Digital Services Tax

Apr 1, 2025

Insight: Current State and Geopolitical Pressures

The digital services tax (DST) has become a focal point in the global effort to adapt international tax rules to the realities of the digital economy. As digital transactions grow, countries face challenges in taxing multinational enterprises (MNEs) that operate with minimal physical presence. This has led to unilateral measures, international negotiations, and geopolitical tensions.

Current State of Digital Services Taxes

Many countries have implemented or proposed their own DSTs to address the taxation challenges posed by the digital economy. Notable examples include:

France: Implemented a 3% DST on digital advertising, intermediation platforms, and user data sales, targeting companies with significant global and national revenues (large technology companies).
United Kingdom: Implemented a 2% DST on certain digital revenues from April 2020.
India: Implemented an "equalization levy" as a form of DST, applying a 6% withholding tax on specified services.
Italy: Implemented a 3% DST on certain digital revenues from fiscal year 2022.
Mexico: Implemented VAT obligations for foreign digital platforms providing services within its territory from June 2020.
Canada: Implemented a 3% DST to be effective for 2024. It is also to be applied retroactively to revenue earned since 2022. The first DST liability payment is set to come due as early as June 2025.
Austria: Implemented a 5% DT from January 1, 2020.
Other countries: Poland, Spain, Czech Republic, Turkey, among others are considering similar measures of their own.

DSTs typically apply to the gross revenue of large digital/technology companies earning over $750 million. Some countries, however, impose lower thresholds or additional conditions. DST is not typically a tax that is eligible for the U.S. foreign tax credit.

Geopolitical Pressures

On March 31, 2025, the U.S. Trade Representative released the 2025 National Trade Estimate Report on Foreign Trade Barriers (the “Report”), in which it evaluated 60 foreign countries. The largest trading partners with the United States.

The Report highlighted practices that the United States deems to be discriminatory towards U.S. companies, create competitive disadvantage or imbalance. Among these are barriers to:

U.S. investments in the foreign country,
Insufficient policies and actions to protect intellectual property rights,
Cumbersome policies, process, delays and lack of transparency in obtaining regulatory approvals for various industries, including agriculture, biotechnology, renewable energy, wine, e-commerce, and professional services, among others.
Perceived corruption and lack of transparency in procurement practices and selection process,
Custom barriers
Tariffs,
Discriminatory taxes, at the forefront of which are DST, VAT, the OECD initiative under Pillar One and Pillar Two.

The unilateral implementation of DSTs by several countries has led to geopolitical tensions, particularly with the United States, as these taxes often disproportionately affect U.S.-based tech giants. The U.S. has responded by investigating and threatening retaliatory tariffs, arguing that DSTs unfairly target American companies.

OECD – Two Pillar Approach

The OECD and G20 have been working on a coordinated international approach through the Base Erosion and Profit Shifting (BEPS) project. The OECD's two-pillar solution aims to:

Pillar One: Reallocate taxing rights to market jurisdictions, allowing countries to tax a portion of the residual profits of MNEs.
Pillar Two: Establish a global minimum tax to prevent profit shifting to low-tax jurisdictions.

In July 2023, the OECD/G20 Inclusive Framework released a statement on this two-pillar solution, aiming to prevent the proliferation of DSTs and enhance international tax stability.

As of today, many countries have adopted Pillar Two measures, with adoption to taxing extraterritorial profits via an under-taxed profits (UTPR) regime being deferred. However, the United States, through an executive order issued on January 20, 2025, affirmatively directed Treasury to inform that OECD that any commitments made by the Biden Administration regarding Pillar One and Pillar Two are non-binding without congressional approval.

Challenges and Future Outlook

The success of these international efforts depends on the willingness of countries to compromise and align their tax policies with proposed international standards.

Available measures at U.S. disposal: Section 891

The unilateral implementation of DSTs poses a risk of international tax disputes and trade tensions as we are seeing in current time with retaliatory tariffs and the willingness of the Trump Administration to invoke other measures necessary and available in the U.S. tax code, such as Section 891.

IRC Section 891 allows the President to double U.S. taxes on corporations and citizens of foreign countries that target American companies with discriminatory taxes. The code section was enacted in 1934 and remains unused. President Trump, through an executive order issued on February 21, 2025, mandated its agencies to consider it as a tool in evaluating retaliatory measures against practices by foreign countries that impose undue burdens on American companies.

A unified approach - a challenge

While many countries have implemented unilateral digital services taxes, there is a concerted effort at the international level to create a unified approach to taxing the digital economy.

India recently proposed eliminating its equalization levy to ease tensions with the United States. It remains to be seen how other countries will react to the tensions, and extent of changes to come.

More importantly, it remains to be seen what measures the United States will introduce in response to the Report's findings. We await announcement by the Trump Administration as early as April 2, 2025.

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Disclaimer:

The contents of this insight are intended for general information only. illumina CPA Group, Inc. is not, by means of this communication, rendering professional advice or services. Before making any decisions or taking any action that may affect your finances or your business, you should consult a qualified professional adviser.