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EACCNY “Digitalization” Series | The taxation of digital services – are we nearly there yet?

With the help of our members, this thought-leadership series explores the acceleration of “digitalization” due to COVID-19 on both sides of the Atlantic, and across various industries. Today, we present Phil Greenfield, from PRICEWATERHOUSECOOPERS, and based in the United Kingdom. He will address: “The taxation of digital services – are we nearly there yet?”.


Digital services have created problems for traditional corporate income tax systems because they don’t rely on the characteristics those regimes have been built on. For example, they don’t need the kind of physical presence in a country that generates a right to tax the profits from that activity.

Encouraged by public sentiment, the desire by some countries for a ‘fairer’ allocation of taxable profit giving more recognition to sales, although the clear principle for this has never been validated, and countries’ needs to generate more money from taxes, there has been a wind of change. With some countries introducing their own ideas on how to deal with the problem (unilateral measures), many of the world’s countries have spent recent years grappling with a possible agreement on a common approach (multilateral consensus) that comprises much more than digital services. The OECD has orchestrated those efforts recently through an Inclusive Framework of 140 countries, urged on by the G20. The principal elements appear to be:

  • A reallocation of profits to market jurisdictions initially for 100 or so of the biggest and most profitable multinational groups (Pillar 1), and
  • The imposition of a top-up tax to a level of an effective rate on profit of at least 15% – a rate still being discussed – for many more groups, i.e., those with an annual turnover of more than €750m for a selection of recent years (Pillar 2).

A large proportion of businesses offering digital services are based in the US, so it is a key stakeholder in these discussions.

The EU was keen to introduce gross revenue digital services taxes (DSTs) in the short term while seeking a longer term system but failed to agree a unanimous approach. Some of the larger Member States, and post Brexit the UK on its own, went ahead with different DST formats or other measures like the UK’s diverted profits tax. The US saw the DSTs as discriminating against US headquartered businesses operating in those countries and sought avenues for mitigation or reprisals.

There are other tax implications for businesses operating or facilitating digital services, including VAT/GST, differing reporting requirements (particularly in relation to the gig economy) and withholding obligations. But in this article, we focus on the search for a consensus on the above.

For the G20/OECD project a deadline for mid-October has been set, but we explore here some of the different things the US on the one hand, and the EU (and the UK) on the other, want and the prospects for the outcome.

The US position

The Biden administration set out in the ‘Green Book’ its proposals for changes to the US international tax rules that sit alongside its need for revenue for domestic infrastructure spending etc. The 2017 Tax Cuts and Jobs Act had introduced fundamental US international tax reform which fostered some of the ideas included in Pillar 2 and the latest discussions have probably helped movement toward a potential global tax reform.

The US House and Senate committees are still working around their own thoughts on legislative proposals. Recent approval by both the House and Senate of an FY 2022 budget resolution with reconciliation instructions provides the procedural protections needed to enact a significant spending and tax bill with only Democratic votes over the expected opposition of Congressional Republicans. On September 15th, the Ways and Means Committee approved a reconciliation bill on a largely party-line vote, with only Congresswoman Stephanie Murphy (D-FL.) crossing over to vote no.

On matters relevant to Pillar 1, a US compromise seems to underlie the current proposals. Based on size and profitability (and likely to exclude certain regulated financial services and extractives), they target less overtly US businesses than would proposals on automated digital services alone. Countries had looked at including certain consumer facing businesses as well, but size and profitability seems a much simpler set of criteria — although further away from the original impetus for the project. A sticking point though is the entities, or ‘surrendering companies’, from which profits should be reallocated and the extent to which that is the ultimate parent entity (UPE) in the group – less attractive to the US – and the holders of intellectual property, etc.

In relation to Pillar 2, President Biden has proposed to increase the existing US minimum tax on various foreign earnings (GILTI) to 21%, i.e. 75% of his proposed increased US corporate tax rate of 28% and double what it has been for a couple of years at 10.5%.  Congress is working through the legislative process and will likely change President Biden’s proposals, perhaps significantly.  The US Treasury will seek to influence this process and the outcome in a way that maximizes their policy positions and the narrative they have offered at the G7 and G20 events.

It has recently emerged that if GILTI is to be recognised as a qualifying minimum tax regime for the global consensus, thereby automatically preventing other countries imposing top-up tax on the controlled entities of US groups, the US must change to GILTI being tested on a jurisdiction by jurisdiction basis rather than a rate blended across multiple jurisdictions. The administration also proposes to adjust its rules for denying deductions for base eroding payments (BEAT) to a revised model (SHIELD) which with other adjustments, if voted through, will more closely mirror the global equivalent proposal than BEAT.

There are two additional fundamental stipulations by the US Treasury in relation to the global deal. Firstly, the need for a mechanism for considering disputes under the new rules that allows for a mandatory and speedy resolution. Secondly, the repeal or rollback of existing unilateral measures with similar objectives adopted by other countries and agreement not to introduce new ones. The office of the US Trade Representative has already determined (‘section 301 investigations’) the discriminatory nature of various countries’ DSTs but held off imposing tariffs or further trade sanctions pending such agreement.

The EU and UK positions

The Cooperation Agreement between the EU and the UK following Brexit tries to ensure a degree of alignment on various matters going forward, including some tax affairs. However, they have different views on parts of the digital services tax debate and this can be seen in their contributions in striving for global consensus and in their own domestic tax plans.

The European Commission released a “Communication on Business Taxation for the 21st Century” on 18 May 2021, setting out its long-term vision and short-term legislative agenda. In the Commission’s words:

“the EU needs a robust, efficient and fair tax framework that meets public financing needs, while also supporting the recovery and the green and digital transition by creating an environment conducive to fair, sustainable and job rich growth and investment”.

One proposal is a single corporate tax rulebook for the EU (BEFIT). The mechanics of BEFIT involve consolidating the profits of a group’s EU members into a single tax base, allocating that tax base to the Member States using an appropriate formula, and taxing the allocated profits at the national corporate income tax rate. The considerations regarding profit allocations are expected to reflect those that have arisen in the Pillar 1 profit allocation discussions. Apportionment factors to consider will include sales in the market, assets (including intangibles) and people in a location. The allocation keys for both Pillar 1 and BEFIT profits are likely to be different and it is not yet clear how such differences may be reconciled.

The Commission has also announced details of new ‘own resources’ (separate to contributions made by Member States), which will raise revenues to pay down debt post-COVID and fund the EU’s Next Generation plan. One such resource is to be an EU digital levy which it claims will sit outside of the Pillar 1 frame of reference and ‘coexist’ with it. The design features are set to be announced shortly after the mid-October consensus document and the precise framing of any agreement on unilateral measures. However, EU Member States would likely eliminate their own DSTs.

The UK’s consistent approach to the digital services conundrum has always been that the existing corporate income tax system does not tax the value created by arrangements that can be categorised as search engine, social media or online marketplace activities. That has been evident also in the UK’s DST and its arguments put to the OECD and the Inclusive Framework. HMRC will be looking closely at those groups which have been on its radar already, even under new Pillar 1 rules. There will be few UK headquartered groups affected by Pillar 1, but if you have a UK subsidiary with a low return but significant presence in a market jurisdiction more profit could be allocated to the UK. Conversely, the rules may argue for an allocation of profit away from the UK if there is a high performing UK subsidiary with lower profile market investments.

The UK has been seeking views on the potential viability of an online sales tax, the details of which would likely be very different from the EU’s digital levy. It is described more as a tax to level the playing field with bricks and mortar businesses which currently pay considerably more in property taxes. An online sales tax would also have to satisfy any agreed global requirement on unilateral measures but the similarity in objectives here would seem to be much reduced.

The UK accepts that Pillar 2 is part of a package and has already been setting up a consultation for how best to implement the requirements that will be announced. The larger EU member states like Germany, France, Spain and Italy are more comfortable with Pillar 2 than some of the smaller ones that have lower corporate tax rates, like Ireland, Hungary, and Estonia (whose tax system does not tax retained earnings) – arguments about the level of the minimum tax will go down to the wire. It may require a Directive if there is to be consistent application across the bloc, if that is what the EU decides given that Pillar 2 may well be stated as a best practice (other countries will pick up the top-up tax).

What the future brings

We expect an agreement to be announced with a huge fanfare in October. There will likely be statements on a wide range of issues for Pillar 2 but rather less detail for Pillar 1. Some technical issues will be left to resolve over the coming months. The EU will progress its digital levy and other countries will look at opportunities in relation to revenues to support their COVID recoveries.

The likely changes to the international tax rules seem destined to be incredibly complex and potentially burdensome and the practical impact on businesses will require detailed modelling and scenario planning. And it cannot be overstated how complex the new rules under Pillar 1 and Pillar 2 are likely to be.  Some countries may be inclined to raise their corporate tax rates to ensure they get the revenues that would otherwise go to others that would apply top-up taxes. While the level of carve-out for substance and existing incentives remains unclear, countries may be looking to facilitate foreign direct investment through other forms of relief outside the tax sphere. Businesses will need to consider the nature of their value chains and whether to relocate elements as well as looking differently at the after-tax return on deals and potential investments.

Many more tax disputes are likely to arise in future. This seems inevitable with any new system and it is hoped that any in-built resolution procedures and panels for Pillar 1 work in the manner foreseen. But where there will be winners and losers following the changes in terms of tax authorities collecting tax revenues for their jurisdictions, one might expect queries to be raised. Businesses having to apply new rules and interpretations may also be the cause of test cases. The threat of trade wars between countries over unilateral measures, or the resolution of disputes to prevent them, also looms large.


  • Phil Greenfield, PwC | +44 7973 414521

Stay tuned for more on this series! We hope you enjoy these Thought-Leadership pieces written by PricewaterhouseCoopers – a member of the EACCNY.