Digital economy update

Friday 11 March 2022

Christiane King
Chancery Chambers, Barbados​​​​​​​

Report on session at the 11th Annual IBA Finance & Capital Markets Tax Virtual Conference

​​​​​​​Date: Tuesday 18 January 2022

Session Chair

  • Michel Collet  CMS-Bureau Francis Lefebvre Avocats, Paris


  • Pamela Palazzi  Sky Italia, Milan
  • Mariana Eguiarte Morett  Sanchez Devanny, Mexico City
  • Nathaniel Carden  Skadden, Arps, Slate, Meagher & Flom, Chicago
  • Willem Bongaerts  Bird & Bird, The Hague


The session chair, Michel Collet, began with an overview of the panel’s presentations. He highlighted that the panel would seek to address and provide insight on the following key topics:

  • the status of the digital service tax (DST) across different jurisdictions;
  • the current attitudes of the tax authorities with digital businesses, particularly in relation to enforcement; and
  • other developments including the Directive on Administrative Cooperation (DAC) 7.

EU implementation of the digital service tax

Willem Bongaerts introduced the first topic through an overview of the DST. Over the last few years, concerns have been raised that the current international tax system does not capture the digitalisation of the economy, and that new rules were needed to replace the existing rules. He proceeded to explain the initiatives to implement DST that have been explored across different regions and jurisdictions.

Bongaerts explained that the EU initially proposed the DST, which would carry a tax rate of three per cent on certain types of revenue – particularly revenue created from activities where users play a major role in value creation and are difficult to capture within the current tax rules. These include revenues generated from:

  • selling online advertising space;
  • digital intermediary activities; and
  • the sale of data generated from user-provided information.

The EU DST proposal aimed to capture large companies that pass the specific threshold of €750m in worldwide total annual revenues and €50m in EU revenues. However, this proposal was not implemented.

European domestic implementation of DST

Nonetheless, Austria, France, Hungary, Italy, Portugal, Spain, Turkey and the United Kingdom have all introduced their own DSTs on a domestic level; other countries such as Belgium and the Czech Republic have proposed to enact similar rules.

The DSTs incorporated within most jurisdictions are based on the EU initial model but differ slightly – primarily in relation to tax base and tax rates. Bongaerts presented a comparative analysis of the domestic implementation of the DST in several jurisdictions and highlighted key features. Key differences include:

  • Austria and Hungary have limited their tax bases to online advertising;
  • France has adopted a broader tax base which captures the provision of a digital interface; and
  • tax rates range from as low as 1.5 per cent in Poland to as high as 7.5 per cent in Turkey.

DST and Pillar 1

Generally, the DSTs were implemented in anticipation of discussions taking place at the Organisation for Economic Co-operation and Development (OECD) level surrounding the adoption of the new international tax system. Such discussions resulted in Pillar 1. As it is expected that Pillar 1 will now be implemented by the end of 2023, there is an interim stage in place until that time.

Meanwhile, the implementation of DSTs by European countries quickly prompted a reaction from the United States, which sought to respond with retaliatory tariffs as there arose generally a threat of double taxation.

On 8 October 2021, Austria, France, Italy, Spain and the UK agreed in a joint statement with the US:

  • to roll back and repeal the DST upon the implementation of Pillar 1;
  • to allow a certain method of crediting DST on revenue A tax to avoid double taxation; and
  • for the US to suspend the retaliatory tariff threats made on certain products.

However, the credit arrangement would only be efficient for companies in the scope of Pillar 1.

Mexico and the DST

Mariana Eguiarte Morett described the unique and interesting approach to a DST as introduced by Mexico.

Morett explained that Mexico's policy is predominantly based on the OECD's Inclusive Framework approach; therefore Mexico has determined that it will not implement a DST until a consensus is reached on the Pillar 2 solution. It is awaiting a worldwide consensus to determine whether it will introduce a DST.

Additionally, Mexico has entered into a free trade agreement with Canada and the US (USMCA), which prohibits the imposition of customs duties, tariffs or other charges or levies on or in connection with the import and export of electronically transmitted digital products. Mexico is therefore unwilling to establish a DST based on the USMCA because it may be deemed as failing to comply with its obligations under the USMCA.

Morett provided insight into Mexico's implementation of VAT at the federal level on digital services and digital intermediation services in the Tax Reform of 2019, which is in force as of July 2020. Mexico has conveniently used foreign digital platforms as facilitators of tax compliance and levies VAT on digital services via these platforms (such as Spotify, Airbnb and Netflix). The foreign digital platforms act as collecting/withholding agents of VAT and are obligated to pay this to the Mexican tax authorities. The VAT therefore impacts consumers directly with a nexus by way of domicile, IP address, Mexican phone number and Mexican payment intermediary.

The foreign digital platforms also become subject to certain obligations implemented by the Mexican authorities, which include:

  • registering before the Federal Taxpayers Registry;
  • withholding and paying VAT generated in the transaction; and
  • filing of informative returns.

The failure to comply with such obligations could lead to operational restrictions for any such foreign digital platform within Mexico.

Morett commented that Mexico City recently enacted a local tax (at state level) that could resemble a DST. Mexico City has implemented a two per cent pre-tax which is obligated to be paid by digital platforms that conduct deliveries within the Mexico City infrastructure. She noted that it is a tax which directly burdens the digital platform, therefore departing from the approach taken at the federal level which obligates the digital platforms to withhold the tax and pay it on behalf of the consumers (thereby directly impacting consumers only). She stated that the two per cent pre-tax is expected to be challenged by way of a constitutional appeal in mid-February 2022.

Interaction of domestic measures and challenges with the DST

Pamela Palazzi commented on the challenges with implementing the DST, in particular the Italian DST, such as managing domestic and foreign group entities obligations including:

  • payments;
  • tax returns;
  • internal reporting measures;
  • administrative mechanisms;
  • determination of the digital services within the scope; and
  • the income scope and tight timelines.

Palazzi highlighted that many of the countries’ DST rules are different, each departing to a certain extent from the existing treaty principles. This creates the potential for uncertainty, disputes and double taxation. DSTs should act as a transitional measure pending the implementation of Pillar 1.

Palazzi also noted that issues arise in considering the extent to which a standalone DST falls within the scope of a tax treaty. The objective behind the standalone DST may be significantly weakened if such DST falls within the scope of existing treaties, given the limitations and restrictions thereunder. The application of the DST to foreign entities without a permanent establishment in the said country could also lead to treaty overriding and, in countries like Italy, it could lead to unconstitutional measures.

Palazzi suggested that the October 2021 agreement on tax credit mechanisms, as discussed earlier by Bongaerts, could circumvent the potential double taxation around the DST. At the same time, Pillar 1 will be applied to entities falling under certain thresholds and there will be a period of huge discrimination and uncertainty.

DST and the US

Nathaniel Carden provided a comprehensive update on the response to the implementation of the DST from the US perspective. Carden indicated that there is generally bipartisan opposition to DSTs in the US at the federal level, with the previous Trump administration and the current Biden administration promoting the repeal of DSTs – describing them as ‘targeted, discriminatory taxation’.

He explained that the US Trade Representative initiated investigations under US trade law; the findings indicated that DSTs were discriminatory. Carden then touched on the joint statement made in 2021 by Austria, France, Italy, Spain, the UK and the US (as discussed earlier in the session by both Bongaerts and Palazzi) and further explained that the mechanism of crediting any taxes that accrue under the unilateral DSTs would be against future Pillar 1 liabilities (if any).

As a result of the implementation of DSTs, the US federal government changed the foreign tax credit (FTC) regulations to adopt a new ‘attribution’ requirement (previously called the jurisdictional nexus) which has two components that act to restrict the availability of FTCs to foreign taxes.

One component applies to taxes imposed on non-residents, such that a foreign tax is creditable only to the extent that the attribution is based:

  • on activities that conform to non-resident activities within the foreign country (ie, no customer-based nexus as foundation for taxation);
  • on a source rule which must generally follow US sourcing principles (non-US characterisations generally hold in this instance; or
  • on situs of property which must be based on real property.

The other component applies to taxes on residents such that a tax is creditable only to the extent that the attribution is based on an arm’s length principle (without reference to ‘customers, users, or any other similar destination-based criteria’).

Carden stated that the US Treasury nonetheless intends to revisit these new FTC regulations if Pillar 1 is implemented. Therefore, the application of these rules within the Pillar 1 and Pillar 2 context remains unclear.

Carden then commented that DSTs are popular at the US state level, with state legislatures proposing DSTs in a number of different forms – including formulary apportionment and expansions on the sales tax base – as it serves as a mechanism to balance their respective budgets. In particular, Maryland has adopted a digital advertising tax based on gross revenues (using device location for apportionment). Multiple states are attempting to follow Maryland’s lead in adopting a tax on digital advertising, including Connecticut and Indiana, which are focusing specifically on a social media advertising tax.

However, the future of state-level DSTs is uncertain, with states being faced with defending legal suits. Indeed, Maryland is being challenged in respect of its own DST in federal court, on statutory and constitutional grounds.

Current attitudes of the tax authorities towards digital businesses

Collet then explored the issue of permanent establishment (PE) and transfer pricing (TP) adjustments, and provided useful references to emerging case law in relation to digital platforms. He commented on the perspective in France surrounding PE, citing the landmark Google case (2019) and the Conversant case (2020).

Collet noted that, in the Google case, the issue arose as to whether there was a PE from Google Ireland (GI) in France through its service manufacturing sister company, Google France (GF). In this instance, GI was providing advertising services to the French clients; GF's role was to contact and deal with existing and new clients. Collet highlighted that the critical question was whether GF had the authority to conclude contracts in the name of GI from a legal point in accordance with precedents.

The French tax court ruled that GI did not have a PE in France on the basis of the activities of GF, because GI was signing contracts through an automated procedure and had to be involved in any new campaign launched by new clients. GF lacked sufficient authority to conclude contracts in France in the name of GI and therefore GI was not subject to taxation in France.

Collet indicated that the case also proceeded to the French criminal court, based on transfer pricing and insufficient allocation of profit to GF – whereby GF decided to strike a deal with the French prosecutor and entered into a 'public interest judicial agreement' for a settlement deal of €1bn (structured as €500m for TP adjustments and €500m as a fine). It was suggested that there is a trend with the French authorities to pursue TP adjustments rather than on PE, as the latter has become a much more complex issue.

Collet then discussed the Conversant case, which involved a provider of digital marketing services with a similar structure to that in the Google case, being an Irish company providing marketing and management services to French clients through a French subsidiary. Unlike in Google, the French subsidiary in Conversant was considered as having the capacity to bind the Irish company since it has practically the right to choose clients and decide to conclude contracts, even if the Irish company also signed contracts through an automated process.

On this basis, the French court ruled that the French subsidiary should be viewed as the dependent agent and thus as a French PE of the Irish company, as the French subsidiary habitually exercises the authority to conclude contracts in the name of the Irish company (even though formal consent can only be given by the Irish company). This decision was based on OECD guidelines with an extensive approach of the authority. The outstanding question is as to whether the legal approach normally retained by the Conseil d’Etat should be considered as overruled.

Directive on Administrative Cooperation (DAC) 7

Palazzi then provided the panel with a summary on the Directive on Administrative Cooperation (DAC) 7 framework for digital platforms. She indicated that, on 22 March 2021, the Council of the EU unanimously adopted the revised DAC 7 to strengthen administrative cooperation by introducing reporting requirements for online platforms and a related exchange of information (EoI) framework.

DAC 7 aims at expanding existing administrative assistance rules, including the introduction of the automatic EoI on royalties and the facilitation of joint audits. Palazzi stated that Member States had until January 2022 to adopt the DAC 7, with a deadline of January 2023 to apply it, and the first reporting requirements due by January 2024.

She further expressed that DAC 7 is another step to strengthen transparency and to aid in fixing the ‘gap’ within the tax administration of digital platforms. It is anticipated that the new harmonised framework under DAC 7 will be viewed positively by governments.