching global cooperation in tax matters.
Canada is well situated to play an influential role in this crucial issue, due to its long-standing reputation as a conciliatory, friendly nation and its historic role in facilitating negotiations among conflicting international actors. Moreover, the propensity of Canadian foreign policy for pragmatism, flexibility and adaptability might be precisely what is currently needed.
Designing an international tax system that is more equitable to poorer economies not only improves fairness among countries but is also a strategic way to achieve global cooperation. More importantly, it might be the only way to avoid a scenario where each state has its own digital services tax, burdening the same tech businesses that the federal government eagerly expects to flourish in the next few years.
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