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Commercial Question

A taxing problem – the challenges of a digital economy

updated on 05 January 2021


How should multinational technology companies be taxed fairly and effectively in a digital economy?


Rapid digitalisation of the economy has resulted in businesses being able to engage and interact with online users and generate profit without having a traditional taxable presence in the market. These businesses – mainly large multinational groups in digital-oriented and intangible-intensive sectors – have been the subject of ongoing discussions at the Organisation for Economic Cooperation and Development (OECD), EU and UK levels as to whether and how to ensure fair and effective taxation of big technology companies. France has recently introduced – and the UK has announced – a Digital Services Tax (DST).

This article gives a background to the various national and supra-national proposals for DSTs, provides detail on the proposed UK DST legislation, and discusses the broader economic and political impact of the new taxes. 

Background to the DST

Broadly, under current international tax rules, a non-resident company is subject to tax on its business profits in a particular jurisdiction only if has a “permanent establishment” there, which entails some form of physical presence. With digitalisation, digital and consumer-facing businesses are able to generate significant value from interacting with users remotely and can easily carry out activities such as data collection and exploitation, marketing and branding, all while having no physical presence in the market. As a result, there is a potential disconnect between where profits are generated and where those profits are taxed.

Addressing the tax challenges raised by digitalisation is a priority for the OECD/G20 Inclusive Framework on the Base Erosion Profit Shifting (BEPS) project, but thus far no international consensus has been reached. One key issue is that it is difficult, if not impossible, to ring-fence the digital economy; as the OECD’s digital tax report aptly pointed out, “the digital economy is increasingly becoming the economy itself”.

Another challenge is identifying an appropriate tax base and the location of value creation. To take an example: if a British person films a cat video whilst on holiday in France and uploads it onto a US video sharing site, which is then viewed by someone in Germany, who whilst watching sees an online advertisement for a hotel in the Caribbean – what exactly should we be taxing, and where? This example contains multiple jurisdictions and multiple potential sources of value creation (eg, user data collection and exploitation, advertising revenues and so on), and is exactly the type of scenario that lawmakers have been grappling with.

The current status of OECD discussions

In October 2019, the OECD Secretariat published its proposal for a “unified approach” under pillar one of its BEPS project. The proposal grants taxing rights to market jurisdictions through new nexus rules which would ensure a company is taxable in a territory even where it is not physically present in the market, as well as revised profit allocation rules that would seek to reallocate to market jurisdictions a share of deemed residual profit of multinationals using a formula. The OECD has invited public input on the proposal and aims to reach an international agreement at some point in 2020.

The EU’s proposals

The European Commission is taking a double-pronged approach to the issue. In March 2018, it proposed two directives. The first directive is aimed at the long-term reform of corporate tax rules. It seeks to lay down rules relating to the corporate taxation of a “significant digital presence” (ie, a digital permanent establishment), granting taxing rights on profits that have been generated in a member state even if a company does not have a physical presence there.

The second directive is a short-term, interim measure, which seeks to introduce a DST of 3% which applies to certain digital-source revenues of internet companies with annual global revenues above €750 million, and annual EU revenues in excess of €50 million. An important objective of the second directive is to avoid fragmentation caused by unilateral domestic taxation measures as the wait continues for a more comprehensive solution to be agreed at international level. The EU Commission had originally aimed for these directives to be approved for entry into force on 1 January 2020, however whether this is still a realistic timeline remains to be seen.

French DST

The French Senate in July 2019 approved a 3% DST, which applies retroactively, with effect from 1 January 2019, to revenues from digital services earned in France by groups with revenues in excess of €25 million in France and €750 million worldwide. These thresholds ensure that the tax captures the roughly 30 largest multinational digital platforms, including Google, Apple, Facebook and Amazon, and has hence been dubbed the “GAFA tax”.

This has not been without controversy. In a move widely predicted by critics of DSTs, Amazon responded by passing this cost on to the businesses that use its platform, increasing its seller fees by 3% from 1 October 2019. President Trump has also hit out at the tax, which he claims unfairly targets “our great American technology companies”, and has threatened retaliatory tariffs on French wine and cheese. He also ordered the United States Trade Representative (USTR) to initiate investigations under section 301 of the US Trade Act 1974 into whether the French DST is discriminatory or unreasonably burdensome to US commerce. French President Macron confirmed in August that the situation had been defused: France has agreed to drop its DST upon the conclusion of an international agreement and tech giants that pay the French DST will then be reimbursed.


Whilst the UK is one of the key supporters of the EU’s interim solution, in his 2018 budget Philip Hammond, the then chancellor, announced that the UK could no longer wait for the outcome of “painfully slow” international discussions and would introduce its own national DST. Draft legislation has been published for inclusion in the 2019-20 Finance Bill.

As currently drafted, the UK DST will apply to the revenues of social media platforms, search engines and online marketplaces that derive value from UK users.

Similar to the French iteration, thresholds will apply to target the UK DST so that it is imposed on internet giants (although current UK Prime Minister Johnson, ever a fan of a snappy acronym, refers to “fangs” – Facebook, Amazon, Netflix and Google). For groups to fall within the scope of the UK DST, they must have worldwide digital services revenues of £500 million and £25 million in UK-user-generated digital services revenues.

If these thresholds are met, DST will be charged at a rate of 2% on the total amount of group-wide UK user-generated digital services revenues exceeding £25 million.

The government forecasts that the tax will raise £275 million in its first year of operation (2020-21). This is expected to increase to £440 million by 2023-24.

If passed, the UK DST is expected to enter into effect from April 2020. However, given the current political climate, it is conceivable that the UK DST may not be implemented. Given Trump’s explosive reaction to the French version of the tax, the introduction of the UK DST may not be a good look for a post-Brexit UK that is seeking to reach a trade deal with the US.


Calls for tech companies to pay their “fair share” of tax continue to strengthen and addressing the tax challenges of digitalisation remains an important topic on the international agenda. However, there is continued disagreement as to what action should be taken and how ultimately to translate policy objectives into statute. But as time ticks on, with no consensus at the international level, more and more countries will take matters into their own hands and introduce domestic DSTs. If international organisations do not take action soon, we may soon see a patchwork quilt of domestic legislation across the globe.

Nicole Lim is a trainee solicitor and Alexandra Liu is an associate at Latham & Watkins. They are both members of the tax team.