Addressing Complications in the International Tax Regime Resulting from the Digitalization of the Economy

• Author: Nolan McCarthy
• Pages: 453-476

Addressing Complications in the International

Tax Regime Resulting from the Digitalization

of the Economy

N

OLAN

M

C

C

ARTHY

*

I. Introduction

This paper will address the impact of economic digitalization on the

international tax structure and the imminent need to respond to these

challenges to avoid global financial turmoil. Despite the world’s two largest

economies, the United States and China, resolving a drawn-out trade war in

relation to disagreements over tariffs at the tail-end of 2019, the possibility

of a global trade war still looms large as the world enters the new decade.

International financial tensions are particularly high due to an increasing

number of countries threatening to impose Digital Service Taxes (DSTs) on

Multinational Enterprises that provide services to their markets without

having a physical presence in that given market.

Historically, multinational companies were subjected to the tax laws of the

countries in which they had a physical presence.

1

Today, because of the

proliferation of the digital economy, companies often have a significant

presence—by connecting with customers and conducting general business

via online forums—in various markets without having any physical

infrastructure in that jurisdiction. As a result, multinational enterprises are

able to conduct business operations in virtually every global market through

online channels, while avoiding local taxes because they lack a physical

presence in the jurisdiction.

Countries are growing frustrated by their inability to tax the revenue that

they deem to be generated as a result of intangible business operations in

their markets under the existing tax structure and are considering drastic

measures, like DSTs, to ensure they receive their fair-share of the tax base.

2

The growing threat of countries taking unilateral action has led to the

* Nolan McCarthy is a third-year law student at Southern Methodist University Dedman

School of Law. Nolan grew up in Newport Beach, California before moving to Austin to attend

the University of Texas where he majored in economics and government. Nolan has been a

member of the International Law Review for two years and currently serves as an Associate

Managing Editor.

1. See Itai Grinberg, The Looming Tax War: A Decaying International Tax Regime Threatens the

Globale Economy,

F

OREIGN

A

FFS

.

(Jan. 17, 2020), https://www.foreignaffairs.com/articles/

united-states/2020-01-17/looming-tax-war.

2. See Elke Asen, What European OECD Countries Are Doing About Digital Services Taxes,

T

AX

F

OUND

.

(June 22, 2020), https://taxfoundation.org/digital-tax-europe-2020/.

THE INTERNATIONAL LAWYER

A TRIANNUAL PUBLICATION OF THE ABA/SECTION OF INTERNATIONAL LAW

PUBLISHED IN COOPERATION WITH

SMU DEDMAN SCHOOL OF LAW

454 THE INTERNATIONAL LAWYER [VOL. 53, NO. 3

formation of a 135-member coalition of nations from the OECD/G20 and

other countries, known as the Inclusive Framework on Base Erosion and

Profit Shifting (BEPS), to work together to devise a global understanding to

address the challenges to international taxation brought about by the

digitalization of the economy.

3

The Inclusive Framework was established at

the beginning of 2013 to develop a consensus solution to modernize the

international tax structure.

4

Nevertheless, after the most recent round of

deliberations to advance the efforts to reform the international tax structure,

the OECD head of tax policy—Pascal Saint-Amans—told reporters, “what is

at stake is a massive trade war.”

5

This underscores the importance of

formulating a solution to the problem as soon as possible.

The position this comment takes is that the current approach to resolving

the international tax crisis needs to be systematically overhauled with a

binding, top-down approach, driven by an impartial, international dispute

settlement body, potentially modeled after the World Trade Organization’s

Dispute Settlement Understanding. The need for such a monumental

modification to the current tax structure is necessitated by the complexity of

the details to be negotiated and the varying political interests of the

hundreds of individual countries implicated by the negotiations, rendering

compromise and consensus unrealistic under the Inclusive Framework’s

current deliberation process.

This comment will build up to its conclusion by setting forth the

historical development of the international tax structure and how the

development of the increasingly international and digitally-driven economy

has led to the need for systematic and multilateral reform. Second, it will

discuss how various countries threatened to respond to the implications

associated with digitalization. Next, the paper addresses the development of

the proposal set forth by the OECD/G20 Inclusive Framework on January

30, 2020. Finally, the paper will address the shortcomings associated with

the latest proposal, discuss the likelihood of a consensus being reached by

the international community, and suggest that fundamental change is

required to avert a “massive trade war.”

II. Development Of The International Tax Structure

Since the 1920’s, the international community has understood that the

growth of the international economy would be hindered in the absence of

clear international tax rules.

6

For example, the League of Nations

recognized the possibility of double taxation—the same corporate income

3. See Action Plan on Base Erosion and Profit Shifting,

O

RG

.

FOR

E

CON

. C

O

-

OPERATION

&

D

EV

. [OECD]

, 14 (2013), http://dx.doi.org/10.1787/9789264202719-en.

4. See id. at 13.

5. Leigh Thomas, Global Tax Rules Set for Overhaul as States Seek to Avoid New Trade War,

R

EUTERS

(Jan. 31, 2020), https://www.reuters.com/article/us-oecd-tax/global-tax-rules-set-for-

overhaul-as-states-seek-to-avoid-new-trade-war-idUSKBN1ZU10F.

6. Action Plan on Base Erosion and Profit Shifting, supra note 3, at 7.

THE INTERNATIONAL LAWYER

A TRIANNUAL PUBLICATION OF THE ABA/SECTION OF INTERNATIONAL LAW

PUBLISHED IN COOPERATION WITH

SMU DEDMAN SCHOOL OF LAW