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France now has the answer to 'big sales, no profits' puzzle of digital giants like Google, Amazon

France has levied a 3% tax on the revenues of 30 digital companies, mostly US-owned.

, ET Bureau|
Updated: Jul 17, 2019, 09.37 AM IST
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Agencies
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Through creating accounting, MNC digital cos can show virtually all their profits in their headquarters in a low-tax countries like Ireland.
France has enacted legislation to tax digital giants like Amazon and Facebook on their revenue, not profits. India — which levies a 6% tax on the ad spends of Google and other tech companies — needs to go the same way, eventually, though not immediately. This is essential to tackle the completely new phenomenon of digital companies that can show massive sales, but no profits, in many countries they serve.

Defying threats from US President Donald Trump about retaliation against a measure that “unfairly targets American companies”, France has levied a 3% tax on the revenues of 30 digital companies, mostly US-owned, with a global turnover of over 750 million euro and a French turnover of over ¤25 million. This will raise a tidy 500 million euro of revenue.

Choking the Trumpet
US Trade Representative Robert Lighthizer has started an investigation to determine whether the French measure unreasonably hits US interests, and, if so, to suggest retaliatory measures. This could take trade war to a new level.

France has declared it is prepared for that. Hopefully, many other countries will join France in a united front, so that Trump will have to declare war on most of the world and not pick off lone wolves.

Traditionally, companies have been taxed on their profits. Calculating profit is a complex affair, affording much scope for creative accounting.

Some experts have long suggested taxing companies on their sales, not profits, to end tax avoidance through creative accounting. However, other experts say this will be unfair to struggling companies that lose money despite having large sales. That is why taxes are almost everywhere levied on profits, not sales.

That system has been disrupted by the new business models of digital giants. Unlike traditional companies, they face no import duties or non-tariff barriers when they enter foreign countries: it is impractical to levy an import tax or sales tax on data. Hence, digital activities have escaped tax.

Digital giants can show virtually no profits in the countries they serve, and show virtually all their profits in their headquarters in a low-tax country like Ireland or Luxembourg.

This can be done by vesting intellectual property rights (IPR) with the company in the tax haven, and arranging to have all other subsidiaries pay high licensing fees for this IPR, thus transferring the bulk of profits to the tax havens. This is a problem for the US. Trump is livid that US companies are salting away their profits abroad and not bringing them back to the country.

But this is also a problem for all countries finding that digital companies have massive activities in their territory that would be taxed substantially if they were traditional sales, but escape altogether because they are digital. This loophole can be plugged by taxing digital companies on revenue, rather than profits. This can be selective, targeting only larger companies, so that small startups are not adversely affected.

To add to the problem, we have the new phenomenon of unicorns, new companies that are enormously valuable and have market capitalisation of billions, yet run at a loss or marginal profit. These companies are well funded by fresh injections of capital and, hence, do not need to generate profits for growth. This means they do not pay taxes despite generating tremendous value for their shareholders. Here again, there is a case for levying a tax on revenue rather than profits.

Cyber Tax for Cyber Cos
But the focus right now is on taxing digital companies. Global talks have been held for years on this issue without coming anywhere near conclusion. The Independent Commission for the Reform of International Corporate Taxation has suggested a global formula for apportioning profits of multinationals across users considering factors like sales, employment and number of digital users.

India, Colombia and Ghana are among the leaders of a similar initiative on behalf of developing countries that also considers the workforce of digital giants in developing countries. India is a hub for digital giants, not just as a consumer but also as a producer.

All digital giants have large workforces in India, helping shape and improve digital programmes. Yet, only a tiny share of company profits is ascribed to the Indian subsidiaries, and so, very little tax revenue accrues to India (via the aforementioned tax on ad spend) despite its crucial role in the overall profitability of the giants. This is an issue over and above that of taxing sales within India.

Ideally, an international agreement should have been reached on this issue long ago. But the interests of all countries are not aligned. Hence, there is pressure for unilateral action. France is the first to act unilaterally. But Britain has also proposed a similar tax on digital companies. British treasury chief Philip Hammond said last autumn, “…the rules have simply not kept pace with changing business models. It’s clearly not sustainable or fair that digital platform businesses can generate substantial value in the UK without paying tax.”

India should not rush to follow the French example. It will make an easy target for US sanctions. Instead, it should join hands with many willing partners to present a united front to the US. Hopefully, this will lead to a negotiated settlement rather than trade war.
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