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The Unintended Consequences of a European Digital Tax

Some countries have health taxes to limit sugar consumption, others have green taxes on gasoline.  What would be the impact of the EU’s proposed digital tax?

On March 21 the European Commission proposed a 3% tax on certain digital companies’ turnover.  This very political proposal ignores evidence that so-called “digital companies” on average actually pay a higher effective corporate tax rate than traditional companies.

More importantly, the Digital Services Tax (“DST”) could lead to a number of unintended consequences for Europe, such as:

Favoring non-digital over digital business models
The European Commission has stated that it wants to “boost e-Commerce in the EU” and make “the EU’s single market fit for the digital age.”  Unfortunately, it conducted no impact assessment on how its digital tax proposal will impact the EU’s digital aspirations.  Under the DST, e-commerce via an online intermediary will be taxed while buying the same product from a physical shop will not.  The proposal obviously discriminates against online business models and thus encourages companies to stay analogue.

Making European companies stay small
The European Commissioner says the DST is needed to “build European champions” and to “enhance Europe’s position as a world leader in the digital economy.”  However, the proposal will effectively encourage European companies to stay small in order to not reach the threshold where it would be taxed on their gross revenues.  A company with €749.999,999 revenue would be subject to 3% tax on its entire EU revenues for making one additional Euro.  The proposed revenue cliff is a disincentive against creating European champions.

Rewarding digital consumption rather than digital creation
For countries the proposal would change a key principle of corporate taxation; from today’s taxation in the country where companies are established to taxation in the country of consumption.  This means that European nations that have massively invested in education, R&D, etc. to create startups would now no longer be compensated when companies bring home corporate tax from profits made abroad.  The DST would essentially reward digital consumption over digital creation. The EU should continue to promote and reward countries for their investments and ability to create successful companies.

Harming European small enterprises
The proposal’s impact assessment states that “SMEs would not be affected, as their revenue would not reach the threshold” to fall within the scope of the DST.  The 3% turnover tax is an additional cost for the targeted companies, which they will pass on to their business partners and customers.  In the case of intermediaries with low-margin and high-investment business models, the tax is likely to be added to the listing fees of the more than 350,000 small European merchants that sell via online intermediaries in Europe.  The proposal will also make digital ads more expensive for European firms and reduce their ability to attract customers globally.

More user surveillance
The DST will require companies to surveillance users’ behaviors and location to determine taxable activities and tax jurisdiction between the EU countries.  Companies will be required to monitor and report on activities such as “the number of times an advert has appeared on users’ devices”, the number of times an account is used and the user’s location, through IP address or “any other method of geolocation.”  This requirement to monitor, retain and share large data sets with many national authorities about users’ behaviors appears in conflict with the aim of the EU’s data protection reforms. It also creates new risks of misuse.

Negatively impacting Europe’s overall welfare
The OECD concluded that this type of measure will likely result in “a negative impact on the overall welfare of an economy and on its output.”  The OECD also warns against the risks of over-taxation and the “likelihood that the cost of administration will far exceed the amount of revenue raised.”

Likely retaliation from Europe’s trading partners
The DST almost exclusively targets large U.S. technology companies, many of which were specifically named in an internal Commission document.  The Commission confirmed that a majority of firms targeted are American and has not identified which European companies, if any, would fall within the scope of the DST.  Finally, the Commission’s internal document also questions whether its tax would “be consistent with WTO obligations as it [could] be viewed as discriminatory.”  The U.S. Administration has already warned that “[t]he U.S. firmly opposes proposals by any country to single out digital companies.”  

Nobody would lose as much as Europe if its trading partners were to introduce a similar consumer tax on European digitally enabled services.  The EU exports $569.6 billion worth of digitally enabled services to the world, resulting in a surplus of $151.6 billion for these services.  This digitally enabled services trade represents 56% of all EU services exports. The U.S. is the largest consumer of such EU exports.  A possible 3% retaliatory turnover tax on European digitally delivered services would significantly impact European exports. As the world’s largest exporter of services, the EU would have most to lose if third countries, notably the U.S., were to introduce a similar turnover tax on European digitally deliverable services exports.

EU unilateral actions hinders international tax reform
European financial ministers, the European Commission and European stakeholders all prefer a global solution rather than unilateral European action.  The OECD is undertaking international tax reform involving more than a hundred countries worldwide, including all the major G20 economies.  The OECD will present its blueprint next year and has cautioned against EU unilateral action: “Don’t do anything short-term that would block us from applying long-term solutions.”  The EU proposal harms the prospects of achieving a much more ambitious international tax reform.

Commission President, Jean-Claude Juncker, promised a “political Commission” when he took office.  The proposed EU digital tax certainly captures the political winds but at the expense of European’s small businesses, exports, digital transformation and the prospect of achieving global tax reform.

European Union

DisCo is dedicated to examining technology and policy at a global scale.  Developments in the European Union play a considerable role in shaping both European and global technology markets.  EU regulations related to copyright, competition, privacy, innovation, and trade all affect the international development of technology and tech markets.