Image by the White House via Flickr

In order to get their ‘fair share’ of tax revenue from non-resident digital service suppliers, many countries recently enacted a digital services tax (DST). A DST is a tax on sales revenue from online advertising and digital intermediation services. The majority of firms affected by DST are from the United States (US). This includes Google, Amazon, and Facebook. They earn approximately half their profits outside of their home country (the US), and dominate markets in many countries, but pay very little (if any) income tax to these countries.

In response to these taxes, the United States Trade Representative (USTR) launched investigations under section 301 of the Trade Act 1974. This was an unusual, although not entirely unprecedented, response to a tax measure of another country.

Section 301 provides for the investigation of foreign trade practices, often leading to the US pursuing a complaint at the World Trade Organisation (WTO). Where no international agreement has been breached, the USTR may still determine the practice to be unreasonable and burden US commerce and trade sanctions may be imposed on a country that is unresponsive to the US complaint.

Section 301 investigations

In December 2019, the USTR issued its investigation report on France’s DST. The report finds that the DST is discriminatory against US companies and contravenes ‘prevailing international tax principles’ by taxing revenues not connected to physical presence. However, the report does not allege that any international tax or trade treaty had been breached.

In January 2021, the USTR found that the DSTs adopted by Austria, India, Italy, Spain, Turkey, and the United Kingdom were also subject to action under section 301. The justification provided for these findings was essentially the same as in the report on France’s DST. On 2 June 2021, the USTR determined to impose additional duties on certain products from these countries, but suspend the application of the duties for 180 days.

As of June 2021, the US has not imposed any tariffs on countries that adopted DSTs. The G7 Finance Ministers’ communiqué issued on 5 June 2021 suggested that the US no longer demands an immediate removal of DSTs. Instead, the group’s members ‘will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes’. This raises a question about the role of the section 301 process in international tax negotiations.

The section 301 process should be understood as primarily a political rather than a judicial process, designed to stimulate the US executive arm of government into taking action to protect the country’s economic interests abroad and to increase the pressure on foreign states to accommodate US wishes. The process has been dubbed ‘aggressive unilateralism’ and is resented by other countries.

Section 301 may have a limited impact on roll out of DST

The Trade Act 1974 seeks to secure an advantage for the US in international economic negotiations. History suggests some clear limits to the statute’s utility in encouraging policy changes abroad.

In the past, section 301 investigations rarely resulted in trade diverting agreements, trade retaliation or no agreement, and almost never resulted in counter retaliation. A successful outcome in negotiations facilitated by section 301 investigations was most likely if the measure that was investigated clearly breached an international rule or there was a broad acceptance that the measure was harmful.

Countries are conscious that making concessions in response to unilateral demands of the US simply invites further demands. By refusing to abandon their DSTs in response to US demands and threats of additional tariffs, these countries resistance has, so far, helped them to avoid making costly concessions on DST or on the future of the international tax regime.

It has also secured a new source of tax revenue for these countries, at least until a global deal on taxation of income of ‘highly digitalised businesses’ is finalised and implemented. On 1 July 2021, 131 countries participating in the Inclusive Framework (IFB) on BEPS has agreed in principle to remove ‘all Digital Service Taxes and other relevant similar measures on all companies’ in exchange for an opportunity to tax some profits of highly digitalised businesses. This opportunity to tax is intended to be available in 2023. This is an optimistic timeframe.

DST may be part of the new tax reality for some time

Should the IFB members fail to agree on income taxation of highly digitalised businesses and abandonment of unilateral measures, DSTs will become more common.

A well-designed DST should pass muster under DTAs and trade agreements.

A DST is not a tax on income or capital. If levied on sales revenue rather than profits and deducted from rather than credited against a company’s profits, the DST will fall outside most obligations in DTAs.

A DST will also need to comply with the enacting state’s obligations under the WTO and preferential trade agreements applicable to indirect taxes, in particular, the obligation not to discriminate against like services or service suppliers. The mere fact that the DST will predominantly impact foreign firms because the tax only applies to firms that meet a high turnover threshold does not mean that the tax will be found to be discriminatory under the WTO’s General Agreement on Trade in Services (GATS).

The current dispute about the tax challenges of digitalisation is not simply about tax. It is part of the strategic contest over the rules that will shape digital markets. An ever wider use of DST, following the increasing digitisation of the economy, could generate millions of dollars of tax revenue for market jurisdictions. At the same time, it could reduce the US income tax base if, in response to pressure from its own digital giants, the US allowed deductibility of paid abroad DSTs against domestic profits.

The spread of DSTs may also impact the global structure of the digital platform services industry and lead to the disappearance of some free services.

A better strategy is needed to arrest the spread of DST

By retaliating against countries imposing DST, the US will harm itself. There is growing evidence of the economic harm caused by the additional tariffs imposed during the Trump administration.

The economic and fiscal vulnerability of many countries flowing from COVID-19 may make countries more risk averse in relation to a trade dispute with the US. However, US digital firms already dominate many foreign markets. The imposition of retaliatory tariffs by the US in response to DST, which is viewed by the countries imposing the tax as a response to unfairness in the international tax regime, may not lead to DST being dropped.

Countries that levy a DST have options for responding to US actions. This includes market access restrictions for US’s digital firms, perhaps under the guise of more demanding regulatory requirements in relation to privacy, hate speech, consumer protection, competition and/or national security. A ‘win’ for the US on DST may translate into a ‘loss’ in the digital trade negotiations.

Restricting market access in digital markets could provide an opportunity for non-US firms to expand. The perceived benefits from hosting a multinational digital services company may further tempt some governments to resist promote their own firms by restricting US firms.

To arrest the spread of DST, the US needed to show that the Organisation for Economic Co-operation and Development’s (OECD’s) Pillar One and Pillar Two proposals is for the welfare of all 139 countries participating in the IFB. The US has succeeded, at least for now, given the in principle agreement of 131 countries to remove DST and similar measures. The ultimate and likely very modest revenue gains for most countries from the agreement may, however, result in buyer’s remorse.

In this context, the growing digital sector, fiscal pressures from COVID-19 and concerns about competitive disadvantages for domestic enterprises, fairness and public confidence in the tax system are likely to increase other countries’ interest in other taxes, if DST is no longer available, or engage in more sophisticated regulatory games to restrict access to domestic markets of digital services.


This blog is based on: Noonan, C and Plekhanova, V 2021 ‘Digital Services Tax: Lessons from the Section 301 InvestigationBritish Tax Review issue 1 and Noonan, C and Plekhanova, V 2020 ‘Taxation of Digital Services under Trade AgreementsJournal of International Economic Law, vol 24 issue 4.



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