Is Europe going the wrong way on taxing tech?

THE European Commission on Tuesday tentatively opened the door to a plan by 10 member states, including Germany, France, Italy and Spain, to hit multinational tech companies with a turnover tax to compensate for their avoidance schemes. A new proposal presented by European Commission vice-president Valdis Dombrovskis allows for such stop-gap measures while it works with members states on a better, more permanent solution. It’s a mistake: A bad tax is a bad tax, temporary or permanent.

According to the Commission, “domestic digitalised business models are subject to an effective tax rate of only 9%, less than half compared to traditional business models.” It’s harder to tax a firm that has fewer tangible assets. That difficulty increases with cross-border business models that allow companies to move intangible assets, such as intellectual property, to places where tax rates are low or nonexistent. WalMart has paid 46 times as much to governments as Amazon since 2008. Google, Amazon, Apple – all the US household names in tech – pay very little tax in the European Union (EU).

The EU’s preferred approach is two-fold. First, it wants to change transfer pricing rules. Now, a company can pretty much pay its entire profits to a Caribbean shell company holding its intellectual property rights. Why? Because current rules demand that these deals are compared with equivalent market transactions – and comparing apples to apples is exceedingly difficult in the realm of intellectual property. That can be fixed by introducing rules against that specific type of transfer pricing abuse.

Second, the commission wants to redesign “permanent establishment” rules that allow companies to choose where to pay their taxes. The Organisation for Economic Cooperation and Development has suggested several possible approaches to determining how heavy a digital platform’s presence is in a specific country, for example, assigning profit to different markets according to revenue made in them, the number of platform users, even the volume of data harvested from these users. The EU approach is to allocate profits to a country according to the firm’s number of employees, assets and sales.

It sounds relatively uncomplicated – but the trouble is that such rules would work only if everyone – ideally, every country in the world – adopted them. Otherwise the tech firms would just use the jurisdictions that don’t. That’s what the G20 group of the world’s biggest economies is pushing, but it faces too much resistance from smaller countries which defend their right to tax competition.

Even within the EU, adopting uniform rules is not an easy proposition: Taxation is one area in which European nations jealously guard their sovereignty, and countries such as Ireland and Luxembourg depend on keeping their tax regimes soft.

That’s why the 10 nations came up with the proposal that tech companies be taxed directly on their revenue rather than profit. It’s something India has been doing since last year, and it’s probably a terrible idea. A turnover tax is easy to pass on to customers, and the dominant tech platforms – such as Google and Facebook in advertising, for example – will do just that. Advertisers aren’t likely to abandon them for traditional media if they raise their prices by, say, 6% – the rate of the turnover tax in India.

It’s highly likely that the top European economies’ finance ministers, who signed the proposal, understand this. The European Commission, too, is aware of the problems of taxing near-monopolies on turnover. But Thursday’s communication still entertains three quick-fix options: The “equalisation tax” proposed by the 10 nations, a withholding tax on digital transactions (which the city of Buenos Aires tried in 2014 and then suspended because payment processors weren’t equipped to withhold the tax; Colombia is now about to try it from next year) and a special levy on digital advertising, also turnover-based.

“All short-term options have pros and cons,” the communication says. “Yet something has to be done.” As he presented the communication, Dombrovskis pointed out that the tech companies keep growing faster than the rest of the economy. That means their tax schemes cover an increasing share of corporate profits – just as these companies account for an ever greater share of market capitalisation.

The Commission stresses that any solution, even a temporary one, should be adopted at least on the EU level, until the G20 spreads it wider. Essentially, it’s endorsing the 10 nations’ proposal as the only one that has serious backing today. But the endorsement doesn’t make the proposal more sensible. A turnover tax doesn’t require universal consensus.

The 10 countries – including Europe's digital markets – can just introduce it on their own. It’s the more complex, more effective and fairer measures that need everyone to come on board.

The regulators’ sense of urgency is understandable. But the EU is missing a chance to tell member states that it’s more important to tackle the tech tax problem right than to do it quickly. Bad provisional solutions have a tendency to stick around and get in the way of better ones.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. — Bloomberg