The digital economy taxation policy must take into account the new business models of digital economy enterprises. Distortive tax policies such as forum shopping – where companies identify low tax jurisdictions – should be avoided to prevent unintended tax consequences for such enterprises.
European leaders have proposed a plan to impose a digital levy on tech giants to counter corporate tax avoidance, as part of an overall effort to revise tax rules to address base erosion and profit shifting.
Preferences
Many countries are adapting their tax systems for digital economy businesses, with some countries introducing new taxes while others expanding existing regulations. These adjustments are intended to create an environment in which digital business models can thrive; however, care must be taken to design policies without distorting innovation or investment patterns.
Changes such as expanding consumption and corporate income taxes to digital services, redefining what constitutes permanent establishment without physical presence, and revising royalties are among many of the reforms in place at present. Although they represent steps forward, such reforms still pose real difficulties when it comes to aligning standards across multilateral environments and their implementation on an international scale.
Some changes to digital startup legislation may also prove counterproductive to their growth. For example, liquidation preference was originally created as a protective measure against high-risk venture investments from venture capital firms; now it may actually hinder development. Therefore, taxing profits instead of revenues allows startups to expand first before incurring taxes.
Gross-based withholding taxes
Taxing digital companies presents numerous challenges. Countries vary in how they impose these taxes, but some use gross-based withholding or turnover taxes as an effective method for taxing digital sales. While these taxes are sometimes combined with corporate or consumption taxes, they do not replace income or sales taxation; rather, these levies tend to fall on revenue rather than profits of an organization.
Other countries take an alternative approach to taxation by adopting both domestic and global minimum tax proposals for digital taxes. This strategy follows the logic that countries with similar economic development levels should start at similar points with their digital taxes.
Ultimately, the best strategy for digital taxes is establishing consistent rules across businesses in order to avoid fragmented digital-specific taxes that could spark trade wars and slow innovation. Such an approach would require considerable coordination among different countries.
International rules
Digital businesses face unique circumstances that make raising capital for early stage startups risky, their potential for exponential growth through economies of scale and their reliance on hiring highly skilled employees a formidable challenge. Furthermore, international differences in corporate tax rules compound these difficulties significantly.
Modern international business taxation rules fail to adequately accommodate digital economy firms’ emerging business models that allow them to generate profits in multiple countries without physically being present there. Therefore, many digital companies seek ways to minimize taxes by setting up headquarters in countries with lower tax rates such as Ireland.
China should actively contribute to global taxation rules to minimize the negative effects of unilateral digital service taxes on multinational enterprises, and adopt an effective strategy that protects its interests while simultaneously developing its domestic digital industry.
Distortive tax policies
As digital business models become an ever-increasing factor in global industries, governments are grappling with how best to tax them. Unfortunately, often this results in distortionary taxes which hinder economic efficiency and competitiveness – this issue can be avoided by adopting an integrated approach to digital economy.
Some nations have proposed a global minimum tax (GMT), which would tax companies according to the roles their users play rather than on the value of services provided. Such proposals would create artificial distinctions between ad-supported and subscription-supported models without sound policy support, in violation of international agreements prohibiting nations from taxing foreign firms unless they have established themselves within their nation and are creating value there.
Such taxes also lead people to avoid heavily taxed goods and activities, decreasing consumption while raising government revenue costs – known as deadweight loss – further diminishing social efficiency and competitiveness.