The EU’s New Digital Taxation Proposal May Hurt Small Businesses

Supported by two of the largest economies in the EU, France and Germany, the European Commission proposed rules on Wednesday to make companies in the digital realm pay more in taxes.

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If enacted, this means multinational U.S. tech companies such as Amazon, Google, Facebook, Twitter, and others may end up paying a tax based on revenues they generate in EU countries!

This revenue-based tax proposal the commission suggests is supposed to be an “interim” tax until a more “equitable” solution can be found that taxes on profits.

The fundamental problem the EU Commission is trying to solve is that multinationals in Europe choose countries that have lower tax rates as their operational base but then gain significant income from activities in countries in which they have no physical presence.

Under the current laws, this means the taxation of profits often happens outside the primary economic activity area, and that is why countries with larger economies such as France and Germany want a more equitable solution.

They fear as digital transaction activities increase, the location of the operational centers matter less, and therefore the big economies in Europe will lose out on taxes from activities that should be taxed in the origin country.

Specifically, small EU countries like Ireland and Luxembourg have benefited from this EU tax “loophole” as they offered attractive low corporate tax rates to US-based multinationals operating in Europe.

In its two-pronged proposal, the EU Commission attempts to find a starting point to equate this taxation problem that it claims provides inequities between digital companies and brick-and-mortar companies.

“The European Commission has today proposed new rules to ensure that digital business activities are taxed in a fair and growth-friendly way in the EU. The measures would make the EU a global leader in designing tax laws fit for the modern economy and the digital age.”

European Commission Press Release

In their own words, the two distinct proposals they offer are:

• The first initiative aims to reform corporate tax rules so that profits are registered and taxed where businesses have significant interaction with users through digital channels. This forms the Commission’s preferred long-term solution.
• The second proposal responds to calls from several Member States for an interim tax which covers the main digital activities that currently escape tax altogether in the EU.

The Problem!

Balancing out corporate tax rates appears to be an internal EU discussion point among its member states. Allowing some countries to benefit from economic activities in other countries raises valid concerns.

But the problem is that such a change in the EU tax law will require the backing of all 28 EU member states. And since this tax reform would result in significant losses to smaller countries with lower corporate tax rates, there is a huge division among member states on this issue.

Is there really a chance the EU could find consensus on this proposal?

According to Reuters, EU diplomats predict it would be hard to push through this type of legislation. That doesn’t sound too promising, does it?

Therefore, the commission proposed another idea that it called an “interim” solution, a tax on revenues. Let’s be honest here, how many “interim” taxes have ever been actually abolished?

And that makes the second proposal the most dangerous. If the EU adopts such a revenue-based tax, it could have a significant impact on the digital economy in the EU.

1. Some companies that do not need a physical presence in the EU may decide to leave the EU. Is there really a need for Facebook or Twitter to have an EU office?
2. Growing companies that are going global may not decide to enter the EU at all. Again, a company that only offers a digital service may not need a physical presence in Europe.
3. Marketplace such as Amazon or eBay will just pass on the interim tax to their fee-paying customers, which are mostly small businesses sellers.

The Small Business Problem

And the last point is why small businesses in Europe must be concerned about this proposal by the EU commission.

If Amazon and eBay are forced to pay the proposed 3 percent on revenues, does anyone really believe Amazon or eBay are not going to pass this revenue-based tax to their sellers?

But what appears to be the most disingenuous about the interim proposal is the reasoning for it.

According to the press release by the EU Commission, “The tax will apply to revenues created from activities where users play a major role in value creation and which are the hardest to capture with current tax rules…”

In other words, the commission is claiming the need for this interim tax is that fees “created from digital intermediary activities which allow users to interact with other users and which can facilitate the sale of goods and services between them” is not taxed?

Let’s get this straight, in one section of the proposal, the commission is saying that it wants to fix the problem that digital activities in one country are taxed in another country that offers a lower corporate tax rate.

But then it goes on to say the interim tax “would apply to revenues created from certain digital activities which escape the current tax framework entirely.”

There appears to be a bit of double talk here! Which is it? One has to really wonder if the interim label on the “second” proposal is just a red herring to establish a new taxing scheme for the digital economy.

Let’s look further in the commission’s press release: “This system will apply only as an interim measure, until the comprehensive reform has been implemented and has inbuilt mechanisms to alleviate the possibility of double taxation.”

In other words, no end date on the interim tax until the EU member states agree on a new taxation proposal over which currently there is only disagreement.

Even if the EU were to abandon its own attempt to find a profit based taxing solution and follow Ireland’s proposal to work out a global deal within the G20 or OECD, does anyone in the EU believe the U.S. would ever go along with a global taxation scheme?

Let’s not be naive about this, that would be a very hard sell to U.S. voters. So, even if all other members in G20 or the OECD miraculously agree on a taxing scheme, the chance the U.S. would go along with that is virtually null.

And don’t think a change in administration or the makeup of Congress would make a difference. Eventually the U.S. Supreme Court would weigh in and I doubt the U.S. constitution allows such global scheme.

Bottom line, under the guise of this only applies to large businesses, the EU may be on its way to instate a “hidden” tax on SMEs that use marketplaces in Europe. They can call it “interim”, but let’s not be fooled about that label!

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