Disagreement over global digital taxes may result in unilateral taxes and increased trade disputes, triggering a global trade war that could potentially shave off 1% of the global GDP annually, the OECD warned on Monday. For now, 137 countries including India — collectively referred to as the OECD/G20 Inclusive Framework for BEPS — on October 8-9 agreed upon the basic skeleton for any future agreement.

Countries have agreed on key policy features and parameters for a future agreement, the organisation said, remarking that the “remaining political and technical issues” on which countries differ and the next steps in the negotiations have been identified. While there will be no agreement by the end of 2020 — the original timeline — due to the COVID-19 and political tensions, the organisation hopes these will be ironed out resulting in a framework “sometime in mid-2021”.

The Organisation for Economic Co-operation and Development (OECD) has been spearheading negotiations between 137 countries to solve the question of a global digital tax framework since 2019.

What a possible agreement for digital tax could look like

Reports on the basic skeleton, work on which has been ongoing since 2014, consists of two pillars to get technology MNCs to pay taxes in countries where they provide services, and not just in countries where they are physically present (see OECD’s reports on Pillar One and Pillar Two).

  • The first (Pillar One) would establish new rules on where taxes would be paid, to ensure that a consumer-facing company pays taxes in countries where it has sustained and significant business even if it does not have physical presence.
  • The second (Pillar Two) would impose a global minimum tax on each company, that would apply regardless of where they are headquartered. This element would “address remaining BEPS issues”, per the report. Pillar Two would also allow jurisdictions with a right to “tax back” when other countries have not exercised their “primary taxing rights”, or if “the payment is otherwise subject to low levels of effective taxation”.

Up to 4% of global corporate income tax revenues, or US $100 billion of revenue gains annually, could be collected under Pillar Two, per OECD’s economic impact analysis. Another US $100 billion could be redistributed to market jurisdictions through Pillar One.

What now?

  • Reports on both the pillars have been released for public consultation until December 14, 2020. Public consultation meetings on the pillars will be held in mid-January 2021 virtually.
  • The OECD will present the approved blueprint reports (Pillar One and Pillar Two reports) to the G20 finance ministers and central bank governors on October 14.

Trade war likely without consensus, warns OECD

While declaring that an agreement is not possible this year, the OECD sounded off a warning about a stalemate. The alternative to locking in a global agreement “would be a trade war”, the body said. Failure to reach consensus would result in “countries imposing unilateral taxes and rise in tax and trade disputes” thus undermining tax certainty and investment, it said.

“It is imperative that we take this work across the finish line. Failure would risk tax wars turning into trade wars at a time when the global economy is already suffering enormously.” — Angel Gurria, secretary-general, OECD

Without a deal, companies also face the threat of double taxation, especially given that countries are reeling under economic pressures from the coronavirus crisis.

Why negotiations have stalled: Geopolitical issues

Technology companies provide services and earn revenue in different countries without any physical presence, hence completely escaping taxation nets. It has been argued that current taxation systems no longer work for fairly allocating profits to different countries. Most Big Tech companies, a key target for a global digital tax framework, are headquartered in the USA.

The US had pulled out of talks on global digital tax plans. When European nations said they would continue despite USA’s absence, had threatened to hit countries with tariffs if they go ahead with their taxation plans, complaining that the framework is less about fairness and more about singling out American companies, setting stage for a trade war. As a result, France, UK, Spain and Italy had offered to limit the scope of their proposed digital taxes. COVID-19 had further delayed OECD’s plans.

The European Commission had said in September that it would look into an EU-wide digital tax if there is no deal at the OECD by the end of 2021. It remains to be seen if the Commission will change its stance given the postponement.

Countries moved ahead with unilateral taxes

Guirra’s fears about increasing unilateral taxes are not unfounded. According to analysis by the International Tax Review, 22 countries have passed or implemented direct tax on digital economy, and another 16 countries have either announced the intention to implement, or are in the process of drafting legislation. 75 countries are imposed indirect taxes on digital services, and another 8 are drafting legislation.

In Europe, France has already implemented its digital services tax, called “Les GAFA” — 3% on digital revenues from targeted advertising and sale of data. Others including the UK, France, and Italy have already begun taxing the companies, which have passed on the burden to consumers in those countries.

Other countries too have launched their own digital services taxes (DST), including India, which imposes a 2% Equalisation Levy on foreign e-commerce operators since April 2020.

Indonesia has implemented both direct (income tax) and indirect taxes (VAT) on foreign sellers, service providers, and foreign e-commerce companies that earn revenue from digital transactions made by Indonesian consumers. These taxes were spurred on by the COVID-19 pandemic — regulations bringing them into effect were passed in March and May 2020. Malaysia began imposing a 6% service tax on imported digital services starting January 1, 2020.

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