How Congress Can Help Overturn the French Digital Tax

January 7, 2020 5:00 AM
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REUTERS/Aaron P. Bernstein

President Donald Trump's trade team is trying to get France to overturn its new digital tax, imposed on revenues earned by Facebook, Apple, Amazon, Google, and other technology behemoths on the services they provide to French users. So far, despite the administration's threat of trade retaliation, Trump is losing this battle. In fact, as 2020 opens, Italy has joined France in imposing a digital tax, and Austria, Canada, India, the United Kingdom, and others are lining up to follow suit.

The tax raises revenue and also singles out the big and unpopular American companies with blatantly discriminatory punishment. Seeking to stop this action, the US Trade Representative (USTR) issued a detailed Section 301 report in December, which threatens trade retaliation against France as early as January. But a stronger response is needed—in fact, congressional action. What's required is a new US tax on large foreign corporations that extracts funds in mirror-image fashion to the discriminatory digital tax on US firms.

A paragraph of explanation: The French version of the digital services tax (DST), inaugurated January 1, 2019, hits firms with global "taxable service" (i.e., digital) revenues of €750 million or more, and French "taxable service" revenues of €25 million or more. The thresholds and definitions of "taxable services" ensure that US firms are the primary target. A tax of 3 percent is levied on calculated French taxable service revenues. The calculations are replete with arbitrary features, described in the USTR report. No matter. Italy and other countries are busy enacting new laws with parallel features—echoing Senator Russell Long's famous ditty with a vengeance: "Don't tax you, don't tax me, tax the fellow behind the tree." American tech giants, already widely controversial because of privacy concerns, are far behind the tree, in the eyes of European parliaments.

The French DST and its brethren trample on accepted principles of international tax comity. First, as a revenue tax, the DST is akin to a tariff, but one that violates bound duties, most favored nation (MFN) duties, and non-discriminatory national treatment—principles agreed in the World Trade Organization (WTO). Second, as a quasi-profits tax, the DST violates the "permanent establishment" principle embodied in multiple tax treaties—the principle that a firm only becomes subject to tax by a foreign jurisdiction when it has employees or assets in that country.

These limiting principles are now being challenged in the Organization for Economic Cooperation and Development (OECD), but until revised they remain established law. Treasury Secretary Steven Mnuchin has asserted as much. The United States is well within its rights to insist that taxes on the global revenues of tech giants should, under current rules, be imposed, if at all, by the US Treasury, not by countries where the firms have neither assets nor employees, nor sell merchandise.

The OECD has proposed a new profit allocation rule that roughly states: When domestic consumers interact with the platforms of highly digitalized companies, such as Google and Facebook, those companies should pay local tax, provided that the revenues exceed certain thresholds. If multiple wrinkles in the proposed rule are ever ironed out, and the rule is accepted by the United States, France and its followers can impose their DSTs accordingly. Not before.

Under an old American statute, enacted in 1934 and never used, the president can retaliate against foreign discriminatory or extraterritorial taxes—an apt description of the DST. Section 891 of the Internal Revenue Code reads in part:

"Whenever the President finds that, under the laws of any foreign country, citizens or corporations of the United States are being subjected to discriminatory or extraterritorial taxes, the President shall so proclaim and the rates of tax imposed by sections 1, 3, 11, 801, 831, 852, 871, and 881 shall, for the taxable year during which such proclamation is made and for each taxable year thereafter, be doubled in the case of each citizen and corporation of such foreign country; …."

While Section 891 authorizes massive retaliation, a nuanced and targeted approach would be far better, and congressional legislation would forcefully express bipartisan displeasure with foreign digital taxes imposed in contravention of existing rules.

To that end, Congress should provisionally mandate a tax on the global revenues of large firms based in France, Italy, and other DST countries, when those firms sell goods or services in the US market. The tax should be set at a mirror-image percentage of revenues calculated to originate from US sales—3 percent in the case of French and Italian firms. Thresholds for foreign firms subject to the new tax should be set generously high, say at $5 billion for global revenues and $100 million for US revenues. The US tax should be deductible from the US corporate profits tax base of subject companies—as in the French DST. The tax should be legislated to expire upon either of two events: agreed international rules that subject tech giants to taxation in countries reached by their platforms or, in the case of an individual country, repeal of its own DST tax.

This response would, to be sure, violate the same international tax principles as the DST taxes. That's most unfortunate. But without a forceful congressional response, US tech firms, their shareholders, and the US Treasury will be taken wholesale to tax cleaners abroad.

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Gary Clyde Hufbauer Senior Research Staff

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