The Digital Tax Conundrum: EU Gets Ready to Swing

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Sep 18, 2017
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It’s no secret that government tax departments around the world have struggled to get to grips with the behemoths of modern growth, those digital companies who are almost ubiquitous in many of our daily lives. I’m of course talking about the Googles (NASDAQ:GOOGL 1,072.00 1.37%) of the world. Huge, multinational organisations that “optimise” their tax affairs to such an extent that they have large cash piles squirrelled away in low tax jurisdictions around the world.

These situations dwarf Enron’s creative accounting scenarios by comparison. Here we have a system which effectively encourages money to sit still and do nothing. Global tax codes are not designed in harmony with one another and hangovers from bygone eras abound such as the infamous Dutch Sandwich and Double Irish schemes among many others.

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The funniest part is that in all of this, tax is often calculated and “reported” (in the media if not in fact) at a headline rate. This rate usually includes amounts that are not paid because the liability technically exists if the company were to repatriate its earnings. However, in the case of the US for example where the high corporation tax rate is often incorporated into the headline numbers that companies report they are liable for, a cheque never actually gets written to the government for that amount because the earnings are not repatriated.

Intellectual property is transferred to low tax jurisdictions, staffed by a shoebox office with zero employees, which then bill entities in other countries for the privilege of using the IP, creating profit distorting losses in other countries so that they do not need to pay tax.

Well, no longer. At least, not if some EU countries have anything to say about it.

EU Tax : The Slumbering Giant Opens an Eye

Like many in the world, the European Union has long been trying to figure out how to more appropriately tax new age, predominantly digital companies. Lengthy battles at both the Commission and country level against corporates like Google (NASDAQ:GOOGL 1,072.00 1.37%) and Apple (NASDAQ:AAPL 173.97 1.02%) (see our reporting here) have yielded mixed results and it’s clear that the bloc is trying to put its house in order.

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The plan, in the first instance pushed for by France, aims to figure out a way to tax the corporates on revenue, rather than reported profit. Supported by Germany, Italy and Spain to begin with, a meeting of EU finance ministers saw additional support for the initiative in the shape of Austria, Bulgaria, Greece, Portugal, Romania and Slovenia.

Although different in nature, the vaunted Financial Transaction Tax seems to follow a similar idea: The concept that the fundamental operation of a business activity must, across the average be a profitable endeavour. As such, the activity is taxed, rather than the reported profit of the activity which can be run through a variety of schemes to effectively allow it to be under-reported. While this may be fine for huge, highly profitable multi-national corporates, the devil will undoubtedly be in the detail about which companies will fall prey to this new method of taxation and to make sure that the edge cases do not also pick up companies which would struggle to survive under the new method and which are not shifting revenues to offshore tax havens.

One shouldn’t underestimate the ability of the EU to get things done, the difficulty it has is in getting things done quickly. Still, with an estimated over $2.5tn dollars held in low tax jurisdictions by US corporations, the incentive is obviously there to chase some of the money, however long it takes.

Offshore tax havens, the bane of (most) governments

The Long Road Ahead

An idea is one thing, but even one which has the support of the major players in the EU such as this one faces significant hurdles. There are many vested interests in maintaining the status quo, whether on the corporate side from the target companies or the country side in the form of Ireland, Luxembourg and others who are the current beneficiaries of the existing system in terms of both jobs and money. The difficulty is that for a change in EU tax rules, all member states will need to agree and perhaps unsurprisingly, this is where the issue currently sits.

Countries which benefit disproportionately from the existing setup are of course crying foul and saying that the issue is bigger than the EU. In many respects, they are right. The ability of a multi-national to optimise its tax affairs is vast and a real solution would involve other significant nations outside the bloc also getting on-board somehow. That much said, the effort needs to begin somewhere and the situation is only likely to intensify in the coming years. Current beneficiaries will of course do all they can to keep the gravy train running for as long as possible which means that until a huge amount of pressure is brought to bear on them, the status quo will remain.

The US is also looking at tax reform under the Trump administration, although given recent legislative setbacks, it seems unlikely that any significant progress will be made in the short term and the priorities there are different. The US wants American companies to repatriate their foreign earnings so that they can be taxed there and it is unlikely to want to help other countries more effectively tax its corporations.

So where does that leave us? The answer, as with most international legislative debates is at the start of a very long road. The EU has effectively fired the starting gun on the race, but given its objective to have an initial proposal in the spring of 2018, it is clear there will be no quick fix.

Taxing revenue generated in its jurisdiction would be an interesting way to proceed, it’s likely that the distribution of the taxes from any such settlement within the EU would need to take into account the outsized benefits currently received by some countries to get their agreement.

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