Haste makes waste: Why the European directive proposal for a digital sales tax should be thrown out

Haste makes waste

During the last ECOFIN meeting held on 6 November 2018, European Finance Ministers met to discuss the proposed directive for a digital sales tax (DST). The proposal would introduce a 3% tax levied on revenues resulting from the supply of certain digital services as determined by user value creation. While the representatives of different member States expressed concerns about some aspects of the proposal, only three member States clearly expressed their opposition to the directive proposal. Each of these dissenters had their own reasons to oppose the tax.  

Numerous technical points still need to be addressed, despite the assertions of the Commissioner Pierre MOSCOVICI to the contrary. However beyond the technical issues, our point of view is that the introduction of a digital tax would be a grave political mistake for two main reasons:


Closing the stable door after the horse has bolted?

The creation of an "information economy" in which knowledge is the primary raw material and source of value and an "attention economy" where the attention of consumers is a currency have already happened, and at lightning speed. To give just a few examples: Facebook's business model was revolutionised rapidly, following a steep drop in the price of its shares due to the explosion of the smartphone market when customer data and attention shifted from fixed devices to handheld ones, Tesla is using digital technology and data capture on a vast scale in order to disrupt the traditional car manufacturer business model, Netflix has transformed our watching behaviour and the production of the content that we watch in a way that not even Netflix foresaw originally. These shifts, like many others, seem obvious now and largely taken for granted. These shifts were not so obvious 5 years ago however. As a consequence, we believe the "quick fix" proposed today of trying to tax what is currently seen as a source of digital value is unlikely to capture taxation rights to sources of digital value in 5 years’ time. We will be fighting to tax what will become yesterday’s profits.

The likely failure of this proposal to be adaptable to tomorrow’s sources of value, could even be seen as a cost which might be acceptable following the philosophy of "move quickly and break things".  Seeking this quick fix on a regional basis however, is likely to frustrate non-European trading partners and reduce our credibility when we seek to tax the next digital shift. This brings us to the second damaging aspect of the DST proposal.


Sawing the branch we are sitting on?

Increasing taxation powers for States where users are located looks appealing in the short term when we are faced with a shift of power and profits to large US multinationals that have transformed the consumer economy by providing new digital services to EU consumers for no direct payment and with a minimal presence in Europe. At best, it looks a bit like sour grapes - a type of resentment that there is no European Google or Facebook. Worse however in our view, the DST lays the groundwork for a drastic reduction of Europe’s taxable base. While it is a simplification, in global terms, Europe can be seen as a producer of high value goods and services that are exported around the world. When the population of Europe is compared to the global one and to some of our larger trading partners, such as India and China, our population and therefore our consumer base is small. A simple statistic can help us visualise this disparity: the EU population represents only 7% of the world population while 60% of global citizens are located in Asia.

We can be proud of having a value added that is significantly greater in proportional terms than our population. It doesn’t take an economist or a mathematician to see what happens to our taxable base if we seek to allocate more of that taxable base to the states of consumers. But, I hear the old economy argue, European exports such as Luxury cars or Luxury consumer goods are different from social networks or search engines. Are they really? The amount of information being captured by modern cars is increasing exponentially and the relative value of the systems in Luxury cars is increasing all the time. Adapting Luxury products to emerging consumer tastes and behaviours is requiring Luxury product companies to capture more information about their consumers either by engaging with them directly or harvesting information indirectly. The same logic is true for advanced engineering such as engines, robotics and many of the other sectors Europe can be justifiably proud of.  In these cases, "internet of things" technology allows the capture of critical information where the machines are used, not where they are manufactured. The same is true for sophisticated services such as financial services where AI enhancements depend increasingly on the end user data created by the ultimate consumer.

Thus we fear, Europe, having argued for the right to tax foreign companies based on the presence of consumers with the DST, will have no legitimacy to resist countries with large consumer populations seeking to tax more of the profits of European companies on the grounds that the intellectual property and the value added of the European companies is largely generated in the consumer states. Instead of arguing that exceptional value can be created by exceptional companies of which we are fortunate to have many within our borders, we will have sawed through this particular branch and will be facing a long drop downwards in our tax receipts.

 Keith O’Donnell
Keith O’Donnell, Managing Partner - International & Corporate Tax

Posted on 12/11/2018
Tags :