Hailed by some as the best answer for countries seeking to capitalize on multinational businesses’ digital operations, DSTs likely do not meet WTO member states’ obligations under today’s international trade framework. 

The world is becoming increasingly digitalized, and as companies have moved more of their core services online, a massive digital economy has grown. But while this new, burgeoning economy has burst onto the scene, some countries are finding themselves unable to capitalize on the digital economy in which their own citizens are participating. 

This is because, under most tax systems, multinational digital companies have traditionally paid corporate tax only to the countries in which they are based. Tax systems around the world have long relied on a company’s “permanent establishment” within a given country’s borders — aka, a company’s physical presence. Similar to the popular phrase “no body, no crime,” the general rule in tax (at least until recent years) has largely been “no physical presence, no taxation.” 

In today’s digital economy, though, only about 50% of massive digital companies’ subsidiaries have been established in foreign countries, and it has become common practice for these companies not to establish a physical presence in most of the countries in which they operate. While Facebook generates revenue from global use, therefore, it is not putting money back into each of the countries in which it digitally conducts its business.

Enter: the digital service tax (DST). A digital services tax is, in its most basic form, a tax on the gross revenue a digital company derives from a specific set of digital services, based on the number of digital users and digital revenue raised within a country. It sounds simple enough: a company collecting revenue from a country should be paying taxes to the country from which it is benefitting.^[1]

More and more countries have begun adopting DSTs in an effort to take a cut of the massive profits that global digital service providers — about two-thirds of which are US-based, like Facebook and Amazon — have been making. In response to the surge in DSTs, the Organization for Economic Cooperation and Development (OECD) hosted negotiations with 130 countries in 2020 to discuss adapting the current international tax system. But the OECD has yet to announce any agreement, and as Europe turns to DSTs with relish, the question remains: is this sort of approach to taxation allowable under international trade law?

Arguably, it isn’t. 

Key Legal Instruments in International Trade 

To determine if a proposed DST is allowable under current international law, WTO member states may look to two main legal instruments: the WTO Moratorium on Customs Duties on Electronic Transmission (or simply, “the Moratorium”), and the WTO General Agreement on Tax and Services (GATS).^[2] 

But wielding these two legal instruments to settle the question of the legality of DSTs is akin to slicing a loaf of bread with a cudgel and a hammer. This is largely because these instruments were adopted between 1995-1998, long before the rise of the internet and the birth of monolithic digital services companies. They were simply not structured to provide insight into the internet-driven problems we face today. Nonetheless, with most countries as yet unwilling to agree on a new legal framework, these are the two instruments we’re left to use to settle the DST issue. 

Applicability of the Moratorium

Under the Moratorium, WTO members agreed not to impose customs duties on electronic transmissions. There are two questions to consider when trying to use the Moratorium to determine the permissibility of DSTs. The first is, as “electronic transmissions” is not explicitly defined in the Moratorium, what does the term mean, and should it apply to all services provided by digital companies? And the second is: should a DST, which is not a “customs duty” in name but arguably operates as one in a de facto sense, fall under the scope of the Moratorium?

If the answers to both questions above are “yes,” then any DST — whether inherently discriminatory or not — would be disallowed. But the general consensus appears to be that the Moratorium should apply only to formal customs duties, and none of the various proposed DSTs have been formally introduced as customs duties; the French DST, for example, has been promoted instead as an internal tax. Though some pockets of argument persist, it doesn’t seem as though the Moratorium is going to be the primary device by which DSTs will be challenged going forward. 

Analyzing DSTs through the GATS

With the Moratorium unlikely to apply, every WTO country should now be looking to the GATS to ensure their DST is allowable under its more rigid framework. A challenge under GATS is arguably the strongest challenge against most proposed DSTs. 

First, a quick primer on the GATS, which provides reliable standards for trade in services between countries. There are two key GATS provisions that might be violated by a DST: first is the “national treatment” obligation, and the second is the “most favored nation” requirement. The former forbids a state from granting more favorable treatment to domestic providers of “like” services than to their international counterparts;^[3] the latter requires a member state to not discriminate between the services and service suppliers of one foreign country in favor of those from another. Many DSTs arguably violate one or both of these obligations made by the member states imposing them.

A major issue with most DSTs is that the way they have been structured is of a “de facto discriminatory character” against services from a specific country — namely, the United States. And this sort of discrimination in taxation is explicitly disallowed under the GATS.

To illustrate with an example, take a look at the UK’s proposed DST, which will only be levied against digital companies whose UK sales exceed $25 million and whose global sales exceed $500 million. For any digital company that meets this threshold, a tax of 2% will be applied on their UK revenue. But there are only a handful of companies that meet that threshold, and none of them appear to be homegrown in the UK or EU — nearly all of them are based in the US. And the UK isn’t alone: almost all DSTs proposed across Europe, and many elsewhere in the world, have incorporated thresholds that lead to discrimination against US-based digital giants. 

If the effect of a DST is that it primarily targets US companies, it arguably violates both of the core provisions of the GATS. First, it flies against a country’s “national treatment” obligation because, in practice, it results in the member state favoring homegrown services over those services provided by competing companies from a foreign nation. And so too does it likely violate a country’s most favored nation obligation, because it would see one foreign country — the United States — more heavily impacted than other foreign countries offering similar services. 

Going Forward

From a philosophical perspective, the debate is one about massive digital companies profiting from populations whose governments will never see any returns.

But the question under GATS is not whether any trade discrimination is “fair” – the question is whether it exists at all. And it cannot be denied that the United States, which is home to more than half of the world’s largest and most profitable digital services companies, will face de facto discrimination from most DSTs proposed to date.  

While many DSTs in their current form are likely to violate the GATS, however, this may not be the end of the road for all digital services taxes. Under the WTO, there are various exceptions that a country could latch onto to show why its specific DST should be allowed. These exceptions, which are found in GATS Subsections C through D (and have largely never before been litigated), may be several countries’ sole means of combating a challenge to their DSTs, should the United States choose to bring the problem before the WTO. 

It may be that digital services companies are reaping huge benefits from their global operations without providing much — if anything — in return to most countries in which they operate. But under GATS, this perceived unfairness doesn’t help make DSTs more viable. It is likely that, going forward, WTO member states will need to pore over the GATS exceptions and bring their strongest arguments to the table to see their DSTs approved. 

Keep an eye out — it should be a very interesting battle to watch unfold in the coming years. 

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^[1]In the EU, proposed DSTs are uniformly targeted against digital companies whose revenues are derived in great part from the use and sale of user data, as the debate about how companies can and should harvest user data rages on. See our Oct 2020 GJIL Blog Post, “Banning TikTok and Regulating Facebook: A Need for Comprehensive Global Standards for Protection of Online User Data Privacy,” for more information on the data privacy debate.

^[2] It should be noted that individual countries must also review whether their DSTs are in compliance with bilateral and plurilateral free trade agreements, but for the purposes of this analysis, only the two trade agreements that apply to all WTO members equally will be discussed.

^[3] Note that, for national treatment to apply to any given DST, the WTO member state in question must have undertaken the national treatment obligation for the service sectors covered by the DST.

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Robin M. Spiess is a 2L JD student at Georgetown University Law Center. After graduating from Princeton University in June 2017 with a major in Public Policy and International Affairs and minors in Moral Philosophy and Creative Writing, she spent two years working as an investigative business journalist in Cambodia. At Georgetown Law, Robin serves on the Alternative Dispute Resolution Division of Barristers’ Council and is currently competing in the Willem C. Vis International Commercial Arbitration Competition. She has also worked as a Teaching Fellow and Research Assistant for Professors Frances DeLaurentis and Ronald Coleman. Since mid-2020, Robin has been studying virtually from Cambodia, where she is externing at regional law firm Tilleke & Gibbins.