Amount A v. Digital Services Taxes : Nana Ama Sarfo

In this episode, Attorney Nana Ama Sarfo shares her expert insights on why there are still no easy answers for developing countries when it comes to choosing between Amount A of Pillar One and DSTs. She also explains the problems associated with DSTs and whether it is possible that countries could potentially design DSTs in a manner that circumvents the definition of DSTs in the MLC, thereby implementing both Amount A and DSTs?

Nana also shares how, like many other professionals, she fell into a career in tax law, the challenges she has overcome to get where she is today, and the sources of inspiration that have guided her remarkable career.

Transcript

Hi everyone, thank you for joining us for the fourth episode of Cross Border Tax Radio. I am Ankur and in this episode we have a very special guest who will be sharing her thoughts on whether it's an easy choice for countries to decide between Amount A of Pillar 1 and digital services taxes. Although in the past the media and academia have thoroughly discussed the trade off between Amount A and DSTs, but lately this discussion has gained fresh momentum for several reasons. One reason is that the OECD's self imposed extended deadline of June 30, 2024 to reach a consensus on the Amount A multilateral convention has passed. And while the OECD secretary general's July 2024 tax report to the G20 indicated that members of the BEPS inclusive framework have secured near full consensus on the Amount A MLC, many tax and policy experts still believe that we are still quite far from seeing Amount A become a reality anytime soon. And another reason is that new DSTs are now being implemented. Just this past June, Canada introduced a new DST and it is expected that more countries might follow suit. Our special guest sharing her thoughts on this very interesting topic is Nana Ama Sarfo, and I'm absolutely honored to introduce her. Miss Sarfo is a contributing editor for Tax Notes, where she specializes in crafting technical articles and long form features for Tax Notes international on a wide array of tax topics. They include tax transparency, the digital economy, the OECD and UN, Tax and ESG and tax policy in emerging markets and Europe. Nana has profiled some of the topmost names in international tax, including Grace Perez Navarro, Michael Leonard, Margaret Hodge, and former polish deputy finance minister Pawel Gruza. She's a frequent moderator and panelist for international and academic organizations, including the OECD Global Forum on Transparency and Exchange of information for tax purposes, the Tax Executives Institute, the CUNY Baruch Zicklin School of Business and Public Services International. She is also presented before the US IRS Nana has been interviewed by several media outlets, appearing on air on BBC News and quoted in the Financial Post and Global Finance magazine. Her work has been cited in academic articles and has been cited by the UK parliament. Before joining tax analysts in 2017, Nana was a managing editor with Thomson Reuters in New York. A licensed attorney, she has a BA in history, English writing and Afrikaana studies from the University of Pittsburgh and a JD from Columbia Law School. Welcome to the show Nana.

Ankur thank you so much. It's truly a delight to join you today.

It's a privilege to have you with us. Now, since the main focus of this episode is the trade off between Amount A and the DSTs. It might be helpful to identify the legal basis of this trade off. So the legal basis comes from Articles 38 and 39 of the amount A MLC according to article 38, the existing DSTs that are listed in annex A of the MLC must be withdrawn when Amount A starts applying. And as per article 39, Amount A allocations will be denied to countries that implement DSTs as defined in the MLC. Before we hear Nana's thoughts on whether it's an easy choice for developing countries to decide between Amount A and DSTs, let's take a step back and understand from her the key problems that are associated with tsts. Nana, I have a couple of initial questions. Could you please tell us why DSTs are considered problematic in international tax law and what led the US trade representative to initially levy additional tariffs on goods imported from countries that had implemented DSTs?

Ankur these are really great questions. I will start off by saying that over the past several years there's been growing attention on how much corporate tax multinationals are paying in the countries where they do business. Now, the current international tax system is over 100 years old, and it's based on the idea that businesses pay taxes where they have a physical presence. Now, you and I know that that rule doesn't work so well in our digitalized economy because digital companies don't fit neatly into the current system. That's because they operate in many places where they are not physically present. So governments that want to tax these digital companies have been brainstorming about ways in which they can do that. Now, within international tax, there are several pre existing instruments that determine just how this cross border activity should be taxed. And well before digital companies even existed, governments debated how they should tax cross border revenue when more than one country can lay a claim to it. So as a result, we now have thousands of bilateral tax treaties, and these are treaties that are negotiated between two partner countries and they lay out which jurisdiction has the right to tax certain economic activities and what rate. And these bilateral treaties help prevent double taxation. Now, the problem for governments that want to tax digital activity happening within their borders is that that activity doesn't fall under these pre existing tax treaties due to the physical presence requirement. So digital services taxes have not been created or negotiated within these bilateral tax treaties. Instead, they've been unilaterally decided by national legislatures, and they're viewed as problematic because they're implemented without any bilateral negotiations, they're implemented outside of this treaty structure. So in some respects, it has felt like countries implementing DSTs have said we're no longer going to follow the rules. Another problem is that these taxes are levied on revenue rather than profit. So the actual tax burden on companies can be quite significant. So overall, the creation of digital services taxes has been especially problematic for the United States. And that's because it's home to the majority of large digital services companies in the world. So from a us perspective, it's really felt like an onslaught of foreign governments has been trying to target some of the country's most successful companies by creating these DSTs. So in the wake of these digital services taxes, the us government was exploring how it could respond to these measures. And it turns out that it had a tool in trade law. So there's a section of the Trade act, that's section 301, that allows the government to investigate and impose trade sanctions on governments for violations that do any of three things. So first, they must deny us rights under a trade agreement, or secondly, they must constitute an unjustifiable action that burdens or restricts us commerce. Or third, the government can impose sanctions on an unreasonable or discriminatory action that, again, burdens or restricts us commerce. So in June 2020, the us trade representative announced that it would investigate DSTs that had been implemented or proposed, and it targeted DSTs issued by ten or contemplated by ten us trading partners. And in the course of that investigation, the USTR determines that six of those DSTs, and Austria and India and Italy, Spain, Turkey, and also the United Kingdom, were discriminatory. So in response, the government said that it would impose 25% tariffs, which is really steep, on more than $2 billion worth of imports from those six countries. But immediately after the USTR announced this, it said it would suspend those tariffs and then it later terminated those actions. And that's because the countries agreed that they would remove their DSTs once pillar one, as you previously mentioned, would become enacted. Now, in the meantime, the USTR has actually gone on to request dispute settlement consultations with Canada, as you mentioned, just enacted a digital services tax. So the USTR is still very active in this space, and we should expect that the USTR will continue to be, if countries continue to implement more DSTs. So that's just a very short explanation of what is a pretty complicated landscape.

Thank you for your answer, Nana. Despite the problems surrounding DSTs that you just took us through, as time keeps ticking on the amount, a consensus DSTs are likely to proliferate. Since the general justification for the implementation is that MNC's should pay a fair share of taxes wherever they operate. But the question is whether it's an easy choice for developing nations to wait for the Amount A consensus, or to implement DSTs. Nana, in your very insightful article that was published on tax notes in July this year, you provide an in depth analysis of why there are still no easy answers for developing countries when choosing between DSTs and amount. Aethereze, could you please share with us some of the reasons that make this choice difficult?

Yes, absolutely. And before I begin, I have to note that we, meaning the international tax community, we are now aware of the tough choices that developing countries have to make. And that's thanks to organizations like the Celt center, the African Union, the African Tax Administration Forum, and also a company called Mira Economic Consulting. So the multilateral organizations that I mentioned, the Seltz Center, Au ATAF and others, they commissioned NiRa to evaluate the revenue outcomes for developing countries under digital services taxes and also under Amount A. So my article, which you mentioned, discussed that report, and it's really expanded the conversation, I would say. So the difficulties in choosing between a DST or a mount a really are based on design choices. And there are several design choices that developing countries have to choose from. So the first question is, what even is a digital services company that is subject to a DST? And the report makes a distinction between two kinds of digital companies. So there are pure automated digital services companies, and then there are hybrid automated digital services companies. Now, the pure companies are actually defined in article twelve B of the United Nations Model Double Taxation Convention. And it says those services are any service provided on the Internet or another electronic network. And in either case, they must require minimal human involvement from the service provider. And then the convention goes on to list specific services that are often considered to be pure automatic digital services. And there are no surprises there. They include functions like online search engines, social media platforms, online gaming services, and then also cloud computing services. Now, hybrid automated digital services companies provide some products and services in both an automated and digital manner. So for the study, which I cited, the researchers defined hybrid companies as businesses that are engaged in business to business b. Two b services companies that sell software in connection with hardware products or services, e commerce companies that also happen to have traditional retail activities, and finance companies that provide payment services, and companies in that flavor. So that's the first issue. Then the second question is, what even should the rate be? Now, we know that around the world, many digital services taxes hover around a 3% tax rate. And the study looked at DST results under a 3% tax rate, but it also looked at a 5% tax rate. And then the third question is what revenue threshold should apply? That's really up to the whims of individual governments. But the report wound up focusing on companies that reported at least €750 million in sales and also positive pre tax income. So, as you can see, there are many variables to play around with when craft, when crafting a DST. Now, there isn't a similar amount of flexibility in applying Amount A. And we know from the OECD's draft, MLC, that Amount A applies to multinationals with at least €20 billion in global turnover and profitability of at least 10%. And under Amount A. A quarter of those excess profits that exceed the 10% threshold are reallocated to countries that earn a certain amount of revenue from those companies. And we know that there are roughly 100 companies that fall in scope of Amount A that's been released by the OECD. And it was also calculated under this study that Nira conducted. So, within the study, Nira found that narrowly crafted DSTs that only apply to pure ads companies at a 3% rate likely won't generate more revenue than Amount A. DSTs that maintain the 3% rate but apply more expansively, and they apply to hybrid ads companies as well, will likely generate about the same amount of revenue as Amount A. And then the research has also found that a 5% rate is going to be Amount A every time, whether it applies to pure companies or hybrid. So you might think, upon hearing that the solution is very simple, that a 5% DSt should apply. That's not the solution that the researchers advocate for. They say that an expansive 3% DST that applies to pure and hybrid companies may be better than Amount A because it's administratively simpler to apply. Even though they say that there's also the very real risk that countries implementing DSTs run the risk of trade sanctions, they run the risk of essentially wasting their time or expense in participating in the pillar one negotiations and ultimately not following through with enacting Amount A. But then, on the other hand, pillar one survival is very much in question. As you mentioned, the MLC deadline has come and gone. There are questions about whether or not the US will ratify this agreement. And if countries want revenue from these digital services companies, they may decide to go it along alone. They may feel as though it's a better bet to just implement DSTs and deal with the repercussions. Now, as for applying a 5% rate, I mentioned before that many DSTs hover around a 3% rate. So countries wanting to push that rate higher would really have to determine whether that decision could alienate businesses and other issues. So, in writing this article, I found that at least seven african countries have digital tax measures, and they are Kenya, Nigeria, Sierra Leone, Tanzania, Tunisia, Uganda and Zimbabwe. Now, of the group, Zimbabwe, Uganda and Nigeria apply rates of at least 5%. So that means for out of four of the seven countries, it's unclear as to whether a mount A or a DST would be better. And that answer would really depend on how each country decides to craft DST. I also found that the numbers are a bit of a toss up in Latin America. So, for example, Uruguay imposes a 12% tax on the income of non resident digital services providers, which is fairly high. Colombia, on the other hand, imposes a 3% income tax rate. And then amongst the south centers, asian members. India's equalization levy imposes a 6% rate on the gross revenues of non resident companies online advertising services, but it also applies a 2% rate on the gross revenues of non resident e commerce operators. Malaysia actually increased its DST rate, which is a trend that we don't see too often, so it raised it from 6% to 8%. And then Pakistan assesses withholding taxes on certain digital activity at a 5% rate. So the numbers really are all over the place.

Thank you, Nana, for your answer. Now, as per Article 39 of the MLC Amount A allocations would be denied to any country that implements a DST or a similar measure. So at first glance, it seems that DSTs and Amount A cannot coexist. Could you please tell us if it's possible that even with a consensus on amount a, countries that implement Amount A could also implement DSTs anyway, is there room for countries to navigate around the DST definition in the MLC?

That is a really great question, and I have to say, based off of the draft MLC that has been released, there absolutely is room for countries to work around this DST definition, and for multiple reasons, which I've actually written about in the past. So, as you mentioned, the definition is found in Article 39 of the draft MLC. And under Article 39, section two, a digital services tax or a relevant similar measure must meet all prongs of a three part test. So the first prong is that the tax must be applied primarily based on the location of a company's customers or users or other similar market based criteria. Then the second prong of the test has two parts, and either of these parts can be met. So the first part is that the tax either explicitly applies to non resident businesses or to businesses that are primarily owned by foreigners. The second part is that the tax must apply revenue thresholds that essentially exempt domestic companies from the measure. So the revenue thresholds are extremely high, essentially so high that they mostly target us companies, we'll say. And this must mean that the tax in practice applies exclusively or almost exclusively to non resident or to foreign owned businesses, and in practice insulates domestic businesses from the DST. Now, determining whether domestic businesses are insulated is a facts and circumstances inquiry. That's what the OECD has said, and they mentioned within the draft MLC that the mere fact that there are few or no domestic enterprises in the relevant market is not dispositive of a discriminatory measure. Now, the third prong is that the tax must fall outside the scope of tax treaties. So these are a lot of conditions that must be met within this three part test. And some stakeholders, particularly in the United States, have said that the OECD should essentially loosen this three pronged test and allow a measure to be treated as a DST if it satisfies just one of the three requirements, instead of needing to fulfill all three. I will also say that we've seen feedback, particularly from us companies who are concerned about the requirement that a DST must apply exclusively or almost exclusively to foreign companies, first of all, and that it must also insulate domestic businesses because the OECD had originally said that only one of those conditions must be met, not both. So, based off of this current draft that we have, some stakeholders say that this test is too strict, and they think that the exclusively or almost exclusively language is too strict. So I know, for example, that the information Technology Industry Council says that the test should be based on whether a measure primarily affects non resident taxpayers instead of exclusively or almost exclusively. So, in summation, the definition is certainly not airtight, at least not from a us perspective. And it seems as though there's plenty of room for countries to implement DSTs while still complying with the amount A MLC. 

Thank you for your very insightful answer, Nana. I'll now move on to the next section of this episode, which has questions focusing on your remarkable career. Tax law can be quite a unique career path, with many professionals either planning for it early on or discovering it along the way. Was a career in tax law always your goal, or did you, like many other professionals, find your way into it unexpectedly? And could you please also share some of the challenges that you faced to get where you are today?

Well, Ankur, I am like many of the professionals with whom you have spoken with, and I really, truly fell into tax, into international tax. So I took a us federal income tax course in law school. But working in tax law absolutely was not my goal, or I would even say not my interest. I took the class, I got my, and then I didn't really think about tax law in any sort of meaningful way after that. But I wound up falling into it when I was working for law 360. And management at the time decided that they wanted to create a tax vertical, and they asked if I would write about tax and create some tax analyses and help launch a product that they were planning. And I thought, well, you know, I might as well give it a try, because I was writing about many different topics at law 360, and I had this baseline knowledge of us federal income tax, and so I thought, why not take on this new adventure? So that's essentially how my tax career started. As for the challenges, I have to thank you for that question, because I think it's very important to be transparent about the challenges, uh, that we face in our careers. So, for me, I would say that surmounting imposter syndrome has definitely been a challenge. At tax notes, I walked into a role where some of my colleagues had many more years of experience than I did, and it really took some time for me to feel comfortable and at home in the role. Um, but outside of that, just keeping abreast of tax developments around the world and then writing about them in an interesting and compelling way is always very challenging. And I would also say that building trust amongst your readers is another challenge. And that's really built article by article. That's a challenge that really takes time to resolve.

Thank you so much, Nana, for sharing that. Your career achievements are truly inspirational. We saw that when I was introducing you at the beginning of this podcast. And in every great career, there are a guiding lights. You know, people whose work or character inspires us along the way. Could you please share whose work has inspired you, whether from the field of tax law or another field?

Well, thank you very much. It's very, very kind of you to say that. Broadly speaking, I would say that I have derived a lot of inspiration from fellow lawyers who decided to pursue editorial careers within my law school. I would say that there's a small number of alums who have worked their way into the media, so I always knew that that could be a pathway for me, and I'm grateful for their example. I've also been inspired by Dalia Lithwick. She's a lawyer and a legal writer for Slate. Also, Amy Howe, who was a writer for ScOTUS blog within the tax world. I think Kelly Phillip's herb is very inspiring in this way. And I also have to name my colleague at tax notes, Stephanie Song. She is another great inspiration for me. She handles the international tax beat with so much agility and grace, and she's very, very generous in her knowledge, which you don't always find in a competitive industry like ours. I would say generally I derive a lot of inspiration from people who are very giving of their time and their knowledge and also are unafraid to share lessons that they've learned along the way. Virginia Latour Yeager, who is a well known international tax attorney, she is one of those people for me, and she's given me so much valuable advice over the years. And then I would also say that I've been inspired by people who write in very vivid and captivating ways, people who know how to make the technical interesting and tell a good story. So I love reading features in New York magazine and the Atlantic and the Financial Times to further expose myself to writing that meets those parameters.

Thank you for sharing that, Nana. It's wonderful to see someone who not only recognizes but also values the impact of their motivators. I have learned so much from listening to you in this episode, and I can't thank you enough for you to accept my invitation and sharing your perspective with us. It's been a pleasure having you with us today.

Oh, thank you. The pleasure is all mine. Really appreciate your time. And to our Listeners, I hope you found this episode helpful and insightful. Thank you again for tuning in. Until next time, this is Ankur signing off from cross border tax radio.