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New Zealanders are increasingly living a digital life. On average, New Zealanders spend nearly two hours per day on social media.

Non-resident social media companies derive income from selling our attention to advertisers. They operate multi-sided platforms that connect users and advertisers. New Zealand, along with nearly all other jurisdictions, currently treats the income earned by social media companies and non-resident digital platforms as non-taxable.

However, there is global unease as prominent businesses, such as Facebook and Google, derive large revenue from market jurisdictions. New Zealand is participating in talks at the Organisation for Economic Co-operation and Development (OECD), where jurisdictions are attempting to ascertain a multilateral approach to tackle the ‘digital economy’. There is a commitment to reach agreement by the end of 2020.

In 2019, the New Zealand Government, along with those of other jurisdictions, proposed a digital services tax as an interim or final solution if there is no multilateral consensus. Inland Revenue has produced a discussion document, Options for Taxing the Digital Economy: A Government Discussion Document, outlining the government’s proposal.

How digital services tax is calculated?

The digital services tax applies a flat 3 per cent tax rate to large businesses on gross turnover of certain in-scope activities.

The tax applies an extremely broad test and then explicitly excludes certain types of activities. The tax would ‘apply to the services provided by business activities whose value is dependent on the size and active contribution of their user base’. The reference to size suggests that the digital services tax only applies to business activities that have network effects — that is, where a service gains additional value the more people use it. Network effects are evident across many industries (for example, insurance, telecommunications). The active contribution of users is another underlying pillar of the tax. Users in New Zealand must actively contribute to the value of the highly digitalised business.

There are several important exclusions to the digital services tax. The first exclusion is the ‘sale of ordinary goods or services (other than advertising or data) over the internet’. The tax is targeting the platform owners (for example, Amazon itself) rather than the user or the advertiser. The second exclusion is the ‘provision of online content, such as music, games, TV shows and newspapers’. Netflix is explicitly excluded, as there is only a transaction between users and Netflix. Netflix offers a subscription service (without advertising) directly to the user. On the other hand, Apple music provides online music, but it is explicitly included as it facilitates the sale of music owned by another party to users. It acts as a platform to bring interested parties together.

Nearly all major newspapers, online media websites, traditional television and radio broadcasters use online advertising on their websites. These activities are arguably in scope, as their advertisements facilitate the sale of goods or services between users and advertisers. Furthermore, the sale of advertising is explicitly removed as an exclusion. The active contribution rationale is difficult to ascertain in these cases. These businesses’ primary activity is to provide information to users, rather than connect advertisers to users. The advertisements are similar to traditional non-digital advertising — as these businesses have limited information about users, they have limited ability to target advertisements to particular users. Therefore, it is difficult to justify including the sale of advertising within the scope of the digital services tax. These examples illustrate how traditional businesses are digitalising their products to enhance value.

The saving grace for the digital services tax is its high de minimis thresholds. First, the group’s global revenue must exceed EUR750 million. Second, the amount of the group’s global revenue that is attributable to New Zealand users must exceed NZD3.5 million. Both thresholds ensure that the tax only applies to large businesses. The EUR750 million threshold, taken from the country-by-country reporting requirement of the OECD, is a positive step in reducing the compliance burden for small- and medium-sized businesses.

The rationale for a digital services tax based on active contribution is premised on three key arguments. First, non-resident multinational technology companies do not pay their fair share of tax. Second, active contribution is unique to these companies. Third, a unilateral approach is the only alternative where a multilateral approach fails.

Paying a fair share of tax?

The fear that digital companies are paying less tax than businesses in other industries is a key driver of the digital services tax. The discussion document states: ‘There has been significant international concern over the under-taxation of the digital economy, and digital multinationals in particular.’ This accurately encapsulates the concerns of governments and other organisations. However, are digital companies under-taxed?

There is no clear answer. Ascertaining the average tax rates for digital companies is extremely difficult. The discussion document quotes an European Commission report, which claims that the average tax rates for a digital company and a traditional business are 9.5 per cent and 23.2 per cent respectively, based on another report by the Centre for European Economic Research. However, it is unclear how the Commission derived these numbers, as the Centre for European Economic Research report does not state these percentages. The Centre for European Economic Research report adopts the Devereux and Griffith model for calculating effective tax rates, which considers a hypothetical incremental investment with several theoretical assumptions, including statutory tax rates. Hence, it is inappropriate to use their model as an indicator of assessing average tax rates between businesses and across industries.

A study by Matthias Bauer claims that digital companies  are paying effective corporate tax rates similar to traditional businesses. Bauer’s report compared the effective corporate tax rates between less-digital corporations, non-digital corporations (Euro Stoxx 50 index) and digital corporations, using actual financial statements. Taking data from a five-year period, the digital corporations had a higher effective corporate tax rate (29.1 per cent) compared to traditional corporations (27.1 per cent). Furthermore, profitability levels and tax expenses of digital corporations varied in a similar manner to non-digital corporations. A report from the Institute for Economic Research found that digital corporations had an average tax rate of 20.9 per cent compared to 26.7 per cent for non-digital corporations. Both reports used the income tax expense calculated under accounting standards. However, this is misleading as actual taxes paid will be different to the accounting income tax expense. This mainly arises through different treatment of depreciation. Furthermore, businesses may take ‘uncertain tax positions’, where favourable tax positions are less than certain.

Without any disclosure by the European Commission, it is impossible to verify their claims for under-taxation of digital companies. Media illuminates high-profile examples of technology giants paying low rates of taxation based on total revenue. However, media reports alone cannot justify new tax rules. Marcel Olbert and co-authors illustrated that the main drivers for lower effective tax rates of digital businesses (based on a theoretical model) are: immediate expensing of investment costs for digital business; more generous depreciation rates for fixed assets; and special provisions that favour digital business models. Countries compete for digital businesses to stimulate their economies. However, a theoretical model is not clear evidence.

Overall, there is a lack of substantial evidence to suggest that digital companies are paying less tax than other businesses. This insight seriously questions the efforts to target digital companies. Ultimately, a lack of evidence did not stop the OECD from pursuing the Base Erosion and Profit Shifting (BEPS) project, and thus, it is unlikely to stop countries targeting digital companies.

Problem with active contribution

There is a major conceptual flaw with active contribution. A key rationale for the digital services tax is that active contribution by users creates network effects — that is, a service gains additional value the more people who use it. However, the network effects created by digital companies are evident in many industries.

For example, consider an old technology, such as fax machines. The more users participating by sending messages via fax machines, the more valuable fax machines become. Telecommunication networks operate in the same manner. Based on the same logic, the users are creating value that justifies taxation of that value where the users are located. Another example is clinical trials. New medicines often require a rigorous clinical trial that involved users providing personal information in exchange for compensation. The resulting data leads eventually to new medicines whereby the pharmaceutical company derives profits. Even a basic loyalty scheme for a local supermarket involves participants receiving targeted advertisements. Other examples include newspapers, broadcast television, video game consoles, financial exchanges, and farmers markets.

Therefore, it is arbitrary to focus only on value created by users on digital platforms. Several value factors within a market jurisdiction could justify taxation — for example, infrastructure, rule of law, reliable payment systems, welfare payments, and so on. Focusing on active contribution by users of particular digital platforms appears confusing and incoherent. The OECD has acknowledged the difficulty of attempting to isolate the digital economy. Efforts to demarcate the digital economy from the rest of the economy are likely to face these issues.

Unilateral approach

The digital services tax is advocated as the only alternative to a multilateral approach. It represents a unilateral approach that could set a dangerous precedent to the multilateral approach to international tax issues. The integrity of double tax agreements will erode if jurisdictions take actions that are essentially targeting income, but designing them in such a manner as to avoid double tax agreements. The key principle of pacta sunt servanda — that is, parties to a treaty must adhere to a treaty in good faith — would be seriously undermined. Perhaps a movement against the ideology of globalisation and free markets is the driving force behind the proposals.

The digital services tax could ignite a cascade of unilateral approaches by governments to common and complex tax issues that could damage the international tax system. The positive aspects of our international tax system cannot be ignored: global institutes that provide a platform for common ground (such as the OECD and United Nations); the rule-based system of double tax agreements; and exchange of information and cooperative relationships between tax administrations. It is far easier to damage a system than improve it. The New Zealand Government should carefully consider this important truth.


There are no easy solutions for jurisdictions attempting to confront the new economic digital reality. The digital services tax proposal would create more issues than it could possibly solve. Its scope is very broad. The proposal fails to distinguish between digital companies and traditional businesses that are digitalizing. However, the high de minimis thresholds ensure only large digital companies will be liable to pay the tax.

There is anecdotal evidence of BEPS behaviour from prominent digital companies, but there is no clear evidence that they are under-taxed. The tax incentives offered by jurisdictions to digital companies suggests lower effective tax rates. The rationale of active contribution is conceptually weak, as network effects are evident across industries. Lastly, a unilateral approach is a dangerous course for a small country such as New Zealand to pursue.

Governments should steer clear of a digital services tax and pursue multilateral measures through the OECD.

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