China needs to take on a more active role in the application of taxes to the digital economy in order to avoid a potential "new tariff war," forewarned Zhou Xiaochuan, the nation's former central banker. The remarks, made during a news conference at the Boao Forum for Asia Annual Conference in Hainan Province on April 21, came in response to a new U.S. government proposal that could allow major economies to agree on uniform tax rules for digital firms.
According to Zhou, former Governor of the People's Bank of China, China has not yet paid enough attention to the issue of taxation on digital goods and services, which have become an important item on the international agenda.
Back and forth
The Digital Services Tax (DST) is a tax on selected gross revenue streams of large digital companies. Operating under a Group of 20 (G20) mandate, the Organization for Economic Cooperation and Development (OECD) is directing efforts for an international solution. The group suggested Pillar One and Pillar Two, basically a set of proposals toward reaching a multilateral, consensus-based solution to the tax challenges arising from the digitalization of the economy.
In October 2019, the OECD Secretariat released its proposal for a "unified approach" under Pillar One. It introduced a revised profit allocation rule applicable to all multinationals that are "in scope" with potential carve-outs for selected industries.
However, each of the OECD's proposals comes with its own complexities, in turn possibly affecting their interaction with one another.
Advocates of a global DST framework argue that multinational corporations should not have permission to extract massive, tax-free profits from countries with heavy digital consumption. At the same time, the creation of a multilateral framework has repeatedly run into roadblocks amid a globally intensifying sense of protectionism and unilateralism.
In the past three years, more than 20 countries have sought to go it alone with DSTs. About half of all European OECD countries have thus far announced, proposed, or implemented a DST.
Amid concerns that a unilateral tax will fall disproportionately onto the shoulders of U.S. tech and Internet bastions, then U.S. Treasury Secretary Steven Mnuchin laid out the U.S. point of view in September 2018, saying "tax should be based on income, not sales, and should not single out a specific industry for taxation under a different standard."
Because these taxes mainly impact U.S. companies and are thus perceived as discriminatory, the U.S. has responded with retaliatory threats. The Donald Trump administration withdrew from the Pillar One discussions in 2019, and launched investigations into various DSTs under Section 301 of the Trade Act of 1974, targeting 10 trading partners, including the EU, the UK, Spain, and Austria, in 2020.
The stalemate between the U.S. and the EU loosened as Joe Biden claimed the U.S. presidency in January. In February, Janet Yellen, U.S. Treasury Secretary, announced during a G20 meeting the withdrawal of a safe harbor proposal for digital companies, which first come to light in December 2019.
This move was hailed by German and French finance ministers as a breakthrough for a global DST framework. This partly fulfilled the two-pillar global taxation scheme pushed by the OECD, which involves taxing digital giants where they make their profits even if they do not have a physical presence within that jurisdiction.
In early April, Yellen urged for the adoption of a minimum global corporate income tax, citing a "30-year race to the bottom" in which countries have slashed corporate tax rates to attract multinational businesses. She stressed that competitiveness is about ensuring governments have stable tax systems and revenue to "invest in essential public goods."
After a meeting of G20 finance ministers and central bank governors earlier this April, Italian Finance Minister Daniele Franco said during a virtual news briefing that the bloc was "committed to reaching an agreement, and hopefully we can expect it to take place in July."
Franco confirmed the discussions homed in on the two pillars of global international taxation: The fair allocation of profits among different countries where multinationals operate, and the global minimum effective tax rate.
Concerns for China
According to data from the Chinese Academy of Cyberspace Studies, China's digital economy reached 35.8 trillion yuan ($5.45 trillion) in 2019, ranking second in the world and accounting for more than 30 percent of the GDP.
Qiushi, a flagship magazine of the Communist Party of China Central Committee, published an article on November 1, 2020, entitled Some Major Issues in the National Medium- and Long-Term Economic and Social Development Strategy. It mentioned the necessity for China to actively participate in the formulation of international rules, including those addressing the topics of digital currency and digital tax, to shape new competitive advantages.
China's taxation system already covers the digital sector, according to Zhou, as companies need to pay value-added and corporate income taxes. However, the country has not yet paid enough attention to the perspective of cross-border taxation.
Zhou pointed out that the major Internet service platforms operating in China are mainly developed by domestic firms, so that China does not face the same taxation challenges as nations in Europe, where U.S. tech giants seek to house their operations in low-tax EU countries.
"China's study on DSTs should demonstrate a global vision and falls in line with the needs of a community with a shared future for all," Zhou said.
While acknowledging that protectionist sentiments or tariff wars are not escalating or becoming increasingly tense as they have been in the past several years, Zhou warned about the possibility of a new tariff war over the DST issue.
"If it does occur, it will be very likely that most countries will respond by displaying protectionism. That is why we need to study the digital taxation issue," he added.
Zhou suggested countries avoid fighting each other over the digital tax issue, especially about where the money came from and whom it belongs to.
Fan Zhixia, a researcher with the China Academy of Fiscal Sciences, told China Youth Daily that, as a big player in the digital economy, China should study related taxation challenges, as well as formulate targeted policies.
Nevertheless, a systematic assessment of the two-pillar international tax reform program's actual impact on China and its enterprises is of the utmost importance.
One main concern is that the minimum corporate tax concept could bear potential risks for Hong Kong, since one of the key advantages for a business to establish itself in the region is its low tax burden. Forcing Hong Kong to raise its level of corporate taxes could subsequently reduce its appeal.
On the short term, the reform has basically managed to establish a structure, but many details remain up for discussion, Fan said.
(Print Edition Title: Taxing the Digits)
Copyedited by Elsbeth van Paridon
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