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US Trade Representative Launches Investigations of DSTs of Numerous Trading Partners

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US Trade Representative Launches Investigations of DSTs of Numerous Trading Partners

On June 2, 2020, the Office of the United States Trade Representative (USTR) announced that it is beginning investigations under Section 301 of the Trade Act of 1974 (Trade Act) into digital services taxes (DSTs) that have been adopted or are under consideration by ten of the United States’ closest trading partners – Austria, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom (DSTs Investigations).

According to USTR Robert Lighthizer, “President Trump is concerned that many of our trading partners are adopting tax schemes designed to unfairly target our companies,” and that “[the United States] are prepared to take all appropriate action to defend our businesses and workers against any such discrimination.”

The initial focus of USTR’s investigations is to determine whether the existing or proposed DSTs discriminate against U.S. companies, apply retroactively, and/or constitute unreasonable tax policy by diverging from norms reflected in the U.S. tax system and the international tax system. The USTR identified examples of such divergent approaches, including extraterritoriality; taxing revenue not income; and intentionally penalizing particular technology companies for their commercial success.

As a next step, the USTR is seeking public comments on any issue covered by the investigations, in particular, the following:

-Concerns with one or more of the DSTs adopted or under consideration by the jurisdictions covered in the investigation.

-Whether one or more of the covered DSTs is unreasonable or discriminatory.

-The extent to which one or more of the covered DSTs burdens or restricts U.S. commerce.

-Whether one or more of the covered DSTs is inconsistent with obligations under the WTO Agreement or any other international agreement.

-The determinations required under section 304 of the Trade Act, including what action, if any, should be taken.

Written comments should be submitted through the Federal eRulemaking Portal and are due by July 15, 2020. Because of the COVID-19 restrictions, the USTR has not scheduled a public hearing at this time but may indicate in a subsequent notice if a hearing is to be held in the DSTs investigations.

Eversheds Sutherland Observation: The timing of the investigations is noteworthy, as many jurisdictions, including the EU, have been highlighting the need for DSTs to address COVID-19 tax shortfalls. It also comes as the OECD continues efforts to find a consensus solution to taxation of the digital economy. The OECD remains committed to a proposal in 2020, although there is some recognition that this timing may slip due to issues around the pandemic. Nonetheless, the reaction of the U.S. is consistent with the response to the French DST, and is noteworthy in that the administration continues to respond to unilateral digital tax efforts through trade, rather than tax, channels. The U.S. has continued to participate in the OECD’s inclusive framework efforts.

The Previous Section 301 Investigations into the French DST

In July 2019, the USTR had already initiated an investigation under Section 301 of the Trade Act with respect to France’s DST Act (LOI n° 2019-759 du 24 Juliet 2019), which French President Emmanuel Macron had signed into law on July 24, 2019.  After requesting public comments and conducting a public hearing in August 2019 (for a hearing transcript, see here), the USTR in a report published in December 2019 determined that France’s DST is unreasonable or discriminatory and burdens or restricts U.S. commerce. Specifically, the USTR’s investigation concluded that the French DST discriminates against U.S. (digital) companies, is unusually burdensome for affected U.S. companies, and is inconsistent with prevailing principles of international tax policy on account of its retroactivity, its application to revenue rather than income, its extraterritorial application, and its purpose of penalizing particular U.S. technology companies.

At the time, USTR Lighthizer said that the “decision today sends a clear signal that the United States will take action against digital tax regimes that discriminate or otherwise impose undue burdens on U.S. companies” and that the USTR is “exploring whether to open Section 301 investigations into the digital services taxes of Austria, Italy, and Turkey.”

Consequently, the USTR proposed action in the form of additional duties of up to 100 percent on certain products of France and considered imposing fees or restrictions on French services as a further option. The list of French products subject to the potential duties included 63 tariff subheadings with an approximate trade value of $2.4 billion. Another public hearing was conducted on the proposed action in January 2020 (for hearing transcripts, see here and here).

However, as reported in late January 2020, U.S. President Donald Trump and French President Macron agreed to a truce on the dispute over the French DST, under which both countries are extending negotiations, while the U.S. is postponing retaliatory action and France is suspending DST collections until the end of 2020. Furthermore, it was reported that under the deal France will (i) withdraw the DST as soon as the OECD’s Inclusive Framework reaches a multilateral agreement on how to reform the international tax rules in light of the digitalization of the economy, and (ii) repay companies the difference between the DST and whatever tax comes from a planned mechanism being drawn up by the OECD.

Eversheds Sutherland Observation: The reported U.S.-French deal did not address many concerns raised by affected companies at the Section 301 hearing regarding compliance with and the administrability of the DST. Initially, it left many affected companies struggling with obtaining information retroactively and preparing DST returns. At the same time, it has created significant pressure to agree on a multilateral solution as part of the OECD Inclusive Framework. In fact, France may be incentivized not to support a multilateral solution resulting in tax revenues that are less than what France can collect under its DST. Moreover, as subsequently observed, the deal did not appear to discourage other jurisdictions to enact their own digital taxes, subject only to an agreement to adjust to reflect any future multilateral solution agreed by the OECD.

The New Section 301 Investigations

An advance Federal Register Notice (Notice) issued by the Office of the USTR on the same day as the announcement provides additional details on the DSTs Investigations, including summaries of the DSTs that have been adopted or are being considered by the ten trading partners and the schedule for submission of written public comments.

DSTs under Investigation

As stated in the Notice, over the past two years, various jurisdictions—not limited to the ones under investigation—have taken under consideration or adopted taxes on revenues that companies generate from providing certain digital services to, or aimed at, users in those jurisdictions. Moreover, the Notice asserts that available evidence suggests these DST are targeting U.S.-based tech companies.

The DSTs Investigations target the following DST regimes:

Austria: In October 2019, Austria enacted effective January 1, 2020, a DST that applies a 5 percent tax to revenues from online advertising services with two revenue thresholds (at least €750 million in annual global revenues for all services and €25 million in in-country revenues for covered services).

Brazil: In May 2020, a draft bill was submitted in Brazil’s parliament entitled “contribution for intervention in the economic domain on gross revenue of digital services provided by large technology companies (CIDE-Digital),” which, if adopted, would apply an up to 5 percent tax on revenue from advertising and services in connection with digital platforms located in Brazil.

Czech Republic: The Parliament of the Czech Republic has accepted for consideration a bill that would impose a 7 percent tax on selected digital services provided in the country by companies with global sales exceeding €750 million and a turnover in the Czech Republic in excess of CZK 100 million.

European Union (EU): In its proposal for a COVID-19 recovery plan, the European Commission (EC) said that to raise the necessary funds, it will propose a number of new resources, which “could also include a new digital tax, building on the work done by the Organization for Economic Co-operation and Development (OECD).” The EC proposed a DST (COM(2018) 148 final) that would impose a 3 percent tax on gross revenues from digital online advertisement, digital platform activities, and sales of user data generated via digital platforms from companies with global sales exceeding €750 million and EU taxable revenues exceeding €50 million.

India: In March 2020, India expanded its equalization levy that has been in place since 2016 and will now impose a 2 percent levy on consideration receivable by a non-resident “e-commerce operator” (with annual revenues in excess of approximately ₹20 million) for “e-commerce supply or services” provided or facilitated by it on or after April 1, 2020.

Indonesia: In March 2020, the Indonesian government enacted a government regulation that adopts (but not yet implements) a new tax on Trade Through Electronic Systems (Perdagangan Melalui Sistem Elektronik or “PMSE”), imposing an electronic transaction tax on PMSE activities carried out by foreign tax subjects that meet certain criteria.

Italy: Italy enacted a DST effective January 1, 2020, which imposes a 3 percent tax on revenues from targeted advertising and digital interface services by companies generating at least €750 million in overall worldwide revenues and at least €5.5 million in revenues from qualifying digital services provided to users located in Italy.

Spain: In February 2020, the Spanish government published a draft bill concerning the implementation of a unilateral DST, which would impose a 3 percent tax on revenues from online advertising services targeted at users, online intermediary services, and data transmission services of companies generating at least €750 million in global net turnover and at least €3 million in revenues from taxable provisions of digital services in Spain.

Turkey: Having imposed a 15 percent withholding tax on online advertising since the beginning of 2019, Turkey has now enacted a DST effective March 1, 2020, which currently imposes a 7.5 percent tax (though the Turkish president is authorized to reduce the DST rate to 1 percent or double it) on gross revenues from certain services, including advertisement services provided through digital platforms, sales of auditory, visual or digital contents on digital platforms, and services related to the provision and operation of digital platforms enabling users to interact with each other, provided by companies with worldwide revenue exceeding €750 million and with Turkey-sourced revenue exceeding ₺20 million, in each case from covered digital services.

United Kingdom (UK): The UK government announced the introduction of a DST from April 1, 2020, which would impose a 2 percent tax on the revenues of search engines, social media services and online marketplaces that derive value from UK users of companies when the group’s worldwide revenues from these digital activities are more than £500 million and more than £25 million of these revenues are derived from UK users.

Section 301 Investigations in General

As described in the Notice, the Trade Act of 1974 authorizes the USTR to investigate whether an act, policy, or practice of a foreign country is actionable under Section 301 of the Trade Act. Actionable matters under Section 301 include acts, polices, and practices of a foreign country that are unreasonable or discriminatory and burden or restrict U.S. commerce. An act, policy, or practice is unreasonable if the act, policy, or practice, while not necessarily in violation of, or inconsistent with, the international legal rights of the United States, is otherwise unfair and inequitable.

As a first step in a Section 301 investigation, the USTR consults with appropriate advisory committees, including the Section 301 Committee, and requests consultations with the governments of the affected jurisdiction(s). The Notice confirms with respect to the DSTs Investigations that the USTR has already consulted with the relevant advisory committees in the U.S., as well as reached out to the governments of the ten affected jurisdictions.

After the USTR determines whether an act, policy, or practice under investigation is actionable under Section 301, the USTR must determine what action to take. Notably, Section 301 authorizes the President to take unilateral retaliatory action in order to force the offending country to end the practices that have been found to be unreasonable or discriminatory against the United States. In past Section 301 investigations, such retaliation has typically involved the imposition of significant additional U.S. tariffs on selected products from the targeted country.

Eversheds Sutherland Observation: Initial reactions to the USTR announcement from the targeted jurisdictions suggest that they are unfazed by the threat of a U.S. trade investigation, as they openly reaffirm their commitment to enact and/or enforce these DSTs as planned. This was true of the French response to the Section 301 investigation into its DST. Perhaps the U.S. is anticipating that, as in the case of France, the Section 301 investigations will lead to agreements to refrain from enforcement of unilateral taxes until the OECD Inclusive Framework is able to reach a consensus solution. However, if countries do in fact continue with unilateral DSTs, the situation may well trigger another potential trade war, at a time when the global economy is struggling to respond to the COVID-19 pandemic. It deserves emphasis that Section 301 is the legal basis for the significant tariffs that the U.S. has imposed on Chinese imports, which has in turn triggered tariff retaliation by China against U.S. imports.

Potentially complicating the U.S. position are digital advertising tax proposals appearing at the U.S. subnational level. The Maryland legislature recently passed a digital advertising tax bill that the state governor vetoed on May 7, and a “copycat bill” was introduced in New York. There are serious questions regarding the constitutionality of the proposals that have been introduced, but their existence may undermine the USTR position that foreign DSTs are unreasonable or discriminatory. Maryland’s proposed digital advertising tax has drawn scrutiny as violating federal law, including the Permanent Internet Tax Freedom Act and the dormant Commerce Clause. For Eversheds Sutherland’s critique of the tax, please see our recent article, If Md.’s Digital Ad Tax Is Passed, Court Challenges Will Follow.”

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Responding to an Evolving Global Tax Landscape

Over the last decade, we’ve seen nations start to address the tax challenges arising from the digitalization of their economies. They want to ensure that multinational enterprises conducting significant business in places where they do not have a physical presence be taxed in such jurisdictions. And, like any tax reform proposal, consensus can be hard to reach because there is so much at stake.

Look no further than the digital tax France aimed at Facebook, Google, and other American technology giants. French lawmakers voted to impose a 3% tax on revenues that companies make from providing digital services to French users. The country estimated that the tax would raise more than $500 million, helping fill a budget hole as more commerce moves online.

Italy, Austria, and Turkey also have imposed their own digital services taxes on large tech firms, and several other European nations, including the United Kingdom, the Czech Republic, and Spain, have announced intentions to implement such a tax. These countries are frustrated by failure to reach a consensus on a digital tax across the broader European Union.

The national policies on digital taxes have drawn the ire of many businesses and political leaders at a time of heightened tensions over global trade. After decades of flourishing globalization, the specter of higher taxes threatens to complicate long-standing trade pacts and add complexity to the operations of multinationals.

The French digital tax angered the Trump administration, which threatened to retaliate with tariffs on a range of French goods. The two sides struck a truce last month, where France agreed to suspend the tax.

All the uncertainty isn’t good for tax planning. Businesses must rethink how their operations are being taxed internationally. This will result in strategic conversations that go further than the tax department, affecting the way businesses operate internationally.

Many U.S. multinationals are still coming to grips with Trump’s 2017 tax cuts, which made taxation on global intellectual property much more complex.

In light of these changes, we’ve seen businesses in jurisdictions across the world change their tax strategies to abide by filing laws in their primary country of operations as well as countries they’ve expanded into.

Case by Case: Responding to Evolving Tax Policies

As businesses continue their overseas expansion in 2020 and beyond, it’s imperative to adhere to these policies to ensure compliance with tax filings across multiple jurisdictions. Businesses have made these new policies a priority as they prime themselves to not only respond to tax policy changes, but also anticipate forthcoming changes that may arise in the coming years.

For companies that have already abided by new international tax policies, we are seeing these changes develop in a few different ways.

Take the United States, for instance. Under their hybrid-territorial tax system, companies based in the United States can invest their earnings into lower-tax foreign countries to ultimately see a reduced tax obligation. Digital taxes would serve as a counter to this, taxing American companies for their digital operations within their jurisdictions regardless of lower-tax investments. As such, we see the potential for American companies to adapt their tax filings to retain the lower-tax investment benefits.

Some businesses have had an easier time than others adapting to this policy evolution over the last five years. France, for example, has seen difficulty from foreign companies operating within its jurisdiction as they report to a separate financial tax administration with a completely different set of processes that often aren’t as modern or up-to-date. Now that France has backed down on its digital tax, these difficulties may very well continue.

Moving Forward: What to Expect

But the fight to tax the digital economy isn’t going away. Even some critics have called for a more unified approach, rather than country-by-country legislation.

The Organization for Economic Cooperation and Development is trying to get nearly 140 countries to agree on a plan to modernize tax policies to keep pace with the digital economy. But the slow pace of talks has frustrated many nations, and a global agreement may be years away.

For policies that we’ll see moving forward, we can expect businesses will continue to geographically strategize their tax filings for 1) global tax compliance either in response to, or in anticipation of, updated digital tax policies, and 2) maintaining adequate tax revenues in light of increased taxation as a result of these policies.

What remains to be seen, however, is whether a reciprocating effect will occur – that is, if business adaption to digital tax laws encourage the evolution of said laws to further ensure tax compliance. One thing is certain, however, that the only constant in international tax law is change… and businesses need to be proactive in the way they prepare and respond to these changes.

Businesses should take a holistic approach to ensure their global operations are compliant with all jurisdictions they operate within. Whether that constitutes an internal evaluation of present tax filing processes or a consultation with their professional accounting team to determine the best course of action in light of a potential new policy adoption should be to their discretion and may be dependent on the jurisdictions in question.

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Jason Gerlis is Global Head of Consultancy Solutions for TMF Group in the Americas.