Entity Management and EU's Plan to Tax Digital Earnings

Back on March 21, the European Commission (EC) announced its intention to tax the earnings of large digital media companies in the countries in which they generate income. This marks a significant departure from previous European law, which has until now only provided for taxation of digital firms in the countries in which their headquarters are located.

The Commission is concerned about the differential impact this may have on traditional businesses, which can’t take advantage of the same perk. Its report also stated that digital companies “benefit from public services and infrastructure — such as the stable court systems or high-speed internet connections” while not paying their fair share of taxes in those countries.

Some have already begun to dispute the EC’s stated concerns of tax base erosion, and the Organisation for Economic Co-operation and Development (OECD), along with the governments of Ireland and others, are pleading with the Commission to wait for a proper debate and consensus within the EU before moving forward with new taxes. What seems certain, however, is that the international tax landscape may be subject to radical shifts following the establishment of a new corporate tax regime in the world’s largest economy, the United States.

This post is meant to offer a basic orientation regarding the context of the EU’s move to tax digital earnings, its potential implications and the prudent response firms should be preparing to it.

Retaliation Against the US Tax Bill

New taxes on digital firms in their countries of operation must be seen in the global context, especially the tax overhaul passed by the US Congress and signed by President Trump before the end of last year. Following from Trump’s rhetoric on the campaign trail in 2016, the tax bill took aim at profit-shifting by imposing a minimum tax on the overseas earnings of firms with US operations, while providing new incentives for American firms to shift operations, especially manufacturing, back to the United States.

New taxes on digital firms are widely understood as the EU leadership’s retaliation to those provisions of the new US tax regime that it believes may deprive Europe of US investment while unfairly discriminating against European firms that operate in the US economy. Already tensions are escalating between the EC and the Trump administration, with Treasury Secretary Steven Mnuchin stating that the US government “firmly opposes proposals by any country to single out digital companies.”

The current tension between Europe and the United States may prove to be merely the first skirmish in an ongoing struggle between these and other governments over the tax overhaul and its implications for the global investment climate. Multinational firms need to pay close attention and develop a proactive response.

Implications of Taxing Digital Earnings in Europe

Many digital firms that operate within Europe have their headquarters in countries like Ireland or Luxembourg, which possess reasonable tax rates, although they operate and generate most of their revenue in places like the UK, France and Germany. The EC has stated its concern that digital firms purposely establish their headquarters in lower-tax environments to avoid paying their fair share in these larger economies.

The new digital tax follows announcements in early February by France and Germany — the two largest EU economies — that they would impose new taxes on Google, Apple, Facebook and Amazon (together referred as GAFA) — four Silicon Valley companies that have outsized earnings in those countries and in Europe more broadly. So this is not the first time Europe has taken aim at digital earnings. In the past year, the government of Luxembourg was ordered by the EC to collect €250 million in unpaid taxes from Amazon, which has its European headquarters in the tiny nation.

The EC noted in its report that GAFA and related firms pay an average tax rate of 8.9–10.1% on income derived from sales to the EU, contrasted to the 23.2% effective rate paid by traditional businesses. At the same time, companies such as the GAFA firms are earning windfalls, for example, Facebook selling its user data to advertisers, revenues that are then housed in the lower-tax environments of Europe.

The proposed tax, according to The New York Times, is “likely to apply to companies with annual global revenue of over €750 million”—about US$925 million. It would cover sales generated within the EU that top €50 million a year and affect revenue coming from specific digital services, including advertising, paid subscriptions and the selling of personal data.

Responding to a Changing Landscape

Although the new digital tax is targeted explicitly at the main Silicon Valley giants, it raises larger questions for any US-based digital firm with operations in Europe, as well as uneasiness among American businesses operating in the EU generally. Entity management professionals who straddle the borders of EU-US tax regimes need to urgently consider the best response to this changing landscape.

Technology-driven restructuring of entities within multinational enterprises is a key strategy to help your organization increase efficiency and productivity, whatever the tax future in Europe and America holds. Many organizations are already in the process of restructuring to take advantages of the new opportunities for profit that the new American tax regime allows to US and non-US firms alike. Digital dangers in the EU are another warning that those firms that haven’t restructured yet need to strongly consider it.

Doing this doesn’t require you to reinvent the wheel. Blueprint OneWorld’s entity management platform offers a number of elegant and effective solutions that will help your leadership make the smartest decisions about reorganizing and reorienting in a rapidly shifting policy landscape. Please call or email us today to discuss them.