Startups Stand to Lose as Countries Implement Their Own Digital Services Taxes
TLDR: As federal officials hold hearings on potential action against countries that have enacted their own digital services taxes (DSTs), U.S. startups remain concerned that they could be affected by the digital levies in the form of higher costs for needed services, or even subjected to the new taxes themselves. Rather than imposing unilateral DSTs that harm startup growth, countries and global officials should work to reach a uniform digital tax framework that provides certainty for Internet companies of all sizes.
What’s Happening This Week: The Office of the United States Trade Representative (USTR) began holding hearings this week on proposed trade actions against six countries—Austria, India, Italy, Spain, Turkey, and the United Kingdom—that have adopted their own digital services taxes. The Trump administration previously began investigating several countries’ efforts to impose digital levies under Section 301 of the Trade Act of 1974, and U.S. Trade Representative Katherine Tai issued a series of reports in March finding that the six countries in question had adopted digital levies that discriminatorily and unfairly harm U.S. companies.
The DSTs adopted by Austria, India, Italy, Spain, Turkey, and the U.K. would impose taxes on multinational, largely U.S.-based companies on revenue where their services are used, rather than where the companies are physically based. Rachael Stelly, Policy Counsel for the Computer and Communications Industry Association, said at yesterday’s USTR hearing that the six countries’ DSTs could cost U.S. companies as much as $3.1 billion. These levies are similar to measures adopted or under consideration by other nations. While many countries, however, have held off implementation of their own unilateral DSTs in order to give the Organisation for Economic Co-operation and Development (OECD) time to reach a multilateral framework, several nations have pushed forward with their own levies over the objections of the U.S. government. The U.K.—which previously adopted a two percent levy on the U.K.-based revenues of large Internet companies that offer search engines, online marketplaces, or social media services in the country—could face retaliatory tariffs of as much as 25 percent annually on British exports if USTR moves forward with its proposed actions.
Engine submitted comments to USTR last week that commended the agency for pursuing action against the countries imposing discriminatory digital services taxes and voiced support for a multilateral framework at the OECD. As we highlighted, the DSTs present significant administrative and compliance burdens for startups, make it more expensive for early-stage companies to undertake tax planning efforts, and threaten global innovation by imposing new regulatory roadblocks across jurisdictions. The Biden administration is continuing to work with OECD on a global digital tax framework, and the international organization said it hopes to reach a global tax agreement in October.
Why it Matters to Startups: While the majority of proposed and implemented DSTs are aimed at large Internet companies, U.S. startups are likely to see increased costs for products and services as a result of the digital levies—and, in some extreme cases, even higher taxes themselves. Most of the impacted technology companies offer critical resources for growing companies, such as cloud-based products and advertising services. Nascent companies rely on these services to reach users and expand their operations, but the implementation of these taxes—particularly on a country-by-country basis—means that large companies are likely to pass on the burden of DST-related costs to startups and other early-stage businesses. As we noted in our comments to USTR, one study on France’s DST found that only five percent of the tax burden would be borne by large companies subjected to the tax, while the rest of it would fall on businesses and consumers that rely upon their services.
Since many startups launch with thin margins and little-to-no revenue in their early stages, even marginal increases in operating costs could have an outsized impact on companies’ long-term prospects. And several tech companies have already announced plans to increase the costs of their services in the U.K. and in Spain and France as a result of the DSTs, underscoring the trickle-down impact these taxes will have on small companies.
While many of these digital taxes only target large companies—Italy’s DST, for example, imposes a three percent tax on Internet companies with a revenue of 750 million euros globally and at least 5.5 million euros in the country—other countries have adopted levies that apply to non-domestic companies with far lower revenue thresholds. India’s digital tax levy applies to all “nonresident foreign companies” that receive approximately $265,000 in revenue from Indian customers, directly impacting a wider swath of U.S. companies. These low-threshold taxes only serve to make it more difficult for U.S. startups to compete in these countries. And, as we noted in our comments to USTR, “all affected or possibly affected businesses will have to undertake costly tax planning to determine what revenue falls within the scope of the taxes.” This presents a significant impediment for early-stage companies that are on the cusp of revenue thresholds, or that generate low profits despite high revenue. As the pandemic continues, there is also growing concern that other countries could similarly adopt DSTs with lower revenue thresholds to account for the ongoing economic uncertainty.
Some states are also pursuing their own misguided digital levies. These digital taxes similarly threaten to increase the costs of digital services and products that startups depend upon to grow. Just last month, the Maryland legislature voted to amend the state’s recently enacted DST that taxes Internet companies that profit from digital advertising in the state up to ten percent of their annual gross revenues. The amendments to the already vague measure delay its implementation until Jan. 1, 2022, and also attempt to prohibit affected companies from passing on the tax to their customers.
While the OECD’s negotiations on a digital tax agreement were delayed as a result of the pandemic, international officials are still committed to crafting a uniform digital tax framework. Rather than moving forward with standalone DSTs, countries should work with the international organization to adopt a framework that provides Internet companies of all sizes with the certainty they need to operate across the globe.
On the Horizon.
The Information Technology & Innovation Foundation is holding a webinar tomorrow at 10 a.m. to discuss the European Union’s proposed artificial intelligence legislation.
The House Science Subcommittee on Research and Technology is holding a hearing this Thursday at 11 a.m. to discuss the National Science Foundation and efforts to advance research for the future of U.S. innovation.
The House Energy and Commerce Subcommittee on Communications and Technology is holding a hearing this Thursday at 11:30 a.m. to discuss disparities in broadband access and affordability.
