With European economies in a slump and the discussion about the Brexit dominating headlines, taxation was not among the hot issue during the last couple of months. It would, however, be a mistake to assume that the pressure exerted on taxpayers in the context of the BEPS-related reforms is going to recede. On the contrary, it seems quite reasonable to assume that the adverse economic conditions will cause European politicians to scramble to obtain additional resources in their efforts to pacify a disgruntled constituency and keep the inflated welfare state afloat. It is indeed most curious (but maybe that is just my perception) that the political debate in Europe remains myopically centered on the distribution of income (including “fair” taxation) rather than on (finally) implementing structural reforms targeted at enhancing competitiveness.
In my previous contribution to CFR1, I touched on the issue that financial ministries and tax authorities in Europe are no longer primarily concerned with minimizing aggressive tax structures by modifying existing principles and regulations but are rather looking for ways to generate additional revenues by implementing entirely new taxation schemes. As shall be illustrated below, the current developments in Europe strongly suggest that that the EU as well as individual member states are poised to continue their aggressive stance when it comes to taxing multinational enterprises (MNEs). While the focus of this contribution will be on “digital taxation,” I will also briefly outline some general thoughts on tax policy in Europe and the optimal prerogative devolution.
Digital taxation – implementation at the national level is imminent
As previously highlighted2, the European Commission, issued a policy proposal in the Summer of 2018 to “reform corporate tax rules.” The intention of this proposal is to enable member states to tax proﬁts that are (allegedly) generated in their territory, even if a company does not have a physical presence there – based on a so-called “digital presence” or “virtual permanent establishment,” which is deemed to exist when certain criteria (turnover or user based thresholds are exceeded) are met. The Commission was estimating that 5 billion euros in revenues a year could be generated for member states if the tax is applied at a rate of 3 percent. The objective of my previous contribution was to emphasize that the proposed policy was misguided and ultimately, nothing but arbitrary expropriation. Fortunately, the policy proposal made by the Commission failed to generate unanimous support among member states – due primarily to “staunch opposition” from (amongst others) “Denmark, Sweden, and Ireland, who have resisted targeting the revenues, rather than profits, of tech companies on their soil” (reported in the FT online by Kahn/ Brundsen, Dec. 4, 2018).
While the scrapping of the original policy proposal is unambiguously good news, no one should be surprised to learn that a watered-down alternative is already on the table – championed by France and Germany. The new proposal aims to taxing a narrower scope of digital activities (i.e. mostly focused on advertising), with the effect that “Facebook and Google would be targeted through their sales of advertising but other big tech companies, such as Amazon, Airbnb and Spotify, were likely to be excluded” (see FT cited above). The estimate of additional tax revenues has been correspondingly slashed in half.
While it is doubtful that even the watered-down alternative will facilitate a compromise among member states, there is little reason to rejoice. First, while the scope of this ill-conceived policy proposal is cut in half, the underlying principle remains bad and subsequent extension of the scope cannot be ruled out. Second, quite a few member states are implementing their national versions of a digital tax which potentially could feature (in variations) comparatively broader scopes. After the U.K., Spain and Italy declared their general intention to impose new national-level taxes for the digital economy, Austria has now followed suit and is expected to present its digital tax policy in January. Austrian Chancellor Sebastian Kurz proclaimed that “In addition [to] the European Plan […] we will take a national step. We will introduce a digital tax in Austria. […] the aim is clear: taxation of companies that make large profits online but barely pay taxes – such as Facebook and Amazon.” Explicitly targeting Amazon already indicates that the Austrian policy will feature a rather broad scope. It also illustrates the arbitrary nature of the tax; i.e. targeting individual (mostly U.S.-based) companies, instead of modifying general tax regulations.
Why improving ‘soft law’ is preferable to discussing the optimal prerogative devolution
For adherents of neoliberal policies (myself included), the developments summarized above are somewhat challenging. Possessing a deeply imbued distrust of the centralization of political and economic power, we intuitively tend to favor national over supranational solutions. To be clear, centralizing taxation policy at the EU level would be disastrous (as highlighted in all of my previous contributions to CFR, specifically those discussing the Common Consolidated Corporate Tax Base). At the heart of discussing the prerogative devolution is the analysis of the trade-off between the benefits of centralization, arising from the economies of scale or externalities, and the costs of harmonizing policies in the light of increased heterogeneity of preferences in a large union (as often discussed by A. Alesina in the context of assessing the status of European integration – in my interpretation the approach comes quite close to Hayek’s general position in Europe as well).
Considering the lack of consensus among the member states is rather evident, we arguably do not have to dwell on the prevailing heterogeneity of preferences. The extent of externalities, which in the case of tax evasion is arguably (approximately) measurable as the resulting tax gap, is often blown out of proportion. In the case of digital taxation, however, one may justifiably conclude that there exist no externalities at all, i.e. there is no tax gap.
The policy proposal of the EU Commission is not based on the notion that the digital tax is needed to curb tax evasion (or avoidance) of Amazon & Co., but rather that there is economic activity which is (allegedly) untaxed and is perceived as inherently unjust. This perception is highly influenced by the notion that the “value of things” depends on how (where) people use them. Leaving the theoretical discussion of “value” aside, it seems quite absurd to define the existence of an (presumably) untaxed Facebook or Amazon account as an externality. Lastly, member states are clearly able to introduce (and implement) a digital tax on the national level. In sum, the analysis of the trade-offs clearly illustrates that there are no convincing arguments for allocating the prerogative for digital taxation to the EU level.
So, if individual member states want to implement additional taxes that further weaken their competitive position and harm local consumers, (let them) it is certainly preferable to contain the adverse effects to the national level.
Considering the detrimental impact of a digital tax as such, however, it does not seem quite adequate to be content with the prerogative being allocated to the national level. Bad policy is policy. The question I am asking myself in this context is how to convince policymakers to refrain from implementing additional taxes or more restrictive regulation. Ultimately, it will be crucial to chance the perception of MNEs as being habitual tax avoiders and tax authorities as being the magnanimous and objective servants of the common good. One sensible piece of the conversation could be to advocate that the OECD, as supra-national organization, is well-positioned and actually doing a credible job in ensuring efficient tax policy framework within the existing global consensus (i.e. applying the arm’s length principle as the international paradigm for transfer pricing). I have previously argued that BEPS is likely to “work out” in the sense that aggressive tax avoidance schemes are curbed, and taxation of profits will be closer aligned with value creation (economic activities). 2019 will see further interesting milestones, as the guidance for financial transactions as well as for centralized services will be updated. Tax avoidance is being addressed and “soft law” (a modernized guidance for applying the arm’s length principle) is a much more promising approach than hard law (or taxing revenues) be it on European or national level. In other words, European policymakers should leave well enough alone.
Many neoliberals have a hard time accepting that the OECD can actually play a positive role. It has been said that BEPS is a concerted effort by high tax countries to sustain (and expand) their tax bases. There is certainly merit to this assessment. The pragmatic question in this context, however, seems to be whether accepting the OECD as a facilitator of soft law is the lesser of two (multiple) evils. Embracing the arm’s length standard as a sort of “meta regulation” is extremely beneficial – i.e. while different national tax rates will continue to apply (tax competition is preserved), taxpayers can trust that the different national tax authorities will at least base their assessments on the same overarching principle. While double-taxation may (inevitably) persist, it will be much lower compared to a situation in which national tax authorities apply differing (irreconcilable) principles when taxing the income – and some member states adding a (digital) tax on revenues resulting from economic activity that is already subject to income tax.
Soft law is sufficiently effective – Amazon is paying taxes based on local activities
When writing this contribution, I got the feeling that my plea for the ALP might be getting old. While I will never relent, I want to conclude by further substantiating my above arguments that the allegedly untaxed digital activities of Amazon & Co. do not result in externalities – let’s just take a look at (some of) the operations of Amazon in Germany. The following table summarizes the tax positions of (some) Amazon subsidiaries operating in Germany: See chart 1
The financial data shown in the above tables can be considered as being representative for local subsidiaries performing routine functions. These entities perform support activities (in the case of the above entities; web-services, logistics and contract development) requiring no unique and valuable intangibles. The strategic leadership and required intangibles are contributed by the Amazon headquarters. It is no coincidence that the local entities exhibit comparatively low but stable profits (EBIT ratios of 5 percent for web-services and logistics and 8.5 percent for development). Assuming that the routine classification can be substantiated, the profitability ratios realized by these German subsidiaries are compliant with the arm’s length principle.
Commensurate with the low value-adding nature of the services contributed the German entities receive an almost “guaranteed” (i.e. isolated from market risks) remuneration, while the residual profits (and losses!) are attributed the group entity(or entities) responsible for the strategic leadership and for contributing the unique and valuable intangibles – presumably Amazon headquarters. From a German perspective the economic value added contributed by the local entities is numerated and taxed appropriately – there is no indication of tax avoidance or of an untoward low tax rate (in fact Amazon pays quite a healthy share of taxes on revenues realized by the local entities). Most certainly, based on the above data, there is no indication that the activity of Amazon could be deemed as constituting an externality from a German perspective. Admittedly, the above data does not allow any conclusions in respect to the arm’s length nature of the allocation of profits relating to the intangibles. But, if anything, this is exactly the issue that was targeted by the BEPS project; i.e. the transfer pricing regulations were modified to ensure that the profits relating to intangibles will be allocated based on economic contributions rather than legal ownership.
So, just maybe, Mr. Kurz and other European policymakers should take a second look at the contributions made by Amazon and other MNEs to the local economies before they embark on introducing local (national) regulations that go “beyond BEPS.” And, also just maybe, some of their economic advisors will point out that taxing digital revenues of (arbitrarily selected) tech companies is not a policy that is likely to facilitate economic growth.
1 Cayman Financial Review 4th Quarter, Issue 53, pp. 56
2 Cayman Financial Review 3rd Quarter, Issue 52, pp. 44