International Tax Update: Digital Service Tax: Dead and done with?

On 8 October 2021, the already historical agreement about Pillars I and II was reached between 136 member jurisdictions of the OECD/G20 Inclusive Framework. A part of the overall agreement is the removal of all domestic digital service taxes (‘DST’). It appears that the existing DST will be phased out and no new DST would be allowed to be introduced.

Several jurisdictions around the globe have already introduced or are/were planning to introduce DST, taxing profits realized through the digital presence and digital services provided in those jurisdictions. Amongst those jurisdictions are Austria, the UK, France, Italy and Spain.

The United States felt that these taxes particularly targeted US based multinational enterprises (‘MNE’) such as Google, Amazon, Facebook and Apple. Therefore, these taxes were sometimes also referred to as GAFA-taxes. It therefore introduced retaliatory measures, such as e.g. higher import duties on typical French export products. The European Commission was also planning to introduce a DST on relatively short notice, but awaited further developments within the Inclusive Framework.

What is being referred to as BEPS 2.0 and in particular the two pillar approach to which 136 jurisdictions of the OECD/G20 Inclusive Framework have reached an agreement, also contains a new ‘nexus’ for profit to be allocated to the market jurisdiction. The so-called Pillar I will initially apply for MNE with a global turnover over 20 billion euros and profitability above 10%. In future, the 20 billion euros threshold would be lowered. If the in-scope MNE derive at least 1 million euros in turnover from a particular jurisdiction, that market jurisdiction is awarded a portion of the taxable profit. That portion of the taxable profit is referred to as ‘Amount A’. Given the high thresholds, the largest digital services providing MNE’s (including GAFA) are particularly in scope.

As what can be presumed to be a quid pro quo for the United States, the 8 October ‘statement on a two-pillar solution to address the tax challenges arising from the digitalization of the economy’ provides for the removal of existing DST and similar measures. Not only with respect to the largest MNE’s – pillar one is expected to initially only apply to around 100 MNE’s worldwide – but with respect to all companies. Also, the 136 member jurisdictions who signed the 8 October 2021 statement, including nearly all EU member states, agreed that no newly enacted DST will be imposed on any company from that same 8 October 2021. The chances of a EU DST seeing the light of day in the foreseeable future has therefore diminished considerably. That is, if and when this two-pillar approach leaves the realms of political agreements and statements and is indeed effectively turned into law.

A transitional approach to existing DST has been agreed to between the UK, Austria, France, Italy, Spain and the United States regarding the application of the domestic DST until Pillar I would become effective. As soon as that happens, the domestic DST rules will no longer apply. But what is more, is that the DST accrued between A) 1 January 2022 and B) the date Pillar I comes into force or 31 December 2023, whichever date is prior, will be compared with the amount of ‘Pillar I tax’ that is due in the first year Pillar I is in force. If that amount of accrued DST is higher– on a pro rata basis – than what is owed under the ‘Pillar I amount’ in the specific jurisdiction in the first year of Pillar I, the excess amount is credited to the MNE. What can be noticed already, is that the potentially to be credited DST is the one accrued before the entry into force of Pillar I. But that to determine the amount of that credit, the accrued DST before Pillar I has entered into force will be compared with the first year after Pillar I has entered into force. If e.g. Pillar I enters into force on 1 January 2024 and the MNE in question would at that moment downsize its operations considerably or even entirely in Austria, then no Pillar I amount would be attributable to Austria in 2024. If the digital presence, turnover and profitability of the MNE in question would differ considerably between the 2022 – 2023 period and in 2024, that would have a significant impact on the potential credit.

As the agreement between these six jurisdictions states that the credit would be creditable ‘against the portion of the corporate income tax liability associated with Amount A as computed under Pillar 1 in these countries’, the domestic DST in Austria, France, Italy, Spain and the UK would be and remain unequivocally due for all MNE’s that do not meet the aforementioned 20 billion euros and 10% profitability thresholds.

The upside for these MNE’s that are not covered by aforementioned Pillar I is that they will – expectedly – no longer be submitted to domestic DST’s, without it being replaced by the Pillar I amounts that will be taxable in the corporate income tax.