Digital services taxes: The new government revenue stream

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  Quantumrun Foresight
• December 6, 2024

Insight summary

Digital services taxes (DSTs) are becoming a tension-filled topic as governments look for ways to tax multinational companies profiting from users across borders. These taxes could raise consumer prices and influence businesses to change how and where they operate. Meanwhile, governments may face new revenue opportunities and potential trade disputes as they navigate these international tax agreements.

Digital services taxes context

DSTs have become a key point of debate in global tax policy as countries grapple with how to fairly tax multinational companies operating in the digital economy. Historically, corporate income taxes have been applied where a company’s physical presence is located, but with digital businesses getting significant profits from users across borders, this model is seen as outdated. DSTs are designed to address this gap by taxing large digital companies based on their revenues in the countries where users are located, regardless of the company's physical presence. 

For example, France, Hungary, and Spain have implemented DSTs on revenues from online advertising and data transmission activities. As digital platforms grow more integral to global commerce, DSTs are increasingly viewed as necessary. However, they remain controversial, particularly among nations like the US that see these taxes as discriminatory against their tech giants.

In response to these concerns, international organizations like the Organization for Economic Co-operation and Development (OECD) have initiated negotiations to establish a more unified global tax framework. Pillar One of the OECD's international tax agreements seeks to replace DSTs with a system that allocates a portion of multinational companies' profits to the countries where their consumers are based rather than where the businesses are headquartered. This shift aims to reduce the likelihood of double taxation, a common criticism of DSTs, particularly from the US. However, the implementation of Pillar One has faced delays, with the OECD missing its March 2024 deadline. The new implementation target date is January 2025.

Disruptive impact

As companies operating under DSTs may pass on these taxes to consumers, subscription fees for streaming platforms or cloud services could increase. Additionally, users in regions implementing DSTs may see fewer services being offered or with reduced features as companies try to minimize their tax exposure. For example, specific digital businesses could prioritize regions without DSTs, limiting the availability of certain technologies in areas with higher tax burdens. Overall, individuals may need to adjust their digital consumption habits or pay higher fees for the same services.

For companies, DSTs introduce new complexities in financial planning and operations, which could affect their long-term strategies. As digital companies are taxed based on their users' location, businesses may rethink their market expansion strategies, prioritizing countries with more favorable tax policies. Furthermore, companies may invest in tax-efficient technologies like artificial intelligence for customer service to reduce labor costs in high-DST markets. In addition, businesses may need to adopt more sophisticated tax compliance tools to manage these growing international obligations.

Meanwhile, governments may experience mixed outcomes as they navigate the implications of DSTs. DSTs offer a new revenue stream that can help governments fund public services or digital infrastructure projects. However, the increased friction with some countries could lead to diplomatic or trade disputes, requiring careful negotiation to avoid economic conflicts. Moreover, governments implementing DSTs may need to invest in more advanced tax collection systems to manage these digital revenues efficiently. Local governments might face pressure to harmonize their tax systems with international agreements like the OECD's Pillar One, balancing national interests with global economic cooperation. 

Implications of digital services taxes

Wider implications of DSTs may include: 

• Governments creating new regulatory frameworks to manage digital tax collection efficiently, promoting transparency and reducing tax evasion.
• Smaller tech startups facing greater difficulty competing in taxed markets, leading to potential consolidation in the digital industry.
• Governments reallocating tax revenue from DSTs into digital infrastructure projects, improving connectivity in underserved areas.
• Tech companies shifting their labor forces to regions with lower tax burdens, changing global job distribution in the digital sector.
• Multinational corporations revising their global expansion plans to avoid high-tax jurisdictions, influencing global market dynamics.
• Some countries becoming digital service hubs by avoiding DSTs, attracting foreign investment and boosting local economies.
• Increased pressure on global organizations like the OECD to streamline international tax agreements, fostering global economic cooperation.

Questions to consider

• How might rising costs from digital services taxes influence your everyday use of online platforms and services?
• How could governments use DSTs revenue to improve digital infrastructure in your community?