On October 21, 2021, the United States, Austria, France, Italy, Spain, and the United Kingdom issued a joint statement setting forth a temporary “political compromise” on the application of digital services taxes (DSTs). See the full joint statement here.

From a political and diplomatic standpoint, the joint statement represents a truce. The United States agrees to forego trade actions against the five European countries in exchange for the five countries agreeing to permit companies subject to their DSTs to reduce their expected payments under one of the proposed international tax changes (Pillar One). Pillar One is the global system designed by the OECD/G20 Inclusive Framework that is intended to allocate taxing rights more in line with the new digital economy. The provisions of Pillar One would create taxing rights for so-called market jurisdictions where digitalized multinational companies operate without having a physical presence.

The joint statement is significant, but also quite narrow. This alert describes the background, the terms of the agreement, who benefits, potential EU disruptions, and what we might expect next.

Background

Since the implementation of DSTs, the United States has argued DSTs unfairly target US multinationals. In response, the US Trade Representative (USTR) launched investigations, which concluded that DSTs were in fact discriminatory against US companies. As a result, the USTR proposed 25 percent tariffs on imports, such as French wine and cheese, from select countries who had implemented a DST. The tariffs were set to begin November 29, 2021. An agreement was deemed imperative for all parties in order to avoid a consequential trade war, compounded by the effects of COVID-19.

Agreement

Per the joint statement, the United States agrees to waive their 25 percent retaliatory tariffs on imports from Austria, France, Italy, Spain, and the United Kingdom. In return, the five European countries will grant tax credits to companies with DST liabilities to be used against future tax liabilities arising under Pillar One. The credits can be obtained regardless of whether the levy imposed by the DST has actually been paid, and they can be carried forward to future tax years until fully utilized.

The agreement runs until the earlier of (a) the date on which the Pillar 1 multilateral convention comes into force or (b) December 31, 2023. The crediting mechanism, however, only takes into account DST amounts that have been accrued on or after January 1, 2022. The countries have given themselves some flexibility regarding effective dates by noting, “The parties will meet regularly to discuss progress implementing Pillar 1 and any implications that may have for the appropriate application of the agreement.”

The agreement does not provide relief for DSTs proposed by other European countries, including Hungary, Poland, Turkey, Belgium, Czech Republic, and Slovakia.

Who Benefits

Countries: Austria, France, Italy, Spain, and the United Kingdom will continue to apply their DSTs until required to withdraw them as part of Pillar One implementation.

Companies: The beneficiaries of the joint statement include any company that is (a) subject to a DST imposed by Austria, France, Italy, Spain, or the United Kingdom and (b) large and profitable enough to be subject to Pillar One. These companies will be able to reduce, subject to the limitations of a complex formula, their expected tax liability in Austria, France, Italy, Spain, and the United Kingdom on their “Amount A” (which is the allocated taxable profit in these market jurisdictions under the OECD/G20 Inclusive Framework’s Pillar One) by the portion of DST accrued in that country by way of a tax credit. The joint statement applies to all companies that meet the two criteria, not just American companies. The joint statement does not affect companies that (a) pay DST to jurisdictions other than Austria, France, Italy, Spain, and the United Kingdom or (b) are small enough to not be subject to Pillar One. Also, since the benefit of the joint statement is a reduction in Amount A tax, there is no value to a company if Pillar One is not adopted as planned.

European Union Digital Levy

In September, the European Union announced it will propose a digital levy regardless of whether an agreement under Pillar One is reached. If the EU digital levy moves forward, it is not clear what impact it will have on the four EU countries party to this agreement with the United States. Particularly, the agreement does not address whether an EU digital levy adopted by these four countries in replace of their own unilateral DST will be creditable against future Pillar One tax liabilities or whether the United States will continue to withhold retaliatory tariffs. As it stands, the EU is expected to release an interim proposal by the end of the year.

What’s Next

The joint statement ends trade threats by the United States against Austria, France, Italy, Spain, and the United Kingdom. It is understandably silent as to whether the United States will follow through on its threat to levy trade sanctions against countries with DSTs that are not a party to the agreement. Whether the agreement has any actual benefit to affected companies depends on whether, and how fast, Pillar One is fleshed out and implemented. For companies that do not expect to be subject to Pillar One, the agreement does nothing to speed up the removal of DSTs and other taxes that meet the definition of “unilateral measures;” as only implementation of Pillar One will be able to do that.

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