Taxing the Digital Economy: Challenges in the European Union
Tax policy reform specifically targeting the digital economy has become a hotly debated subject in the European Union (EU). In recent years, several EU member states have faced issues in taxing digital technology giants like Amazon, Facebook, and Google. Supporters of reform, such as the governments of Germany and France, argue that companies operating in the digital arena profit unfairly of their internet-based operations. Others, such as the governments of Ireland and Luxembourg worry that tax reform could lead to double taxation and higher prices. While reform on corporate tax policy for the digital economy at the global level is far from reaching a consensus, the European Commission (EC) is calling for immediate change. Just last month, in a report prepared for the European Parliament and the Council, the EC called for reform in the corporate tax framework within the EU. Corporate Tax Climate in the EU
Corporate tax rates in the EU are already low when compared to other groups and regions, despite the common belief that Europe taxes corporations heavily. The average statutory corporate tax rate in Europe is 18.35%, the lowest among all other regions in the world. As shown in Figure 1, the average statutory corporate tax rate in the EU’s 28 member states is 21.85%, making it the third lowest rate after Europe as a whole—all 49 countries—and Asia. If we look at tax policy reforms from this comparison, it would not be unreasonable to think that there is room for increasing the corporate tax rate within the EU.
Growth of Digital Technology Companies in the EU
In the last decade, digital technology companies have significantly outperformed traditional brick-and-mortar companies. In 2006, only one digital technology company was among the top twenty companies in the EU, accounting for 7% of the market share among these high performers. Today, nine digital technology companies are in the top 20, accounting for a far more substantial 54% of market share.
Between 2008 and 2016, the revenue of the entire retail sector in the EU grew 1% on average. In the same period, the revenue of the top five e-retailers grew 32%. Yet, due to the virtual nature of business conducted by these digital technology companies, tax loopholes were invariably created, preventing many EU member states from collecting taxes on profits from such companies.
Difficulties in Taxing the Digital Economy
Unlike traditional companies, where profits are taxed at value creation, digital technology companies conduct most transactions electronically. This makes it challenging to capture where value is created, what it is, and how to measure it.
Additionally, companies are taxed through permanent establishment rules. The report published for the European Parliament and Council specifies that these rules are “used to determine the threshold of activity that needs to be carried out in a country in order for a business to be taxable in that country and are largely based on physical presence”. So, while digital technology companies operate virtually all over Europe, their profits are taxed only in the state where they have a physical establishment.
Last summer, France lost a case against Google, which has a “permanent establishment” in Ireland, and consequently did not have to pay a 1.11 billion Euro tax bill to France. The EC expressed concern regarding the fairness of this rule, arguing that such companies have access to markets, infrastructure and regulatory institutions all over the EU, but “are not considered present for tax purposes.”
The issue becomes more complex when considering that even when taxes are collected, the average tax rate for digital companies ends up being much lower than that for non-digital, traditional companies. The Centre for Economics and Business Research found that in the United Kingdom, Amazon pays 11 times less corporation tax than traditional booksellers. Differences on effective average corporate tax rates between digital technology companies and traditional ones, within the EU, are shown in Figure 2.
The fact that there are different corporate tax rates in different EU member states is another implication. Differences in corporate tax rates indicate that states with lower rates might benefit more from the “permanent establishment” rules since many digital technology companies are physically headquartered there, as in the case of Ireland. At 12.5%, Ireland offers one of the lowest corporate tax rates within the EU, as shown in Figure 3. Many digital giants have set up their headquarters in Ireland as it is also considered to have an overall better business environment. However, the EC has raised questions on the magnitude of benefits that these low tax-rate states receive from tax collection. Last year, the EC found that in 2014 Apple paid an effective tax rate of only 0.005% to Ireland, leaving an unpaid tax bill of around 13 billion Euros.
In Defense of Digital Technology Companies
Arguably, the attitude of the European Commission, especially of Margrethe Vestager, who is the EU’s competition commissioner, has sometimes been described as openly belligerent against these digital giants. Some have argued that the changes in corporate tax policy outline would create a “hostile work environment” for US businesses. Uncertainties among consumers may also arise since such reforms could lead to changes in prices, which could directly affect consumers within the EU. Finance Ministers from Ireland and Luxembourg, who are not in support of proposed changes, have raised the issue of double taxation as another concern. Moreover, the framework of the international tax rules would need to be re-written in case different countries and regions start to neglect or redraw rules concerning permanent establishment or transfer pricing.
EU’s Policies Forward
The report released by the European Commission addresses some of the abovementioned concerns. While in the long run, the EU is planning to move towards an integrated Digital Single Market (DSM), where rules regarding digital economy would be harmonized among all EU member states through policies such as Common Consolidated Corporate Tax Base (CCCTB) – “a single set of rules to calculate companies' taxable profits in the EU,” as a short-term measure, the report suggests an “equalization tax on turnover of digitalized companies.” This, the EC believes, would address the issue of fairness within the EU member states, since taxes would no longer depend on “permanent establishment” but rather on “income generated from all internet-based business activities.”
Unlike traditional companies, digital companies already operate virtually all over the EU, while maintaining a “permanent establishment” in the countries with the lowest tax rates. Some believe that low tax rates helped states such as Ireland or even the UK, but as in the case of Apple in Ireland, even these countries do not always generate revenues from their already-low rates. Targeting digital technology companies would narrow the current gap in tax rates between these companies and non-digital, traditional companies.
Finally, we need to bear in mind that the EU is not the only region considering tax policy reforms for the digital economy. Along with numerous countries around the world, major international bodies such as the OECD have joined the discussion to resolve challenges of taxing the digital economy. Indeed, issues related to rules such as “permanent establishment” go beyond the EU borders. Although EU member states have not reached a consensus on joint policies forward—often a challenge in the EU—the need for reform regarding the taxation of the digital economy seems to be imperative at the global level today.
Edison Jakurti is a second-year Master of International Development Policy (MIDP) student at Duke University focusing on applied economics.