What’s Behind USTR’s New Digital Services Tax Investigation?

June 19, 2020

With the increased digitalization of the global economy, foreign countries have started proposing and implementing taxes on digital services. A digital services tax (DST) is a tax on revenues companies generate from providing certain digital services to, or aimed at, users in those jurisdictions. Digital services include online advertising, data transfer services, and online marketplaces. Although there are differences among digital services taxes, most include domestic and global revenue thresholds that must be met for the tax to apply to a company. The Trump administration and U.S. technology companies claim that many DST proposals are designed to punish U.S. companies. The current tax system’s reliance on territorial connection fails to adequately capture the rise of digital services, which companies can distribute to customers in countries in which they have no presence. Instead, DSTs aim to capture the so-called digital presence of companies. This dynamic has driven countries to unilaterally establish digital services taxes.

On June 2, 2020, the Office of the United States Trade Representative (USTR) announced Section 301 investigations into taxes on digital services adopted or proposed by Austria, Brazil, the Czech Republic, the European Union, India, Indonesia, Italy, Spain, Turkey, and the United Kingdom. This is not USTR’s first Section 301 investigation into digital services taxes, but it is its broadest.

Q1: What is a Section 301 investigation?

A1: Section 301 of the Trade Act of 1974 provides statutory authority to address unfair foreign trade practices. Section 301 procedures apply to foreign acts, policies, and practices that USTR may consider to either violate a trade agreement or are unjustifiable, burdensome, or restrictive to U.S. commerce. Section 301 requires the United States to, upon initiation of an investigation, request consultations with the government—or in this case governments—subject to the investigation. Following consultations, USTR will determine if the conduct in question is unfair or breaches trade agreements. USTR has 12 months to determine whether the act is unfair in cases that do not involve trade agreements and 30 days in cases that do. At the conclusion of the investigation, any retaliatory action determined necessary by USTR must be implemented within 30 days unless the action is modified by a postponement under Section 307 of the Trade Act. Throughout the investigation, USTR may pursue a negotiated settlement with the foreign country in order to eliminate the trade barrier or practice, or to receive compensation. During this process, USTR will meet with an interagency Section 301 committee and solicit comments from outside parties on proposed action after the investigation is completed.

The Trump administration has used Section 301 in three previous instances: to investigate Chinese practices related to intellectual property, EU subsidies for large civil aircrafts, and France’s DST. (The Section 301 investigation into the European Union differed slightly from the others as it was initiated to confirm the World Trade Organization’s (WTO) decision regarding the European Union’s breach of WTO obligations by providing subsidies to Airbus, determine the level of retaliation available to the United States, and receive input on which EU products should be subject to tariffs as a result.)

Q2: What are the administration’s concerns with DSTs?

A2: In July 2019, USTR initiated a Section 301 investigation into France’s DST after the French Senate approved a 3 percent levy on revenue from digital services earned in France by companies with more than 25 million euros in French revenue and 750 million euros worldwide. USTR found that the tax was inconsistent with prevailing international tax principles on account of its unprecedented retroactivity, its application to revenue rather than income, and its extraterritorial application. The revenue thresholds of more than 25 million euros in French revenue and 750 million euros worldwide also seem to largely apply to U.S.-based companies. In addition, under the international tax system, foreign companies should not become subject to a country’s tax regime without a territorial connection. Yet, the French DST uses the location of a website viewing to determine if the tax applies, rather than the location of the company or the service generating the revenue. These findings led to great concern from the Trump administration that France, along with other countries, is targeting U.S. companies like Google, Apple, Facebook, and Amazon by framing their tax policies around services like targeted advertising, and is choosing to tax revenue streams where U.S. companies are most dominant.

Q3: What options does the administration have to respond to DSTs?

A3: The administration has four options: reach negotiated solutions with countries under investigation, impose tariffs or other forms of retaliation on countries subject to the Section 301 investigations, pursue negotiations for a global digital tax framework, or do nothing.

Section 301 investigations are intended to result in negotiated settlements between the United States and the foreign countries under investigation. The statute provides the administration 12 months—the length of the investigation period—to reach a negotiated solution. If a resolution is not found, USTR may decide to retaliate through the imposition of tariffs on selected imports at a level equal to the estimated economic losses incurred by U.S. companies from the foreign trade practice subject to investigation.

After a conclusion was reached on the Section 301 investigation into France’s DST in December, USTR released a Federal Register notice seeking comments from the public on its proposed plan of action of imposing tariffs on French imports and fees or restrictions on French services. The Section 301 committee held a hearing on January 7, 2020, regarding the administration’s proposed action, which included the imposition of tariffs of up to 100 percent on French products like wine, cheese, and handbags.

However, the administration opted not to impose tariffs after Treasury Secretary Steven Mnuchin and French finance minister Bruno Le Maire reached an agreement in January to pursue a negotiated solution through the Organisation for Economic Co-operation and Development (OECD). As a result, France suspended its DST until the end of the year.

Q4: Why did the administration initiate a new investigation into DSTs?

A4: In short, the administration may be seeking leverage in the negotiations for a global DST framework, and it may be firing a shot across the bow of governments considering DSTs. The initiation of a Section 301 investigation into countries like Austria, Brazil, and the Czech Republic for their proposed DSTs on June 2, 2020, follows an announcement by the French government on May 14, 2020, that France will impose its DST this year, regardless of its January agreement with the United States and ongoing OECD negotiations. Le Maire stated that, “France will apply as it has always indicated a tax on digital giants in 2020 either in an international form if there is a deal or in a national form if there is no deal.” France’s decision to follow through with its DST is rooted in a desire to reboot the French economy. DSTs have become of increasing interest to many countries, especially as Covid-19 lockdowns have led to greater pressure on governments to raise revenue. Le Maire later blamed the United States for holding up an agreement at the OECD.

United States Trade Representative Robert Lighthizer responded during a testimony before the House Ways and Means Committee on June 17, warning that a decision by France or any other country to implement a DST may result in the imposition of retaliatory tariffs.

“The United States will put in place, although it is up to the President, tariffs against these countries if they move forward unilaterally discriminating against American companies.” — Robert Lightizer, responding to a question on DSTs during a House Ways and Means Committee Hearing on June 17.

Further complicating the issue is the United States’s decision to pull out of the OECD negotiations. On June 12, Mnuchin wrote to France, Italy, Spain, and the UK’s finance ministers that the United States was withdrawing from the ongoing negotiations for a new global tax framework. According to Mnuchin, the United States had determined that the negotiations have reached an impasse and that negotiations were headed in a direction that would establish a framework which would target U.S. digital companies. Lighthizer confirmed the U.S. withdrawal from the negotiations the same day.

The United States could let pressure build by staying out of the talks and pursuing its new, sweeping Section 301 investigation only to come back to the OECD negotiating table later. Alternatively, it could pursue individual negotiated solutions, armed with the threat of Section 301 tariffs. Each path carries economic risks, and the cost of failure could be the proliferation of trade wars and digital taxes targeted at U.S. companies.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jack Caporal is an associate fellow with the CSIS Scholl Chair in International Business. Carlota Martinez-Don is an intern with the CSIS Scholl Chair in International Business.

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