Digital Tax Proposals Produce New Discord in the EU

taxThe European Union is preparing to debate the way corporate taxes are calculated and paid. In the coming months, the European Commission and large EU countries like Germany and France will present proposals to change regulations that currently allow companies, especially in the digital sector, to report their income and pay taxes in low-tax nations even if most of their earnings are generated in countries where taxes are higher. But many smaller member states, such as Ireland and Luxembourg, see this potential change as a threat to their economic models. A battle between large and small member states could result, creating further divisions in the European Union during a time in which the bloc is trying to introduce reforms in several areas.

The governments in Paris and Berlin are determined to stop what they see as unfair competition from smaller countries that offer tax deals to multinational corporations in the digital economy. Internet giants like Apple Inc., Facebook, Amazon and Google pay few taxes in the EU countries where most of their consumers are located because they have subsidiaries in low-tax EU members like Ireland and Luxembourg. France and Germany are working on proposals that would require companies in the digital sector to pay taxes where they generate money, rather than where they are legally registered. Italy and Spain support these proposals, which are expected to be introduced by June.


Meanwhile, the European Commission is working on its own proposals to make internet companies pay higher taxes in the EU countries in which they operate. The commission is considering options such as a levy on revenue generated from the provision of digital services or advertising activity, or a withholding tax on digital transactions. Brussels will present its suggestions in late March. These proposals are part of a more ambitious plan, because the commission wants to introduce a single set of rules to calculate the taxable profits of all large companies operating in the European Union. In EU jargon, this is known as a Common Consolidated Corporate Tax Base. Its goal is to present multinational companies with a single EU system to compute their income, instead of the different national rules that exist today. According to the European Commission, this would reduce red tape in Europe while also eliminating the existing mismatches among national tax systems.

But not every country embraces these potential changes. Ireland has been particularly critical, because the proposed reforms threaten its economic model, which is based on offering tax incentives to multinational companies. Some countries in Northern and Central Europe also contend that the European Union does not have the right to interfere with their tax systems.

At this stage, none of the proposed plans implies the imposition of a common corporate tax rate, but Ireland and others like it are concerned that this could happen. Those tax rates vary among EU countries, from below 15 percent in Hungary, Bulgaria, Cyprus and Ireland, to above 30 percent in France and Belgium. Ireland and other low-tax countries fear that the proposed reforms would open the door for the European Union to try to establish a minimum corporate tax rate. This fear is not unfounded: France has said its supports such an idea.

Even if Ireland has the power to block EU initiatives on tax-related issues, the bloc’s heavyweights can find ways to pressure Dublin not exercise it.

The Battles to Come

Reforming the way digital companies are taxed will not be easy. Changes in EU tax rules must be approved unanimously, giving individual countries veto power. The European Commission has said it wants to change the voting mechanism for this issue, but doing so also requires unanimity.

Even if Ireland has the power to block EU initiatives on tax-related issues, the bloc’s heavyweights can find ways to pressure Dublin not exercise it. For example, the European Union supports Ireland’s position that the border between it and Northern Ireland must remain open after Brexit and is asking the United Kingdom to find a solution to the problem. But in exchange for its continuing support on the matter during the Brexit negotiations, the European Union could ask Ireland to drop its opposition to tax changes. This is probably one of the reasons why Dublin has sought to enlist other EU countries on its side in the tax fight.

Should the European Union fail to find unanimity on this issue, a smaller group of countries could decide to implement reforms without involving the entire bloc. This would be only a consolation prize for the likes of Germany and France, as the changes probably would not be sufficient to end what they perceive as unfair competition from the low-tax countries. As a result, pressure on those countries probably will continue regardless of the future of specific measures currently on the table.

A Digital Single Market?

The debate over the best way to tax digital companies is a natural consequence of the rapidly increasing importance of the sector. Only one digital company was listed among the top 20 companies in Europe by market capitalization in 2006. By 2017, nine were, led by the U.S. giants. According to a recent report by the European Commission, revenue of the top five e-commerce retailers operating in Europe grew by an annual average of 32 percent between 2008 and 2016. During the same period, the revenue of the entire retail sector in the European Union grew by a yearly average of 1 percent. The rapid change is forcing policymakers to undertake the complex process of adapting to the new environment. Increasing the complexity with internet-based companies is that unlike traditional businesses, it is hard to determine exactly where value is created and how profits should be taxed.

Ireland and others have argued that the issue should not be discussed at the EU level, but rather at the level of the Organization for Economic Cooperation and Development (OECD), a club of rich countries. Ireland and other low-tax nations argue that restricting the reforms to the European Union would reduce the bloc’s competitiveness and make it less attractive to foreign investors. They also argue that a change in taxation could lead to higher prices for consumers. While the European Commission supports the idea of discussing the issue at the OECD level, it has said it is willing to push ahead with a European solution in the likely case that a broader consensus cannot be found.

Ultimately, these disputes are the result of an attempt by Brussels and the largest EU countries to move the bloc toward a federal system. Just as the European Union created a single market for the movements of goods, services, capital and people, it is now trying to introduce a “digital single market” with uniform rules. For many EU member states, this push will threaten their national interests and economic models. For tech companies, the taxation issue is only the tip of the iceberg. In the coming years, disputes with the European Union over issues such as data policy and privacy regulations will also surface.

France and Germany will probably reach an agreement between themselves on the taxation issue in the coming months and, together with other big economies like Italy and Spain, pressure smaller EU members to accept their plans. But unanimity probably will be hard to find, and the bloc will have to decide whether to pressure the rebel members to comply, at the risk of deepening fragmentation in the bloc, or to simply leave the reforms to a smaller group of countries.




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