The makings of a trade war

Mar 20, 2018

Sunday Business Post, 18 March 2018

Say you go into a shop to buy a garment.  There is no assistant around, so you search the racks yourself, find your size, make sure it fits and then bring it to the checkout.  The price tag says €19.95.  But you point out to the till operator that you had to do all the work making the purchase so instead of paying €19.95 you want to pay just €19.

I'm not sure how well that argument would go down in most shops.  Yet on a grander scale that is the gist of forthcoming and much leaked EU proposals for taxing digital businesses.  When a customer engages with a company online, the EU is suggesting that some types of company be subject to a corporation tax levy of up to 5%.  Their argument is that in an online world, the customer does quite a bit of work, and therefore in some way creates value.  That value should be taxable where the customer puts in the effort, rather than where the company is located.

Diamonds are the taxman’s best friend

For as long as companies have been taxable, the principle has been that they pay their tax where value is created.  Countries lay claim to their share of tax on company profits based on rules which are over a century old, derived from a situation which bears little resemblance to modern commercial arrangements.  In a landmark case heard in 1906, the profits which the DeBeers mining company made from selling diamonds mined in South Africa were considered properly taxable in London, where the company HQ was based.  The reasoning was that the “real business” happened on the sale of diamonds, not at the time of their mining.  If the diamonds were sold in London, then that's where the value was created, and the tax on the profits should go to the British Exchequer.

The modern-day translation of the ruling is that companies are usually taxed where the boards of directors meet and their sales are booked – where the "real business" takes place.  But this is 2018, not 1906.  In the online age the question is where does the "virtual business" take place? 

Roll forward 112 years to this week and to the views of the Chancellor of the same British Exchequer which pocketed the DeBeers tax.  Philip Hammond seems to be siding with the Europeans.  The UK position (published last Tuesday) suggests that the amount of time a UK consumer might spend online tapping details into the corporate website of the US supplier has value.  That value should be taxed in the UK where the consumer is based.  Which is more or less what the EU is saying.

Threat to Irish jobs

Before anyone starts cheering too loudly that the thorny problem of corporation tax avoidance by multinationals has finally been solved, let me point out that these policies are more about where tax is paid, rather than how much the multinationals pay overall.  The proposal document itself describes the revenue raising potential as “rather limited”.  There are also two major snags to these plans.  The first problem is that whenever a government creates a levy calculated on a sale price, it is the end customer that tends to end up having to pay it.  This kind of corporation tax levy based on sales will most likely end up as some form of excise duty or other premium paid by consumers.  It’s the same as what happens when excise duty on alcohol or fuel is increased.

The second snag, if anything, is more serious.  The leaked EU proposals propose that the levy would only apply to companies with a worldwide turnover of €750 million or more with very specific business models relying on the value of user data or the creation of digital marketplaces.  Because of the size and trading conditions of such businesses it's impossible to conclude that the new EU proposals are primarily targeted at anything other than US multinationals operating in Europe – the likes of Google, Facebook and Airbnb.  That is trade war territory.  Despite the EU contention that these would be interim, short-term measures, I can’t see how these EU proposals differ in philosophy to the new US tariffs on metal imports.  Short-term tax measures have a habit of becoming long term and un-shiftable.

Both of these snags pose serious problems for Ireland.  We are a tiny market making up only 1% of the EU population.  The full implementation of the EU proposals would mean the shifting of tax on corporate profits from countries in small markets to countries with large markets.  The EU focus on US multinationals will be a direct threat to Irish jobs in those companies which have a significant footprint in this country.

Tax Shifting

The EU policy initiative is not about collecting more tax from multinationals, but rather shifting where tax is paid.  Make no mistake – if the Googles of the world had chosen Paris for the corporate headquarters instead of Dublin, these proposals would never have seen the light of day.  Neither is it helpful to the Irish cause that the UK is now beginning to make similar noises to the EU about the rationale for taxing multinationals.  With Brexit looming, the UK government is looking for tax revenue wherever it can get it. 

Of all the corporate tax proposals for multinationals that have been put on the table in the last 20 years, this is the one which could have the most direct impact on the average Irish consumer because it could have direct impact on the price they pay for some online services.  There are alternatives being worked out by the OECD, alternatives which might better recognise value creation than the century old rules we currently work with.  

We have yet to see the shape of those OECD proposals which are due within the next few weeks.  They have to be better than the current EU notions which could lead to a trade war, in which Ireland would be among the first of the casualties. 

Brian Keegan is Director of Public Policy and Taxation at Chartered Accountants Ireland